“States have a good nose to smell just which industry isn’t compliant with their escheat laws and could target the cryptocurrency market,” cautions Robert Peters, managing director and head of the unclaimed property and tax risk advisory practice for Duff & Phelps in Chicago.
Unclaimed accounts represent a multimillion dollar annual revenue stream for state treasurers and other financial officers who can use the proceeds from their prompt liquidation until the rightful owners or heirs turn up years later. That is if they ever show up. So far, state coffers hold more than US$60 billion in unclaimed accounts. As the market for cryptocurrencies grows so does the potential that accounts could become abandoned with digital asset exchanges and custodians holding the bag.
“Auditors, working on behalf of states in exchange for lucrative contingency fees won’t hesitate to call holders to the carpet for recordkeeping and other errors which caused them not to ship unclaimed cryptocurrency accounts to states,” cautions Freda Pepper, an attorney with the law firm of Reed Smith in Philadelphia. The penalty won’t be a slap on the wrist, but hefty fines representing the value of the accounts and interest for the time they were not escheated.
State unclaimed property statutes might not define cryptocurrency let alone explain who are the holders of unclaimed accounts, but legal experts have come up with their own interpretation. “Cryptocurrency custodians which securely store cryptocurrencies whether for institutional investors or individual owners may have access to the private keys necessary to transfer their customers’ cryptocurrency,” says Kendall Houghton, a partner with the law firm of Alston & Bird in a February 2019 article she co-authored for Bloomberg Tax Report. “Therefore, because these custodians have the ability to transfer cryptocurrency that is presumed abandoned by the state they may be considered holders for unclaimed property purposes.”
In another blog published last year, attorneys from the law firm of Evershed Sutherland reached the same conclusion saying, “Since unclaimed property obligations apply to companies holding property belonging to another, cryptocurrency exchanges and the providers of online wallets will feel the most direct impact of the unclaimed property laws as long as they have the ability to transfer cryptocurrencies to third parties on behalf of thir customers.”
Neither law firm names which cryptocurrency custodians or exchanges that might be affected, but given that BitGo, Coinbase, Gemini, Kingdom Trust, and Paxos offer trading or custody services or both it is likely they could become unwitting participants in the escheatment process despite the states’ tenuous rationale. “A state could still lay claim to an unclaimed cryptocurrency account after three to five years if no trading occurs or communication with the investor takes place,” says Peters.
As a rule of thumb, unclaimed securities and other forms of accounts must be transferred — or escheated– by the holders to either the state of the last known address of the investor or if unknown the state of incorporation of the holder after a dormancy period of either three to five years. What triggers the start of the dormancy period differs for each state depending on the type of asset. It can range from an uncashed check, the lack of any activity in account, or lack of communication with a financial intermediary.
So far, four states — Colorado, Illiinois, Tennessee and Utah — have adopted a version of the Revised Uniform Unclaimed Property Act of 2016 (RUUPA) which theoretically categorizes cryptocurrencies as property, subject to echeatment, based on the definition of a “digital representation of value used as a medium of exchange, unit of account or store or value, which does not have legal tender status recognized by the US.The RUUPA expressly excludes from the definition the software or protocols governing the digital representation of value game related digital content or a loyalty card.
Although RUPPA aims to standardize the groundrules and process for escheatment among the fifty states, it never clarifies under what circumstances a cryptocurrency account could be considered abandoned or who is the holder. States, which don’t follow RUPPA or define cryptocurrencies, could decide to interpret their statutes as placing them in the miscellaneous catch-all category of “other intangible property.” Doing so would make it difficult to apply any dormancy period, writes Houghton, because of the unique characteristics of cryptocurrencies. The dormancy period would need to start after the property becomes payable or distributable to the owner. Most cryptocurrencies are not redeemable for cash and the owner has no right to receive cash from the holder of the cryptocurrency.
A 2018 class-action lawsuit involving Coinbase as the alleged holder of unclaimed cryptocurrencies was settled out of court earlier this year, leaving no legal precedent on whether holders of unclaimed cryptocurrencies even have a legal obligation to escheat them to a state. The two lead plaintiffs, who are residents of Michigan and California. sued Coinbase on the grounds it illegally kept unclaimed cryptocurrencies instead of notifying customers that it would escheat them to the state of California if they didn’t come forward. When Coinbase asked for the case to be dismissed on the grounds the plaintiffs could not sue on the basis of California’s unclaimed property law, the plaintiffs amended their complaint removing their claim based on violations of unclaimed property law. They retained their allegation that Coinbase engaged in unlawful and unfair business practices under California’s Unfair Competition Law, because it didn’t comply with the state’s unclaimed property law.
