Asset protection is the utilization of laws and legal entities (such as trusts, limited partnerships and limited liability companies) which safeguard assets from attack by future, unsecured creditors. Traditionally, asset protection attorneys protected their clients' bank and brokerage accounts, real estate, business interests, art and other things of value. Lately, practitioners have also protected crypto assets, including digital coins, utility tokens and non-fungible tokens (NFTs) in domestic and offshore Asset Protection Trusts (APTs). Today, there is a burgeoning industry of professional trustees, banks and other custodians who are equipped for safekeeping and protection of digital assets.

Foreign asset protection trusts are established in offshore jurisdictions which typically offer the following: (1) non-recognition of U.S. civil court judgments, and (2) legal and procedural hurdles if a U.S. creditor commences litigation in the foreign jurisdiction against the trust or its assets. These hurdles include short statutes of limitations, the absence of contingency fees, and a high burden of proof for the creditor. Not all foreign jurisdictions are equal. In Liechtenstein, for example, the U.S. creditor also must demonstrate malicious intent on the part of the recipient of the assets, the trustee. While many foreign jurisdictions claim to offer hurdles for the creditor, the better asset protection jurisdictions also offer political, economic and social stability; top banks with a well-developed regulatory system, and a strong rule of law. Other factors to consider in choosing a foreign jurisdiction include ease of communications with trustees and custodians, encryption and other technological capabilities, and of course safety and security, especially when crypto assets are involved.

Some jurisdictions are actively embracing and promoting expertise in crypto assets. Liechtenstein, for instance, passed the "Law on Tokens and Trustworthy Technology Service Providers", also known as the Liechtenstein Blockchain Act. The Bahamas has promulgated the Digital Assets and Registered Exchanges Act. Such laws provide a legal framework for digital assets, including governmental regulation of crypto custodians and service providers.

It should be noted that offshore asset protection works because the assets are physically removed from U.S. jurisdiction. The foreign fiduciary must own and take possession of the assets. Thus, the U.S. client must understand and get comfortable with the concept that the U.S. client cedes control over the asset to a trustee in a foreign country. If the U.S. client still controls the asset, then a U.S. judge can order the U.S. client to exercise that control and bring the assets back and made available to creditors. With respect to crypto assets, the grantor must therefore transfer the crypto assets to the trustee's digital wallet. Of course, any reputable foreign trustee, bank or other custodian will perform extensive due diligence and know-your-client analysis, including the source of the crypto assets, and will comply with strict anti-money laundering regulations.

Crypto as an asset class held in trust would operate like other asset classes held in trust. However, a significant difference is that the crypto assets would be held in "cold" storage, meaning that the crypto assets are physically separated from the Internet ("off-line") which offers more security against online hacking and theft. Further, the cold storage should be geo-redundant, or located in several different places, for added security. While the trustee keeps and controls the private keys, no one individual at the trust company should have complete control over the private keys. Instead, the trust company should have portions of the private key entrusted to various people, so that an unauthorized usage of the key would require multiple parties.

Domestically, many U.S. states have now passed local legislation allowing for domestic asset protection trusts (DAPTs), to attract assets to their states rather than to offshore jurisdictions. In so doing, these states allow for self-settled trusts which run counter to long-standing legal principles that if you settled a trust of which you are also the beneficiary, then your creditors could attack the trust. DAPT legislation also usually abolishes the Rule Against Perpetuities and allows for dynasty trusts. In 2020, Connecticut became the 20th state to allow for such self-settled asset protection trusts. Wyoming, in addition to offering DAPT laws, is also very crypto-friendly. Wyoming has implemented legislation specific to crypto (including property rights on par with traditional "fiat" currencies) and is the first state to issue official charters to depository institutions that provide banking and transactional services for digital assets. Such charters require the crypto banks to be fully reserved, i.e., maintain dollars or securities available to meet all possible withdrawal demands. Major crypto companies including Kraken, Cardano, Ripple Labs and Avanti Bank are located in Wyoming.

While domestic APTs may overcome a client's fear of sending his or her assets to a foreign country, domestic APTs may not offer asset protection as good as offshore APTs. First, DAPT assets are still within the jurisdiction of the U.S. legal system and are subject to seizure or forfeiture by a U.S. judge. Second, domestic APTs are untested in many aspects, especially under the Full Faith and Credit Clause of the U.S. Constitution. Under this clause, a judgment from, e.g., New York, a non-DAPT state, is required to be honored in a DAPT state like Wyoming. Third, a judge in a non-DAPT state could order a DAPT void as against public policy. See, e.g., In re Huber, 201 B.R. 685 (Bankr. W.D. Wash. 2013) (Washington Bankruptcy court refused to apply Alaska DAPT law because of Washington's public policy interest against self-settled trusts); Dahl v. Dahl, 2015 UT 23 (Utah 2015) (Utah law, rather than Nevada law, governed interpretation of Nevada APT, and Utah had a substantial public policy interest in including DAPT assets in equitable division of marital property). The DAPT case law to date suggests that grantor residents of non-DAPT states (such as New York) who avail themselves of the laws of DAPT states should not expect their DAPTs to be upheld in their home states. While crypto assets are, by definition, not located in one single state because crypto is decentralized on the blockchain, a judge could still order a DAPT trustee to, for instance, transfer crypto currency or surrender private keys.

Should the client, therefore, instead look toward offshore APTs, then in addition to the client having to accept loss of control over the asset (in favor of the trustee), the client also must understand the U.S. tax implications of establishing an offshore APT. Such a trust is considered by the IRS to be a grantor trust, which means that the grantor (i.e., the client) is still considered to own the trust assets (even though the foreign trustee owns and controls the assets) and the grantor is responsible for reporting the trust to the U.S. government and paying any U.S. tax on the assets in the trust. The grantor will be responsible for filing IRS Forms 3520, 3520-A, 8938 and FinCEN Form 114 (also called the FBAR form), among others. Income from the crypto assets in the foreign trust is attributable to, and reportable by, the client grantor. For federal tax purposes, because virtual currency is treated as property, rather than currency (see IRS Notice 2014-21), every disposition of virtual currency, whether to trade, sell, as payment for a good or service, etc., is taxed as a capital gain or loss. (Further, because cryptocurrency is considered property, this also provides a basis for attachment or seizure by creditors.) Gain or loss from virtual currencies is reported on IRS Form 8949 and Form 1040 Schedule D, which apply to short-term and long-term capital assets. Clients should be aware that a foreign asset protection trust containing crypto assets should not be considered "secret" or a tax-avoidance strategy. While protecting assets from creditors, one must not run afoul of the IRS.

Over the last decade, market capitalization of crypto assets has now reached approximately $2 trillion. For many people, digital assets now comprise a substantial component of their wealth. As clients seek to protect their assets from future creditors and threats, asset protection attorneys should focus on the specific requirements for protection of crypto assets. Clients residing in states that have adopted domestic asset protection trust laws may find that their home states provide some degree of protection. However, other clients should be prepared to explore the laws of foreign jurisdictions, which provide maximum protection for crypto assets.

Asher Rubinstein is a partner at Gallet Dreyer & Berkey. His practice focuses on domestic and international asset protection, wealth preservation, estate planning, tax planning, tax controversy, offshore tax compliance, and related litigation. Mr. Rubinstein is a recognized expert on offshore entities, foreign banking and IRS compliance issues.