Five percent of Americans own cryptocurrencies, the money that is not money, but is an asset that is easy to hide and hard to value. It is the perfect place for a spouse who is “divorce planning” to conceal assets from the other. The first ripples of crypto litigation have reached South Florida, and when it hits divorce courts, it could wreak havoc.
The white paper for Bitcoin was published 11 years ago, but the courts are still grappling with just the concept of cryptocurrency and the blockchain technology upon which it relies. In January 2019, the Florida Third District Court of Appeal released what is thought to be the first appellate decision in the country regarding cryptocurrencies. There are no appellate cases addressing cryptocurrencies in divorce cases, even though such guidance is needed for an asset that shrouded in anonymity and almost impossible to value with precision.
A preview of this future is playing out in a federal courtroom in Miami-Dade County in the case of The Estate of Kleiman v. Wright, which would be a run-of-the-mill partnership dispute if it did not involve U.S. $11 billion in bitcoin. The dissolution of a business partnership and the dissolution of marriages are opposite sides of the same coin, so many of the legal concepts in Kleiman also apply to divorce cases. Dave Kleiman’s estate alleges that he and Craig Wright had a partnership; that the partnership held 1.1 million bitcoin when it ended upon the death of Kleiman; that the value of the bitcoin can be expressed in U.S. dollars; and that Kleiman’s estate is entitled to half the bitcoin.
Florida Statutes Section 61.075 requires a court to presume that jointly owned, marital assets should be divided equally between the parties. Also similar to partnership dissolution cases, a party must prove the existence and value of such assets. Section 61.075(3)(b)-(c) requires:
… any distribution of marital assets or marital liabilities shall be supported by factual findings in the judgment or order based on competent substantial evidence … The distribution of all marital assets and marital liabilities … shall include specific written findings of fact as to the following: Identification of marital assets, including the individual valuation of significant assets, and designation of which spouse shall be entitled to each asset;
Bitcoin is the oldest and most common crypto. It sells for about $9,200 a coin, occupies about 65% of the market and has a cap market value of about $158 billion. It is just one of 2,300 cryptocurrencies that are largely unregulated and extremely volatile. For example, the crypto market lost about 80% of its value in just a few weeks in January 2018. Accountants have to make an educated guess when determining the tax owed on crypto assets because they are so difficult to value. This could become a potential nightmare for a court trying to fashion an equitable distribution scheme in a divorce.
In the Kleiman case, the estate sought discovery of bitcoin assets that existed as of Dec. 31, 2013, the day Kleiman died. During discovery, Wright dropped a bombshell; he testified he was unable to comply with the discovery request because the bitcoin was in an encrypted file to which he had no access. The file could only be accessed by the use of an electronic “private key” that had been sliced into sections, some of which Kleiman had in his possession when he died. As a result, the bitcoin cannot be recovered and is effectively lost forever.
The court found that Wright was lying when he testified that there was an encrypted file that could not be accessed. The court held that it had been invented by Wright when he belatedly realized the initial acquisition of bitcoin could be traced. As a sanction, the court made factual findings that there was a partnership between the parties; that the partnership owned the 1.1 million bitcoin when Kleiman died; and that the estate retained “an ownership interest in the partnership’s bitcoin, and any assets traceable to them.”
Of note is what the court did not determine—“how much bitcoin, if any, Dr. Craig Wright controls today.”
The parties tentatively settled, but in early November, Wright backed out of the deal, saying he didn’t have the bitcoin worth approximately $5 billion that he would be required to pay the estate. The case goes to trial in early 2020.
All cryptos have two components: the cryptocurrency itself, often called “coins” or “tokens;” and the blockchain, a public, distributed ledger that is designed for both security and anonymity, and that makes crypto possible.
Cryptocurrencies are not currencies in the traditional sense, but are snippets of electronic code that can be described as an electronic IOU. Financial transactions take place directly between the two parties to the transaction, or peer-to-peer. There is no trusted third party, like the U.S. Federal Reserve, in crypto transactions.
Crypto transactions are recorded on a blockchain, such as the bitcoin Blockchain. Each transaction is recorded and sealed in an electronic “block.” Each block is electronically connected to another block so that it forms a never-ending chain. The transactions are secure because in order to access and alter a transaction inside a block, it is first necessary to alter all of the blocks in front of it to get to the block in question.
Each crypto user has an electronic wallet, as well as a “public key” and a “private key.” The unique public key ensures secure transactions, but does not reveal the owner. The identity of the crypto owner is masked by the electronic wallet, opened only using the private key, which can be thought of as an electronic version of a secret code, known only to the owner.
The “public key” was designed for security and the “private key” for anonymity. It takes law enforcement years to pierce the veil of anonymity to identify bitcoin users in illegal transactions. In a divorce case it is often most practical to start with a conventional record—such as a bank statement—that shows the purchase of crypto. From there, a trained investigator might be able to trace transactions from block to block. Savvy spouses, of course, can find ways to make it more difficult, for example, by paying cash for crypto and making personal contact with the seller. Tracing crypto is a job best left to the professionals.
What will cause problems in a divorce is that while it may be called currency, crypto is not real money. It was defined by the Third District in State v. Espinosa as a “payment instrument” that has monetary value as it is “a medium of exchange, whether or not redeemable in currency.” The IRS, more simply, defines it as “property” subject to capital gains tax.
Whatever it is called, Florida Statutes Section 61.075 requires that it not just be identified (the tracing component), but that it be valued, often on multiple days (such as the date of marriage or the date a divorce action is filed). The IRS requires that the value of crypto be expressed in U.S. dollars and divorce courts will undoubtedly follow suit. However, without a central bank involved, there is no exchange rate for bitcoin. Since the transactions are peer-to-peer, the value of a bitcoin is the amount someone is willing to pay in an arms-length transaction. Values are often determined by crypto exchanges, websites that match up those who want to sell crypto with those who want to buy it. Values, however, are not consistent across exchanges. One CPA described her valuation method as choosing a reputable crypto exchange, consistently using its exchange rate for all crypto values and then hoping the IRS agrees with that approach.
Existing statutes and regulations provide little help in resolving crypto issues, as the laws often were written before crypto was even invented. The IRS is one of the few agencies that has published guidelines in 2014 and 2019, although they are still vague and of limited use to a family court judge. Until the law catches up with the technology, a crypto expert will be a necessary part of any legal team to explain what crypto is, how it is valued, and how it is traced.
Robert F. Kohlman is a shareholder with Buchanan Ingersoll & Rooney in Miami. He co-chairs the firm’s matrimonial and family law practice group.