There has been increased interest from individual investors in Bitcoin and other cryptocurrencies. What about fiduciaries? Can trustees consider investing in Bitcoin or other cryptocurrencies — and should they?
Originally published on Kiplinger.com August 10, 2021
Bitcoin and other cryptocurrencies, such as Ethereum, Litecoin and Cardano, have recently become a popular way for individual investors to diversify their investment portfolios and realize substantial growth. Bitcoin, which has the largest market capitalization among cryptocurrencies, remains dominant in the field, rising a staggering 302% in 2020. Since the beginning of this year, the S&P 500 has posted a strong 17% return, while Bitcoin has risen by 43% as of late July.
The success of Bitcoin is due to a variety of factors:
• Its limited supply has increased demand. There are currently about 18.7 million Bitcoin in circulation. It is widely known that the algorithm that forms the foundation for Bitcoin mathematically provides that no more than 21 million Bitcoin will ever exist. Limited supply has contributed to its demand and its success.
• Some investors see Bitcoin as a way to protect themselves from potential inflation caused by new monetary policy and fiscal stimulus associated with the pandemic.
• Additionally, some well-recognized companies have begun to show more interest in the use of cryptocurrencies as a form of payment.
• Finally, some large securities firms have been exploring opportunities in the cryptocurrency derivatives market.
The market for Bitcoin has become more volatile due, in part, to competition from new forms of cryptocurrency and specifically digital currencies backed by traditional currencies. The Securities and Exchange Commission has, to date, failed to approve applications for Bitcoin-related exchange-traded funds (ETFs) in part because of concerns about security and the potential for market manipulation. Combining these reasons with uncertainty about the future regulatory framework has led institutional investors and managers of trust portfolios to be justifiably cautious when considering whether Bitcoin and other cryptocurrencies are appropriate for use in fiduciary accounts.
Can a trustee hold Bitcoin, another cryptocurrency or a cryptocurrency derivative in a trust?
Investing trust assets in a cryptocurrency is not strictly prohibited by state law. Like any other investment, a trustee must follow the terms of the trust agreement and each state’s application of the Prudent Investor Rule when determining the appropriateness of any fiduciary holding. The Prudent Investor Rule allows a trustee to invest trust assets with a total portfolio approach and relieves a trustee from analyzing each investment in isolation. In other words, a trustee is judged on the result of a diversified portfolio without regard to a single risky category or type of investment provided that the trustee considers the needs of the beneficiary, the purposes of the trust and its anticipated duration. The Prudent Investor Rule gives a trustee more freedom to make investments than he had just a few generations ago. It does not, however, allow unrestrained speculation and outright risk-taking.
The Prudent Investor Rule’s application of Modern Portfolio Theory assists those who wish to utilize Bitcoin, other cryptocurrencies and alternative assets in trust accounts. Bitcoin may be too volatile when viewed in isolation, but can be appropriate when viewed as part of a total management strategy. Only time will tell if a present investment in cryptocurrency is prudent in relation to the purposes of a trust, the trustee’s risk tolerance and the beneficiary’s needs.
Are there strategies available to estate planners and their clients to predict a positive future for cryptocurrencies or other digital assets?
Traditionally, a trust agreement will list certain types of assets, such as stocks, bonds, mutual funds and common trust funds, as permissible investments. If the trust is still in the drafting phase, adding cryptocurrencies and digital assets to this list makes it evident that the person creating the trust, the trust’s grantor, wants the trustee to have the freedom to consider this type of investment. A trustee still must exercise discretion in selecting investments, so including digital assets in this way will not guarantee that cryptocurrency will be held, but it does provide some evidence of the grantor’s intentions. Permissive language of this type could give the trustee more comfort in doing so.
A trust agreement often contains a clause allowing the trustee to retain investments held during the grantor’s lifetime. If a trust created for the grantor’s benefit is revocable by the grantor, the trustee owes its fiduciary duty only to the grantor under the laws of most states. The grantor can direct the trustee to purchase and hold cryptocurrency or other digital assets, like non-fungible tokens (NFTs). Allowing the trustee to retain these types of investments already held by the trust at the grantor’s death may result in a willingness of the trustee to exercise investment discretion by continuing to hold, invest or reallocate the holdings into other cryptocurrencies.
The laws of some states, including Tennessee, Texas and Mississippi, permit directed trusts. Creating a directed trust relieves a trustee of potential liability for following the direction of a named adviser or advisory committee. Louisiana takes a slightly different approach by providing for the bifurcation of co-trustee duties allowing for separate administrative and investment trustees. Directed trusts, or selecting an investment co-trustee, afford more flexibility for investment in cryptocurrency, digital assets or alternative investments, which decreases the likelihood that these types of investments will be overlooked or will be deemed too risky by a trustee or co-trustee.
If the trust is irrevocable and does not have these provisions, a trustee and the beneficiaries can consider modifying the terms of the trust judicially, non-judicially or by decanting, if permitted under state law. The possible outcome may result in dividing the trust into separate trusts, some holding cryptocurrencies and others not, with each geared to the respective needs and risk tolerance of a beneficiary or class of beneficiaries.
So, what is the bottom line on the Bitcoin investing picture going forward?
It is hard to deny that Bitcoin has increased the net worth of some early, more speculative investors. There are no promises that its growth will continue. Bitcoin and other cryptocurrencies will most likely have a role as a form of payment and as an investment. Increased regulation, security and the number of new types of cryptocurrencies entering the market have caused uncertainty for Bitcoin as an investment. This uncertainty has caused trustees to take care when selecting Bitcoin, NFTs or other cryptocurrencies in designing an investment strategy or to avoid any cryptocurrencies altogether.
The good news is that the Prudent Investor Rule and Modern Portfolio Theory allow a trustee more flexibility than in years past, but not all fiduciary investors have a great degree of confidence in cryptocurrencies. If these types of investments are part of your personal strategy and you realize the potential benefits of cryptocurrency in the global economy, you and your attorney should consider some of the above suggestions as you review your estate planning documents.
Jim Ferraro is a vice president and trust counsel in the Shreveport, La., office of Argent Trust Company. Ferraro is a 2003 graduate of the University of Missouri at Kansas City School of Law, past president of the family and the law section of the Kansas City Metropolitan Bar Association, and is a member of the Tax and Estate Planning Council of Shreveport.