Blockchain technology has opened up huge entrepreneurial opportunities that a great number of industries have been quick to exploit. The trust industry, on the other hand, is naturally (and with good reason) circumspect about all things blockchain. But perceptions within the industry are rapidly changing.
The trust industry, and the private client industry generally, have always lagged behind the corporate and funds industry in adoption of cryptoassets. Now trustees and trust companies, or at least the majority of them, have accepted the inevitability of cryptoassets and that they will be asked by settlors or investment advisors to hold such assets.
Trustees are therefore now grappling, in some cases urgently, with the challenges of holding cryptoassets in trust. The three core challenges that every trustee is considering are custody, investment risk and compliance.
Previously there was a concern that cryptoassets may not constitute ‘property’. A number of erudite commentators suggested that cryptoassets, in their base form of code, represented nothing more than information. This presented a problem as case law had established that pure information cannot be property. If cryptoassets are not property, then trustees cannot exercise proprietary rights that they normally take for granted. However, following the Singapore Court of Appeal case of Quoine Pte Ltd v B2C2 Ltd , and subsequent decisions in England, it is now accepted that cryptoassets do constitute property. This means that trustees can now seriously consider cryptoassets as an asset class for inclusion in a trust.
Another preliminary issue is insurance. Trustees should engage with their insurers on whether they can hold cryptoassets within structures and deal more generally with cryptoassets.
Why Indirect (Fund) Investment May Not Cut It
In speaking with many trust companies about cryptoassets, sometimes their first instinct is to state that they will only hold cryptoassets indirectly (via a fund). Trustees could adopt such a policy, but it is likely to provide a limited offering for clients. Often settlors are zealous about particular cryptoassets, and are not attracted ideologically to fund investment. They may also object to the additional cost of fund investment, when a direct holding of cryptoassets achieves the same investment outcome. Some settlors may also ask the trustees to hold non-fungible tokens (NFTs), which due to their unique characteristics and personal connection to the settlor, cannot be replicated through fund investment. As such, in the author’s view, trustees need broader solutions than mere fund investment.
Custody Of Cryptoassets
The first duty of trustees is to place trust property under their control. In the case of cryptoassets, this means taking control of the private keys. Cryptoassets are built on the technology of public key cryptography, whereby a private key is used to access a corresponding public key, which allows the user to transact and deal with a cryptoasset.
Accordingly, the trustees must take possession of the private keys (or seed phrases if that is how the private keys are represented). However, in practice and almost without exception, trustees will delegate the responsibility of custodianship. It is generally accepted amongst trust companies and trust practitioners that trustees should not take custody of cryptoassets, unless there are critically urgent or compelling reasons for them to do so. Instances of cryptoassets becoming inaccessible are notorious, usually through loss or destruction of the private keys.
When establishing trusts, settlors may ask to retain title themselves. All other things being equal, it may be possible to delegate custody to the settlor. However, whether under English law or the law of some offshore jurisdictions, there are often regulatory restrictions on who can act as a custodian. Legal advice should therefore be taken on the extent to which the settlor can act as custodian, and on whether any statutory limitations on custodian appointments can be modified. There will also be risk-based considerations on whether an individual such as the settlor should act as custodian.
In practice, the default position will be to partner with a regulated custodian. Traditional banks have generally not (yet) entered the cryptoassets custody market, so the gap has been filled by a number of new companies dedicated to the crypto space. Some custody providers are well known cryptoasset exchanges who have extended their offering to include institutional-grade custody. Others are dedicated custody providers.
Trust statutes (in England, the Trustee Act 2000) invariably impose duties on trustees in connection with the monitoring and review of custodians. This may include, in urgent cases, the need to intervene in the custodian’s management. Therefore it is incumbent on trustees to become very familiar with the exact custody arrangements of their custody partners. This will include familiarity with the general methods of cryptoassets custody.
There are broadly two systems of cryptoassets custody: hot storage (where private keys are stored online) or cold storage (where they are stored offline). With cold storage solutions, the private keys are held by the user on hardware devices with no online connection; they cannot be accessed through software systems. With hot storage solutions, in contrast, the user holds the private keys in systems with online connectivity or in hardware devices with online connectivity (such as a local hard drive). Hot storage solutions often rely on cloud storage.
Settlors always have strong views on custody solutions, which the trustees should accommodate as far as possible in a letter of wishes. But trustees should also form their own view on custody options and should always interrogate the precise security arrangements when placing cryptoassets in storage.
Aside from “hot” vs “cold” considerations, trustees will also need to observe a great number of other considerations when appointing a custodian. These include terms of remuneration, delegation, insurance, the legal arrangement of custody, the regulatory position, the precise mechanism by which assets can be traded or staked (especially those in cold storage), and trustee liability.
Some trustees may also take the view that a formal custodian relationship is not required, as they can hold cryptoassets with exchanges. However, using an exchange as a custody substitute is generally not best practice, for many reasons. That said, trustees should also be aware of the different types of exchanges and their advantages and disadvantages, as engagement with exchanges or regulated trading desks during some part of the trust process will likely be inevitable.
Statutes in most trust law jurisdictions contain a very broad general power of investment. Usually this includes a statutory power for trustees to make any kind of investment that they could make if they were absolutely entitled to the assets of the trust. In addition, modern trust instruments normally contain express broad powers for the trustees to invest as they see fit.
It will protect the trustees further still if the trust deed (and letter of wishes) expressly authorise the trustees to invest in cryptoassets, if indeed that is the wish of the settlor. The letter of wishes should also specify what type of cryptoassets the settlor would wish the trustees to invest in. Clearly cryptoassets like Bitcoin (BTC) or Ethereum (ETH), or a newly issued token in a start-up company, are a much more risky and volatile asset than a stable coin or some asset backed tokens. There will also be ESG considerations; some cryptoassets operate an energy intensive ‘proof of work’ mining system.
Certain types of cryptoassets are notoriously volatile. Trustee nervousness may be exacerbated by the lack of, or at the very least the uncertainty surrounding, regulation in the sector. Nonetheless, given the breadth of cryptoassets, from stable coins to highly volatile exchange tokens and asset backed tokens, trustees (and their advisory single family offices where relevant) may now take an active interest in how modern portfolio theory can be applied to cryptoassets.
Even with express authorisation and clear guidance in the letter of wishes to invest in cryptoassets, some trustees may still express reluctance to allocate even a small percentage of the trust fund to the asset class. To overcome trustee reluctance, a private trust company could be established. In most cases, it is thought that an underlying company (perhaps with a robust anti-Bartlett clause) should be used. Appropriate delegation of investment powers to a suitable advisor or committee, with bespoke provisions and roles in the trust instrument, should also be considered.
Finally, although beyond the scope of this paper, is compliance. Cryptoassets evangelists often advertise the fact that blockchain transactions are publicly traceable, and how this vastly improves the compliance process. Others will point to the murky association of cryptoassets with the dark web, even if that particular image of crypto is being reformed by institutional adoption. The true position is often much more nuanced and each case must be assessed on its own merits and protocols must be established.
Forward thinking trustees should now be holding discussions at board level to assess their risk appetite for cryptoassets. They should also be speaking to their insurers and taking legal advice to put policies and protocols in place. The Canadian-Russian programmer and creator of the Ethereum network Vitalik Buterin once said:
“Trust is our product. We're okay being the tortoise in the race.”
So could those words be uttered by trust companies. The trust industry may be the last sector to arrive at the crypto party, but us tortoises will get there in the end!
James is a Partner with the firm, specialising in trusts, estate planning, UK tax and cryptoassets.