The new digital horizon

In recent years, there has been a growing appreciation of the potential application of traditional trust and other asset-holding structures to solve challenges faced by digital wealth owners seeking to interact with the wider on- and off-chain economies.[1]

For example, the purpose trust and Cayman Islands foundation company have been deployed as a ‘wrapper’ for decentralised autonomous organisations (DAOs)[2] due to their ability to ‘mirror’, in legal form, the unique attributes of a DAO. These are notably formed as ‘orphan’ structures, existing for a purpose rather than for the benefit of shareholders.

A DAO is not a legal entity and therefore has no ability to hold assets, often leading to a situation where individual (or a group of) DAO members must hold assets personally.

Holding assets, which may include intangibles such as the intellectual property created by the developers of the DAO, in a structure with an established legal ‘personality’, such as a purpose trust or a foundation, limits personal liability for DAO members. It also enables the DAO to engage with the traditional financial world, connects it to the regulatory environment and facilitates good governance with international regulations and compliance requirements.

Use cases are not, however, limited to DAOs. Trusts, as well as certain other corporate structures, have been demonstrated to provide similarly significant advantages to individual investors and their families.

Asset-holding solutions

Trusts and foundations can also be effectively deployed for passive holding of digital assets for high-net-worth individuals (HNWIs) and family offices, just as they can be for traditional assets.

The well-worn saying ‘not your keys, not your crypto’ provides valuable insight into dealing with the psychology of crypto-native HNWIs. From a psychological perspective, the barriers to convincing digital asset owners to trust in such structures are often higher. The volatile nature of the market, in addition to several highly publicised exchange failures and fraudulent activity,[3] as well as general disapproval by traditional markets, all make for a certain level of mistrust across this client base and they may, in some cases, feel a high level of discomfort with ceding legal control of their assets. Some may even feel it is counterintuitive to engage with a traditional financial service for a need that is at the cutting edge of technological innovation.

But there is a solid role for trustee services to play, not least to relieve owners of the administrative burden they face in managing their digital wealth but often as a segue to traditional markets and services. There are practical realities to consider too, not just for sophisticated digital natives with complex on-chain requirements but for ‘casual’ investors/collectors of digital assets.

Structures such as a discretionary trust have been demonstrated to be effective for centralising and managing a portfolio of non-fungible token collectibles, for instance. This can allow the collection to be held in a tax-neutral environment while providing for a straightforward transfer to the beneficiaries on the death of the settlor without the administrative challenge of liquidating the collection or establishing smart contracts for individual heirs in probate. Without appropriate structuring, it can be challenging for these assets to be effectively transferred, especially where the beneficiaries have limited knowledge or understanding of crypto-assets and how (and where) they are held.

It is also worth noting that, much in the same way that trustees would not hold hundreds of thousands of their client’s bank notes in their safes, they should never hold (or even have sight of) cryptocurrency keys themselves. However, they have an important role to play in undertaking rigorous due diligence to find the right key custodian so that assets can be accessed by beneficiaries as and when appropriate.

More complex scenarios may require a sophisticated structuring framework, combining a trust with an underlying special purpose vehicle, for example, or deploying a mix of structures across jurisdictions to manage gains/profits, mitigate price fluctuations and provide clarity over the international tax position for owners and their enterprises. This is especially critical for owners who are globally mobile or who are in the process of relocating between jurisdictions that may take a very different approach to digital asset regulation and taxation.

Expertise and infrastructure

The right choice of trustee is vital. Not all service providers will feel comfortable acting on behalf of clients with digital assets and those who do must be able to evidence that they have the requisite experience, expertise and networks.

Trusts and trustees should have substantive supporting infrastructure, including appropriate anti-money laundering (AML) and on-boarding protocols, the correct scale of professional indemnity insurance and tailored accounting procedures. They will also require access to specialist expertise where necessary, such as digital experts for legal advice and drafting, reliable custody and investment solutions, and good relationships with banks and other financial institutions to smooth decentralised/traditional finance on- and off-ramping.

Settlors will need assurance about how transactional decisions will be taken and verified, including what tools will be used to maximise security and what the trustee will do to anticipate future challenges and support the settlor over the long term. As appropriate, such details can be set out within the service agreement.

Choosing the right jurisdiction

One of the most critical decisions to make when assessing the suitability of digital asset-holding structures is location.

The Cayman Islands, Guernsey and Switzerland are among those that lead on digital assets legislation, have a robust recognition of trust law, offer a wide range of digital-friendly structuring vehicles, have a strong legal framework, well-tested case law and sound regulatory oversight.

Guernsey has strong regulatory oversight, a large network of professional advisors and a highly permissive framework for establishing trusts. Moreover, its body of law provides flexibility for digital asset investors to use trusts. In 2022, it launched its own cryptocurrency fund and the world’s first Tier 1 Bitcoin exchange-traded fund. With its independent legal, fiscal and administrative systems, it is also insulated from volatility and uncertainty in the EU, the UK and beyond.

The Cayman Islands is a well-regarded international financial centre with a stable economic and political environment, robust judicial system and sophisticated advisory community. Its trust law is derived from English and Welsh common law, but its independence has enabled it to innovate with its Special Trusts (Alternative Regime) Law, 1997, which allows flexibility to hold and manage higher-risk assets. In 2020, it implemented its virtual asset service providers framework, strengthening its attractiveness as a location for digital asset owners.

Switzerland has one of the most stable political and financial systems in the world. It is a signatory to the Hague Convention of 1 July 1985 on the Law Applicable to Trusts and on their Recognition and has introduced specific licensing for trustees. In 2020, it passed the Federal Act on the Adaptation of Federal Law to Developments in Distributed Ledger Technology to license certain crypto banks and exchanges, while Lugano’s Plan ₿ is establishing cryptocurrency as a de facto legal tender in the city. It also boasts a thriving ‘crypto valley’ Web3 community.

Other locations such as Dubai and Singapore are also taking significant steps to establish themselves as leading digital asset jurisdictions. For example, Dubai recently established the world’s first virtual assets regulator and a new digital assets law is now being consulted on, while Singapore has become one of the first jurisdictions globally to introduce a reserve-backed stablecoin.

Ultimately, when it comes to dealing with digital assets, supporting innovation is almost as important as wealth protection. Asset owners rightly want to be confident that their digital wealth is being managed by a professional trustee who is compliant with the highest international AML and global tax reporting standards, and who has the expertise and infrastructure necessary to manage digital assets in line with their wishes, while meeting regulatory requirements and tax obligations.

Despite an uncertain landscape over the past 18 months, digital wealth is only set to grow in one form or another as the next generation of digitally native wealth owners and creators become more influential economic and investment actors. And as the demarcation between the digital and traditional realms becomes more intuitive and user-friendly, trusts and trustees can play a pivotal role in supporting their success.