Coinbase denied all the charges, but its own practice of allowing users to send cryptocurrencies, including Bitcoin, to email addresses of recipients appears to have been the cause of the dispute. The plaintiffs did receive e-mails telling them how to create Coinbase accounts and access their cryptocurrency, but when they tried to use the links in 2018 they didn’t work. At the time Coinbase sent the plaintiffs emails in 2013, the plaintiffs were entitled to receive either 0.10 Bitcoins or 0.01 Bitcoins. The price of Bitcoin had traded below US$1,000 in 2013 until year-end when it had a brief sprint trading above US$1,000.
An attorney for the plaintiffs in San Diego declined to comment on the case and Coinbase did not return emails seeking comment on why it was voluntarily dismissed. Unclaimed property attorneys, unrelated to the litigation, speculate that Coinbase was either able to successfully argue it was not a holder of the unclaimed cryptocurrencies or that the dormancy period for the unclaimed accounts had not expired. Another reason could be that the state of California could not accept the cryptocurrency.
As of press time, a spokesperson for California State Controller Betty Yee would only confirm that whether cryptocurrency accounts are subject to the state’s unclaimed property law is “under review.” Attorneys specializing in unclaimed property law have interpreted California’s unclaimed property statute as categorizing virtual currencies as intangible property.
The dismissed lawsuit involving Coinbase also did not resolve the issue of which entity is responsible for liquidating and reporting unclaimed cryptocurrency accounts for cash. If the states don’t have the technological ability to liquidate the accounts, then custodians and exchanges might be forced to do the job, say attorneys specializing in unclaimed property law. However, that solution leaves them open to potential lawsuits from investors for wrongful escheatment. “Because the extreme volatility of some cryptocurrencies can result in massive appreciation over short time horizons any liquidation of a cryptocurrency has the potential to expose the industry to unwarranted risk,” writes Evershed Sutherland in its blog.
So far, New York appears to be ahead of the curve when it comes to defining a virtual currency and the obligations of holders of unclaimed accounts. A bill specifically addressing unclaimed cryptocurrency accounts proposed by Assemblywoman Helene Weinstein, at the request of the New York Comptroller Thomas DiNapoli, is still in its infancy. Nonetheless, several unclaimed property attorneys tell FinOps Report that they are encouraging their clients– cryptocurrency exchanges and custodians — to prepare for the possibility the new rules would come to fruition and that other states could follow suit.
Weinstein’s office referred FinOps Report’s questions to Comptroller DiNapoli’s office where a spokesman says that the prupose of the new abandoned property law was to ensure that the rights of cryptocurrency account owners will be protected and that holders of the unclaimed cryptocurrency accounts would be subject to the same due diligence requirements required of other holders under the law.
In response to FinOps Report’s e-mailed questions, DiNapoli’s spokesperson calls the draft legislation’s description of a virtual currency and holder consistent with the regulations of New York State’s Department of Finance. A virtual currency, says the proposed New York measure, is broadly defined as any type of digital asset used as a medium of exchange or digitally stored value. The digital asset could even be created by computing or manufacturing effort. The definition includes decentralized currencies as well as those with a central repository or administrator. There are some exceptions such as digital assets used within online gaming platforms and offered through prepaid cards.
If passed, the new New York law on unclaimed cryptocurrencies would consider the holder of the virtual currency responsible for escheating an unclaimed account, to be any banking organization, corporation or other entity engaged in the virtual currency business. “In general terms, the holder is the entity maintaining the virtual currency,” writes DiNapoli’s spokesperson. The list of entities engaged in the virtual currency business, he explains, include firms which “store, hold or maintain custody or control of a virtual currency on behalf of others.” They could also be buying and selling virtual currency as a customer business, performing exchange services as a customer business or controlling, administering or issuing virtual currency.
The New York bill provides for a three year dormancy period which can be delayed if the owner communicates with the holder. New York State’s Comptroller has the right to sell the virtual currency on an exchange or any other necessary means.
