How the rise of NFTs is changing the world of digital investing

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Anita Shaha senior partner of McDermott Will & EmeryPrivate Client Practice, explains the rise of NFTs and how the frenetic new world of digital investing works

The world of investing in cryptocurrencies or digital assets, especially digital collectibles in sports and art, is experiencing a meteoric rise, with blockchain technology and digital currency providing many with a revolutionary means of sell, exchange and collect digital assets in the form of non-fungible tokens (NFTs). At the start of 2021, only a small proportion of people had heard of NFTs, but by the end of last year over $40 billion had been spent on them globally, creating a lucrative but also wild and frantic.

With anyone able to buy cryptocurrency to create an NFT, and anyone from celebrities to kids trying their hand at selling or collecting digital art or sporting goods, digital asset sales are at an all-time high, with profits spreading far beyond just niche holders. Before discussing the implications of holding or managing cryptocurrencies and NFTs from an estate planning, inheritance or trust perspective, it is important to first understand what NFTs are. and how they interact with cryptocurrencies.

NFT and cryptocurrency

Essentially, NFTs are a digital certificate of ownership that can be bought and sold using cryptocurrency. Each NFT is entirely unique and, as with cryptocurrency, the record of ownership and any transaction is stored, recorded and shared on the blockchain – a type of public ledger invented in 2008 to record the movement of cryptocurrency and ensure its integrity by continuously encrypting, validating and recording transactions.

Some NFTs incorporate smart contracts that specify and automate certain rights and obligations of the buyer and seller – for example, to provide that the creator of the NFT automatically receives a percentage of the transaction proceeds each time the NFT is sold.

For the world of crypto investments, this means that any digital file – a song, video, jpeg image file, meme, voice recording, even a GIF – can be attached to an NFT, making it makes a unique and original digital asset that can be collected and traded in the same way as an original Van Gogh or an exclusively autographed World Cup football shirt.

While nothing is stopping anyone from copying digital art or merchandise, and in fact it has never been easier to do so by simply searching Google, sharing or downloading a digital file, only the buyer of the NFT possesses the “token” which proves that he owns the “original” work, thus distinguishing it from any copy. Likewise, there may be millions of identical Mona Lisa prints but there is only one original painting.

This means that even if a buyer does not acquire the intellectual property right to the work, they actually acquire the ownership right to the original work via the unique token.

While anyone can simply tokenize their creation to sell as an NFT, recent attention has been on multi-million dollar NFT transactions. For example, the most expensive NFT is a digital collage of images by Beeple (a digital artist called Mike Winkelmann), which sold in March 2021 for $69 million through Christie’s. Right after that, Twitter co-founder and until recently CEO Jack Dorsey sold an image of the very first tweet for $2.9 million, and a Diego Maradona digital fantasy football card sold. for $4.3 million.

As crypto-assets become more commercially mainstream, especially with NFTs which have been catapulted into the public eye over the past year due to their association with sports teams, celebrity endorsements and exorbitant transaction prices, the NFT market is incredibly speculative. Investing, protecting and managing NFTs comes with significant risk and volatility, especially when certain markets associated with them become overvalued and overinflated.

However, as the potential to facilitate new revenue streams by establishing new forms of digital ownership and digital investments increases, for those involved in administering estates or trusts, moving away from managing traditional assets for a whole new form of virtual assets can be a legal quagmire. .

Inheritance and succession issues

The decentralized nature of ownership of cryptocurrency and NFT assets can cause practical difficulties for personal representatives dealing with an individual’s estate upon death. Unlike a land registry or share registry, there is no controlled registry for digital assets, and access is therefore based solely on being able to access the digital wallet which contains the “private key”. (an alphanumeric password used to access digital wallets and sign transactions). Therefore, digital assets belong to whoever holds the private key, making that person the putative owner who can manage and transfer the asset.

Upon death, unless the digital wallet and private key are known to personal representatives, executors or assigns, it will be impossible to access or prove ownership of the digital assets. Currently, of the 18.9 million Bitcoins in circulation, an estimated 20% appear to be lost or otherwise in blocked wallets due to misplacement of private keys. It is therefore essential that owners of digital assets follow practical measures to mitigate the risks of valuable digital assets becoming inaccessible upon their death.

First, digital asset owners need to identify the assets they own and make them known to their advisors and/or personal representatives. This inventory of digital assets should be reviewed regularly and include up-to-date instructions on how to access private keys and wallets. Such an inventory should be kept securely and advice should be taken on how to maintain confidentiality, while allowing access in the event of death. This information should not be included in a will, which becomes public once a probate is obtained after death.

Second, owners should discuss with their advisors who should benefit from their digital assets upon their death and include instructions in their will or an accompanying letter of wishes advising personal representatives of how the digital assets should be administered – by example, instructions indicating which asset or account should be closed or transferred.

Trustees and digital assets under trust

With a growing number of HNWs and family offices seeking exposure to this digital asset class, there are several important considerations directors should take into account before agreeing to invest or hold NFTs and cryptocurrencies online. as fiduciary property.

Trustees should consider their fiduciary duties when making trust investments and, in doing so, take into account the need to diversify investments, consider the suitability of investments and protect the assets of the trust. A trustee should pursue a variety of investments of different kinds to reduce a trust’s risk exposure and, in doing so, should be mindful of their ongoing duty to monitor the suitability of such investments.

Although trustees may come under more pressure from settlors or even market developments to make speculative or high-risk investments, they should exercise great caution when considering the suitability of cryptocurrencies. assets, given their highly volatile and unpredictable nature. It is essential that directors receive appropriate and regular advice to fulfill their due diligence obligations to act within their mandate and not to expose the trust (unless expressly permitted) to high investment results. risk. This is imperative to avoid exposing themselves to breach of trust claims that disgruntled beneficiaries may seek to pursue if their assets lose significant value. It is also prudent for trustees and advisers to ensure that there are strong safe harbor provisions in the trust deed that clearly recognize the volatility of investing in digital assets and account for impairment losses.

Final Thoughts

Looking to the future, we expect the upward trend in investment in digital assets to continue. While there are certainly promises of a robust supporting infrastructure and increased global regulation, the pace at which the digital market is changing means that clarity and regulation will catch up for some time. It is therefore essential that all those involved in trust and estate planning take proactive steps to monitor and assess the impact on private wealth and trusts, engaging with their advisers to identify and then minimize exposure. the challenges and risks associated with the world of digital investing. .

Includes input from Justine Wadhera

Image: Shutterstock

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