The crypto challenges facing London’s divorce courts

Caroline Park examines the issues the divorce courts will face when dealing with digital assets

In the next few years, the traditional approach in the family courts when determining divorce judgments could be radically shaken up. Millennials, those born into a generation largely defined by dramatic and sometimes disruptive technological change, will become the dominant parties as they reach their mid-40s. As recently released figures reveal, the average age for divorce in England and Wales is now 45 years old, no doubt an unwelcome statistic for some of those born in the 1980s and 90s. For the courts, however, the looming reality of that milestone is one which needs to be addressed.

Digital assets

This generation will be the first for whom digital assets, particularly in the form of cryptocurrency, represent a significant proportion of their investment portfolios. In order to accurately assess an individual’s overall wealth, it will be vital that judges and lawyers have at their disposal the tools to grapple with crypto’s fickle and at times elusive actual value.

Crypto is undoubtedly a thorny financial commodity to analyse, a phenomenon that only entered mainstream consciousness within the last decade and which needs to be dealt with in an innovative way.

As has been the case since crypto’s earliest days, investors in the newest form of currency remain disproportionally represented by the younger generations. The transfer of wealth from baby boomers to Generation X and through to millennials - sometimes referred to as Generation Y - is a trend which will inevitably accelerate as they reach the peak of their earning powers. London’s busy divorce courts will, therefore, need to move with the times, to ensure that the growing millennial cohort does not lose out when crypto is part of the divorce settlement.

In cases involving high net worth (HNW) and ultra-high net worth (UHNW) families, for whom the UK remains a key international destination, this will be even more acutely felt. Even though crypto is now firmly established and widely known about following the launch of the first Bitcoin ledger in 2009, digital assets remain statistically the preserve of the more affluent, and affluent investors represent the most significant proportion of individuals who have invested in the 21,000 cryptocurrencies in existence today. 

Despite recent negative publicity about the demise of crypto following the collapse of the FTX exchange, the sector remains a dynamic, albeit volatile, investment choice for those aiming to diversify their portfolio beyond traditional routes. From the outset, crypto was designed to be different - a new class of asset which set out deliberately to ensure its valuation would not to be tethered to traditional investments, government policy or stock exchange movements.

The unconventional, slightly anarchic quality of cryptocurrencies - typified by the creators of the first bitcoin software hiding behind a pseudonym - adds to their allure. As well as the better-known cryptos, such as Bitcoin, there are also crypto-tokens. These represent an ownership interest in an asset, such as a piece of digital artwork or even a physical asset or a holding of some other utility, such as granting access to a physical or virtual space or unlocking benefits in a virtual or physical environment. For HNW individuals, such acquisitions can seem to be an attractive or quirky addition to their investment portfolios. Against such a background, it is self-evident that divorce lawyers working for such clients must establish a clear, trusted approach so these assets can be properly accounted for over the coming years. 

Crypto and divorce

While crypto can no longer be considered a strictly niche investment, there are still no reported judgments in England and Wales dealing with crypto-assets on divorce. Its burgeoning prevalence though has meant that divorce lawyers are already having to contend with the issue. Within the profession, much of the discussion has focused on the challenges of tracing and identifying these assets. Concurrent with these conversations are concerns about non-disclosure, and the potential for hiding crypto holdings from view, which is arguably more acute than for a more conventional financial holding, such as stocks, bonds or real estate. Recent volatility in the value of crypto and the so-called ‘crypto winter’ - in which a prolonged bear market in the industry led to a significant decrease in cryptocurrency prices - have brought issues beyond disclosure into sharper focus than ever. It might be simple for the courts to say - as the Commercial Court has in a line of reported decisions - that crypto can be treated like any other property. In the context of divorce, however, this stance belies some of the difficulties which will inevitably arise, principally in relation to how to value such assets and how to divide them on divorce.