Given the potential for states to lay claim to unclaimed cryptocurrency accounts, digital asset custodians and exchanges had better come up with either a good defense or an even better offense. Reed Smith’s Pepper says that cryptocurrency holders could always argue that virtual currency doesn’t fall under any proscribed categories of property, including the miscellaneous category of intangible property. Alternatively, digital asset custodians and exchanges could claim they are not holders of the unclaimed cryptocurrencies because they are not debtors nor obligors to the owners. However, as Pepper acknowledges, that defense might not work if a custodian or exchange holds the private key to an account.
When asked about whether New York State’s definition of a holder of an unclaimed cryptocurrency account would include a firm that didn’t have access to the account’s private key, DiNapoli’s spokesperson says that such a scenario was “outside the scope of the abandoned property law.”
Marc Musyl, a partner in Denver in charge of the escheat practice for the law firm of Greenberg Traurig, recommends that digital asset custodians be proactive with their customers to avoid accounts becoming dormant. Using the argument that unclaimed cryptocurrency is not escheatable, he believes, wil fail because states can always interpret their statutes to include cryptocurrencies as intangible property.
“Regular, perhaps annual communication with investors is critical,” says Musyl. adding that the communication must demonstrate that the client acknowledges ownership of the account. An unbounced email simply won’t do. “The digital custodian must ensure that it receives a return e-mail which verifies the investor’s existence and contact details,” says Musyl. What if the investor doesn’t respond? The digital custodian would still need to document the event and start the dormancy period.
Even if states cannot accept the escheated cryptocurrency, as long as the digital custodian is the holder it can still report the account as unclaimed, subject to escheatment, says Musyl. When questioned about whether New York State could technologically accept unclaimed cryptocurrency accounts, DiNapoli’s spokesperson explains that the state’s Office of Unclaimed Funds has a custodian for maintaining and liquidating non-cash assets. “Some virtual currencies may be delivered to the custodian or the original holder may continue to maintain or liquidate the assets,” he writes.
Should the owner of an unclaimed cryptocurrency account come forward to claim its account from New York State after the assets are liquidated, it would only be entitled to the value at time of liquidation. Holders of accounts which liquidate them would be indemnified from any legal liability, writes DiNapoli’s spokesperson.
Cryptocurrency exchanges and custodians aren’t taking any chances when it comes to fulfilling their possible responsibilities regarding unclaimed cryptocurrency accounts. In response to e-mailed questions from FinOps Report, Charles Ives, president of Murray, Kentucky-headquartered digital custodian Kingtom Trust, says that his firm “encourages” account holders to keep it up to date concerning changes in addresses and to list beneficiaries with enough identifying information to be tracked down.
According to Ives, Kingdom Trust rarely sees abandoned accounts and has yet to escheat any unclaimed digital assets to any state. “In the event that we do have to deliver such property to a state as abandoned property we will have to know the state has policies and procedures and the necessary technology required to accept the assets,” writes Ives, whose firm operates as a South Dakota trust company .
When asked what Kingdom Trust would do if a state could not accept unclaimed cryptoaccounts, Ives responds, “As a state chartered trust company we would look to the state and its laws as to how it wished that circumstance handled.”
Paxos is also taking a proactive approach working with what a spokesperson calls a “trusted third party,” to manage accounts involving unclaimed cryptocurrency assets. She says that as a New York State-chartered trust company, Paxos is required to retain documentation of customer accounts and activity as part of its record retention requirements. “Paxos has a thorough onboarding process and we collect names, phone numbers, addresses and emails of each customer,” writes the spokesperson in response to emailed questions. “We use those tough points to continually re-engage a client until Paxos is required to escheat under the state law.”
DiNapoli’s spokesperson confirms that the regulations of New York State’s DFS require entities conducting virtual currency business activity in New York to capture owners’ names and addresses. “This information would be reported to the Office of Unclaimed Funds and used for the purpose of reuniting lost owners with their assets,” he writes.
So far, not all state statutes may have kept up with the nuances of the cryptocurrency market, but cryptocurrency custodians and exchanges are clearly bracing themselves to the possibility they are next on state radars. More states could either adopt new rules specific to unclaimed cryptocurrency accounts or creatively enforce existing ones. Digital asset custodians and exchanges had better hope for a lot more clarity.