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How to Protect Your Cryptocurrency Investments From Liability

Cryptocurrency is a fast-growing asset class. One year ago, in April, less than a month after the U.S. lockdowns started, due to COVID-19, bitcoin was priced at $4,679. Now, a year later, the price is $62,855.

Crypto is volatile and suffered its biggest one-day loss in 2021 on May 19th, when China purportedly forbids banks from digital currency business. That was the major factor that caused Bitcoin to plummeted to as low as $30,846, and a day later is setting at $40,197, a volatile short-term investment with a lot of interest in the long-term upside.

There are many articles about protecting your cryptocurrency from hackers, which is vital to protecting your asset from that point of view. In this post, we will address the key points to protecting your cryptocurrency from lawsuits and probate.

Cryptocurrency Asset Protection Five Strategies to Protect Your Cryptocurrency from Liability:

  1. Understand the difference between protecting your crypto account from hackers vs. liability.  Yes, it is vital to protect your crypto account from hackers and theft and be organized, depending on how you set up your account.  Protecting your crypto account from hackers includes steps around the type of crypto wallet, whether it’s a paper, cloud-based, or non-custodial online wallet.  Regards to protecting your crypto account from personal liability are centered around asset protection of a safe asset. Crypto is similar to an investment (although not according to the IRS) from the standpoint it is considered a “safe asset.”The asset is not going to cause direct liability to the owner. The opposite is considered “risk assets,” like real estate, a business, a boat, or a car that can cause direct liability.  Safe assets are typically held in a separate entity that only owns other safe assets, including stock in other companies or investments in the stock market.
  2. Your cryptocurrency is subject to being lost in a personal lawsuit when you own it personally.  Most individuals own cryptocurrency in their name, personally. For example, a Coinbase Wallet is a cryptocurrency wallet and DApp browser controlled by you and only you. This means that the private keys (representing ownership of the cryptocurrency) for your wallet are stored directly on your mobile device and not with a centralized exchange like Coinbase.com. When you open a Coinbase wallet, you can only fund it individually. This means the asset will be titled to your name only. This is similar to opening an eTrade account and buying stock in Tesla. You have invested in a company’s stock (a safe asset), and you directly own it. The critical question is, how could you be personally sued? Let’s assume you have an e-commerce business on Amazon, and you diversify a percentage of your profits into cryptocurrency as a hedge against inflation vs. investing 100% into more inventory. Your e-commerce business should be established as a separate legal entity. Globally, the U.S. is the largest consumer market, but the downside is that we have the most lawsuits, especially regarding product liability. Most Amazon sellers know that you are required to obtain product liability insurance once you cross $1-million in sales, but Amazon does not currently enforce that rule.
    Litigation in the United States costs small businesses more than $100-billion each year. It’s not a matter of “if” it will happen to your business, but “when.” “By some estimates, there are over 40-million lawsuits filed every year. What happens if your company is sued for product liability, you lose in court, and you don’t have any insurance? Let’s assume you lost the product liability case, and a judgment is filed against your company. If your company did not have the cash to satisfy the judgment, the plaintiff might move to pierce the entity veil and go after you personally. Most form a cheap LLC online and have ZERO protection because there are no corresponding operating agreements and formalities for the LLC. Most likely, if your LLC is sued, you, as the manager or member, will also be personally sued.Let’s say that aside from the equity in your home that is not protected by a homestead, your most significant personal asset may be the cryptocurrency you have accumulated over the last couple of years.You might say, “My crypto account is private. No one can access it without a public or private key and a password.” This falls under privacy and asset protection. Yes, it is helpful if no one knows what assets you control and under what entity or name, but if you have a judgment against you and hid personal assets, that is a big problem with a judge.The best approach is to assume your crypto account could be found.  If it is, would it be protected if a personal lawsuit results in a judgment against you?Here are some other ways you could be individually sued and lose control of your crypto assets. Social media post tearing down your competitors.  For instance, suppose you personally created an ad campaign for your corporation criticizing a competitor. The competitor views the campaign as malicious and untrue and decides to sue. They might sue your corporation and you, personally, as the creator of the ad. While you would not be liable for any settlement the corporation has to pay due to the suit, your assets could be attached to pay off any judgment the competitor won in its case against you, the individual.

    What else can be taken in a lawsuit against you?

    Savings accounts are usually fair game in a lawsuit. However, retirement accounts, such as 401(k) and IRAs, are typically protected from a liability lawsuit.

