How should courts approach dividing cryptocurrency and NFTs in a divorce? My recent article addresses this very question. The article carves out specific recommendations regarding NFTs, but for the purpose of this blog post, I will discuss cryptocurrency generally. Bitcoin reached a record high price of over $68,000 in November 2021. In the months that followed, the cryptocurrency market crashed, leading to prices of bitcoin and other top currencies to plummet to less than half of their value and digital asset brokerage firm, Coinbase, to plunge more than 75%. This crash has been deemed by the digital currency industry as “crypto winter.” As we reach the end of 2022, investors are mixed in whether they believe crypto winter is ready to thaw into spring. In September 2022, prices started to plateau despite the comparative crash of the stock market in this same time period, which traditionally is highly correlated with cryptocurrency market movement. However, just as prices started to plateau, FTX, the world’s largest cryptocurrency exchange, collapsed and filed for bankruptcy on November 11, 2022. Investors speculate that the FTX collapse could extend crypto winter into the end of 2023.
Though the recent drastic decrease in price is alarming, cryptocurrency has always been a volatile asset. In the few years prior to the pandemic, Bitcoin, the largest cryptocurrency by market cap, hit a high of $17,527 in January 2018 and a low of $3,236 in December 2018. As with any divorce case involving an estate with highly volatile stocks, my article advances that family law practitioners and courts should adopt the same general four-step approach when analyzing any other asset in a divorce:
- Identify: Develop and issue discovery requests that are specifically drafted to help identify cryptocurrency and review all produced discovery, including tax returns and bank account statements, for evidence of cryptocurrency;
- Characterize: Once attorneys review the discovery to determine whether a spouse owns cryptocurrency and to what extent, consult with cryptocurrency valuation experts;
- Value: Determine the value of cryptocurrency separate from the rest of the marital estate and address any future earnings received from cryptocurrency or assets;
- Divide: Encourage/advocate for a like-kind division of immediate sale of cryptocurrency upon divorce (with a clause preferably providing for percentage division of sales proceeds rather than a dollar amount given cryptocurrency’s volatility).
Identification of Cryptocurrency
A court must first identify that an asset exists before they are able to value it.
Although some courts support that cryptocurrency should be classified as “cash” or a “cash equivalent,” this is not a widely known or a universally accepted classification. Oftentimes a cryptocurrency holder spouse may not disclose cryptocurrency when asked for information regarding “cash accounts.” Best practices therefore would be to specifically issue discovery requests catered to obtaining information regarding cryptocurrency. My article sets forth recommended document requests and interrogatories to propound, seeking specific information about the party’s cryptocurrency holdings, include wallet addresses, public keys, web 3 service providers, and transaction IDs. Importantly, the article also sets forth a proposed definition for “cryptocurrency” that helps clarify the scope of these discovery requests. The article further presents strategies for identifying the existence of cryptocurrency holdings through review of other types of statements, including tax returns, bank account statements, and business documents.
Characterization of Cryptocurrency
The next step courts should undertake is characterization of cryptocurrency. The first consideration will be what type of property division scheme the state follows. In the majority of states, courts make a distinction between marital/community property and separate property, finding that a spouse’s separate property is not subject to division in the event of a divorce. Typically, separate property is defined as property acquired by gift or inheritance or owned prior to the marriage. A minority of states follow the “hotchpot” method where courts may divide both marital and separate property, in which case characterization of property becomes less critical. In cases where the cryptocurrency-holding spouse has not actively invested and transacted in cryptocurrency, it is likely not worth the funds to hire an expert witness to help trace the assets. However, where the cryptocurrency-holding spouse is an active investor, attorneys should recommend the retention of an expert witness who has specialization in both valuation of assets in the divorce context, but also valuation of cryptocurrency.
Valuation of Cryptocurrency
When valuing the cryptocurrency, courts should designate in (or attorneys should draft) decrees that specify a date and time certain for valuing the cryptocurrency assets. As cryptocurrency values can fluctuate widely, even in a single day, and there is no “opening” or “closing time” like in a traditional stock exchange, it is critical to specify both the date and time. The article surveys different state approaches to set a valuation date for volatile assets and proposes following the Wisconsin approach, where a court may hold a separate evidentiary hearing to determine the date of valuation. This helps protect against intentional delays by one spouse who sees the value of cryptocurrency is trending up or down.