Viewed from a crypto novice’s perspective, it can be difficult to understand why such currencies must be assessed so distinctly from other assets. The contagion that swept through many cryptocurrencies as a result of the uncertainty prompted by the FTX collapse might be naively compared to a stock market crash. There are, however, fundamental contrasts. One reason for this is that digital currencies like Bitcoin operate free of any central control, without the oversight of a central bank or government. Instead, the currency relies on peer-to-peer software and cryptography. The consensus on who owns which coins within the ledger is arrived at cryptographically across computer servers known as nodes, so there is no stable source of trust like a bank. A blockchain, formed of transactions collated by so-called Bitcoin miners, becomes the definitive account book, effectively a history of all publicly broadcast transactions. Crypto coins are held in digital wallets, in the same way traditional metallic coins are stored in a physical wallet, but as the above explanation indicates, the contents of that wallet are far more vulnerable to rapid and unforeseen fluctuations in value. There is no fall-back governing body which can intervene in the event of a crash, as happened, for example, when the subprime crisis engulfed global markets between 2007 and 2010.

Traditional valuation methods, which put a figure on assets at the point of financial disclosure and which then update these valuations ahead of trial, might suffice where assets are relatively stable. With crypto though, the same conventions clearly do not apply. Cryptocurrencies are not bound by the same rules as listed securities, private equity interests or real estate. Price volatility means that, in the time between the conclusion of a divorce trial and a judgment being handed down, there is the potential for very significant changes in asset values. As the bankruptcy of the FTX exchange demonstrates, what was a highly lucrative asset in July 2021 can become worthless within a relatively short space of time, less time than it might take some complex divorce cases to reach court. As such, the established practice of judges using a settled asset schedule, which summarises and quantifies all the family’s assets, when determining how assets should be divided on divorce, is unfit for purpose in the face of such fluctuation. Market commentators predict that greater regulation of crypto-assets is coming or, perhaps, is more likely for crypto exchanges, which may in time reduce this valuation fluidity, but for now the current volatility of the market means the potential for very significant changes in asset value remains.

These valuation issues feed into the second major issue in divorce cases involving crypto: which party will keep the crypto on divorce? It is still relatively unusual for both parties to be crypto enthusiasts, and for the party without the background or expertise in managing crypto, the unpredictability of a crypto-asset can be a daunting prospect, especially when even the most sophisticated investment managers and financial advisers can be reluctant to assist. Trying to offset value, where one party keeps the crypto and the other keeps an equivalent value of other assets, creates the potential for real unfairness. An alternative is for the court to order the sale of crypto and share the proceeds equally once liquidated and, therefore, crystallised. While this might feel fairer, such action has the potential to result in significant losses depending on movements in value.

Courts often end up falling back on a well-established principle in English divorce law known as Wells sharing, deriving from a 2002 case in which the Court of Appeal found that fairness in the division of assets on divorce might be achieved by a fair distribution of ‘the copper-bottomed assets and illiquid and risk-laden assets’. Superficially, this approach of dividing the crypto equally and in specie, so each party retains their own crypto portfolio sidesteps the issues of valuation but, especially in crypto cases, it is rarely popular with either side.

Long-established methods for valuation and division are thus, being strained by this newer type of digital asset. Some of these concerns can be addressed with better knowledge, understanding and experience about crypto amongst divorce lawyers. There is also a developing, albeit still limited, body of forensic experts in the field, who are using software to map out crypto across the blockchain to seek to identify and value assets. Meanwhile, judges in England and Wales have recently been offered training on crypto-assets.

Conclusion

The UK government has now set out a goal of making this jurisdiction a global hub for digital assets, and the Law Commission has been tasked with reporting later this year on reforms to the law on digital assets. The review’s conclusions will follow a consultation on the digital pound published by the Treasury and the Bank of England in February. If introduced, the digital pound would be issued by the Bank of England, not the private sector, and would therefore be backed by a central authority, making it less prone to volatility. The digital pound would be distinguished from crypto-assets, which are decentralised by design.

Nevertheless, this mainstream exploration of digital currency demonstrates the rapidly changing relationship with assets and the forms in which they are held. There can be little doubt that divorce and family law is one area of the law that will need to deal with these developments, and our millennial clients will rightly demand the issues receive the proper attention and scrutiny they deserve.

Caroline Park is a partner at Hughes Fowler Carruthers
hfclaw.com