    Although 401(k) retirement plans are protected under the Employee Retirement Income Security Act of 1974, individually held IRAs get only a partial exemption in bankruptcy. You would have to rely on state laws for protection.  When collecting assets to satisfy a judgment, some attorneys will go after everything else, including your crypto account.  They ask for all checking and savings accounts, partnership agreements and records of partnerships, real estate (including timeshares), trusts, contents of all safe deposit vaults, titles to all properties, and a complete list of jewelry, art objects, and personal property. A defendant could lose his car, cash, or other assets to satisfy a judgment.

    How Do They Know What Assets You Have?

    But how does the court know about your assets?  A creditor can require your appearance at court for an asset hearing, where the creditor can ask you questions under oath about your assets and demand you produce documentation regarding your wealth and ability to pay.  Failure to appear at an asset hearing generally results in a bench warrant being issued for your arrest.  The creditor can then request a cash-only bond in the amount of the judgment. That could cause you to be held in custody until the judgment is paid in full, until a new asset hearing can be held, or until the judge lowers the bond.

    Do you need liability insurance? Yes.  “Without liability insurance, you’re responsible for damages and injuries if you caused them.

  3. What amount of crypto in your name is worth protected with a separate legal entity?  The question you need to ask is, how much would you be willing to lose in a personal lawsuit? Meaning, if you had $5K in a brokerage account invested in Apple, would you form a separate LLC for only $5K to protect that as your only safe asset? Probably not. If you had other safe assets, such as stock in a start-up, plus the $5K, that might be different. You will want to determine your risk tolerance and the level of protection required for your situation. The other factor with cryptocurrency is that it is very volatile, especially on the upside. If it is at $50K in March of 2021, will it be in March of 2022? What if that goes up 20%, 40%, or even more in one year? The value of your account will grow accordingly. If you have $100K in crypto or other safe assets, and that is 20% of your net worth, you will likely want to take steps to protect those safe assets using another entity or structure.  If the $100K is 5% of your net worth, you still might consider a separate structure to protect your safe crypto-asset due to the potentially explosive upside over the next 1-3 years.
    Your age will also be a factor. If you are 21 with $50K in Crypto, you have less risk and the ability to start over, vs. someone at age 65 with the same amount.
  4. Why do I need to protect myself if I have insurance?  We always recommend the correct entity structure to protect your assets, whether it’s your business, real estate, or safe assets such as cryptocurrency. Besides, we recommend you have insurance, whether that is business liability insurance, product liability insurance, homeowners and car insurance (of course), and a personal umbrella policy was covering any overflow. Some things are not covered by insurance, including breach of contract, defaulted loans, family disputes, fraud,  and sexual harassment. Over the years, insurance has developed more and more loopholes, separate from pre-existing conditions, exclusions, incomplete documentation, and including less coverage due to excess claims – for example, in-mold cases, needing to report the gathering of water on your property within 72 hours and reporting it vs. months later, when it won’t be covered, in many cases. For all these reasons, having insurance is a great idea, but not enough to protect your crypto. You might be asking can I buy insurance directly designed to protect my crypto? In 2020, Gemini Exchange, a regulated cryptocurrency exchange, wallet, and custodian, formed its own insurance company to cover up to $200-million for crypto custody.  Lloyd’s Launches Cryptocurrency Wallet Insurance Policy.  Lloyd’s did create a space for insurance to protect against your crypto being stolen, https://www.insurancejournal.com/news/international/2020/03/02/559855.htm
  5. What Entity Options or Structures are Available?  If you hold your crypto directly in a self-directed IRA, it is protected while in the IRA. Once the money is distributed based upon IRA rules, the asset may or may not be protected, depending upon state law. What about using your living trust to protect your cryptocurrency? A living trust is a good idea for protecting your assets from the probate courts after death, but not against liability. Most people seem to forget all assets held by a living trust are not protected against liability. The key to passing on your crypto assets according to your estate plan is to make sure your estate plan provides for disclosure of your crypto assets and provides for a secure method of transfer of the private key to your heirs (if that is the case) and your passwords on any accounts. Should you consider an LLC or limited partnership to protect your cryptocurrency? These are traditional tools to protect safe assets, and the key is to know which entity is best and how to transfer your crypto account to an entity. There are situations where an asset protection trust (not a living trust) will provide excellent protection, but that usually involves a two-year or longer statute of limitations. From a tax point of view, selling, exchanging, or using cryptocurrency triggers capital gains and losses for traders. The IRS treats cryptocurrencies as intangible property. Most feel the IRS is off track and needs to treat crypto as a currency, not an intangible property.

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