Division of Cryptocurrency
In August 2022, the Financial Times reported on a reader who was seeking advice following negotiation and entry of his divorce judgment. In the height of the cryptocurrency surge, the reader had entered a final agreement with his ex-wife that he would keep his cryptocurrency assets and she would be awarded the “lion’s share of [his] pension and other investments.” Following the cryptocurrency crash, the reader reported he was “considerably worse off than [his ex] and worried about [his] financial future.” The Financial Times accurately advised that the court would be unlikely to reopen the reader’s case as that would set a dangerous precedent. Whenever a volatile asset did not perform well in a market, “courts would face a deluge of cases looking to reopen agreed settlements.” Generally, courts will only set aside a divorce agreement if it was unconscionable or entered into involuntarily as a result of duress, coercion or fraud. See, e.g., Star v. Star, 260 A.D.2d 363, 364 (1999); In re Marriage of Callahan, 984 N.E.2d 531, 536 (Ill. App. Ct. 2013). In this instance, the reader made a conscious decision and agreed to take all of his cryptocurrency assets based on the state of the market at the time and effectively had “buyer’s remorse” after. These facts do not indicate any grounds for setting aside the final agreement.
This story serves as a cautionary tale and underscores my recommendation that (1) courts should order, and attorneys should advocate for, like-kind division or immediate sale of cryptocurrency, and (2) cryptocurrency should be divided separate and apart from the rest of the marital estate. First, encouraging a like-kind division of cryptocurrency would help prevent the situation above, where one spouse is saddled with all of the cryptocurrency or other risk-laden assets, the price decreases substantially following the divorce, and they do not have an alternative financial security blanket. This is akin to the well-established investor’s creed of “diversify your portfolio.” Spouses should similarly diversify their assets following a divorce. The article outlines recommended language for practitioners to incorporate into their decree to effectuate the like-kind division and sale.
This does not mean a spouse should insist on dividing each and every asset in a final agreement. Say Husband has ten thousand dollars in his bank account and Wife has ten thousand dollars in her bank account. It is logical for each spouse to keep their respective bank account in the event of an equal division of assets rather than divide both accounts in half and have each spouse transfer five thousand dollars to the other spouse. But in the case of cryptocurrency, each coin experiences such large fluctuations in value on a daily basis that you could not, for example, award one spouse six bitcoins and the other spouse six Ethereum and guarantee an equitable result. Rather, each spouse should be awarded three bitcoins and three Ethereum. Alternatively, the final divorce decree should provide for the immediate sale and a percentage split of any cash received from the cryptocurrency (i.e., 50/50). This allows for a readily ascertainable value shortly after the divorce, and the onus would then be on the spouse seeking to reinvest the funds in whichever way they choose following the divorce.
Further, courts should separate division of cryptocurrency from the rest of the marital or community estate. Say in the example of the Financial Times’ reader’s case, the attorneys prepared a marital balance sheet that provided the cryptocurrency assets Husband was awarded were worth about $100,000 and the pension and investments Wife was awarded were also worth about $100,000. On paper, it would seem equitable for each spouse to be awarded $100,000 in assets. But as the Financial Times reader found out, following the divorce, Wife’s assets remained relatively steady compared to his.
Similarly, courts should avoid conditioning any future events in a divorce decree upon the sale or division of cryptocurrency. For example, the Financial Times article also mentioned that the reader and his Wife had divided the equity in his marital home. However, a worse alternative could have been that Husband wanted to stay in the home but did not have sufficient cash to buyout Wife’s interest. The court could have ordered the sale of Husband’s cryptocurrency to free up cash to effectuate a buyout within a set number of days. However, upon the crash, Husband would no longer be in a position where he would have received sufficient funds to effectuate the buyout. So now- the disposition of the marital home is also impacted and halted. By dividing virtual assets separately, you remove these potentially deleterious domino effect that could impact the couple’s other assets.
Although it is still unknown whether and how long “crypto winter” may wage on, family courts still need to adopt a more uniform approach to handling these assets. The paucity of case law on point, summarized in my article, indicates courts who are addressing these cases for the first time are lacking in guidance, trying to turn to established case law regarding other classes of volatile assets. Rather than creating a completely new approach for judges to learn when dividing cryptocurrency, my article builds on the comparative model and proposes an approach based on familiar judicial analysis. Adoption of this framework by practitioners and judges would help increase uniformity across courts and education regarding this evolving asset class.
Stephanie Tang is an Assistant Professor of Law at the Baylor University School of Law.
This post was adapted from her paper, “Cryptocurrency, NFTs, and the ‘Metaverse’: Addressing the Expanding World of Virtual Assets in Divorce Proceedings,” available on SSRN.