Many people believe cryptocurrency, such as bitcoin, might be the holy grail of asset protection. They think that cryptocurrency cannot be garnished or seized by a judgment creditor, and they think that cryptocurrency holdings are confidential assets that debtors do not have to disclose bitcoin to creditors.
Alas, cryptocurrency may not be as protected as some people may think.
What Exactly is Cryptocurrency?
Cryptocurrency, or virtual currency, including its best-known product “Bitcoin,” is a currency alternative and a new payment system. Cryptocurrency is expressed as credits recorded on a publicly available online ledger, or blockchain. In any transaction, payment and receipt of cryptocurrency changes the buyer and seller balances on their respective ledgers. The crypto blockchain ledger is distributed to computers worldwide, and transactions are validated by the worldwide distributed ledger.
A person who buys cryptocurrency obtains a personal online wallet that acts as a ledger of his own cryptocurrency transactions and currency balances. The owner gets a private digital key (a string of characters) to control his digital wallet. Only the possessor of the private key may make withdrawals and activate payments. Anyone can send cryptocurrency to your wallet address, but only the owner with his private digital key can transfer cryptocurrency from his own address. Cryptocurrency transfers are final and irreversible. Once a party sends cryptocurrency to a recipient, there is no way to cancel or reverse the transaction.
Records of transactions between crypto addresses are public. The sender and recipient’s digital address is recorded and listed for every exchange. However, the records of the sending and receiving cryptocurrency addresses do not identify the owner of the address. There is no online record that identifies a person associated with any digital cryptocurrency transaction.
A cryptocurrency owner can maintain his digital key himself either on his personal computer or in a physically secure location. Self-storage of crypto keys ensures privacy and anonymity of a person’s cryptocurrency holdings. No one else has enough information to discover or manipulate the cryptocurrency. If the owner forgets or loses his digital key he has no way to retrieve his currency. There also have been instances of theft of keys held in the owner’s possession.
Where Do You Store Cryptocurrency?
Most investors can use third party apps or services to hold and exchange cryptocurrency. A popular issuer of cryptocurrency exchange and holder of crypto wallets is the internet app Coinbase. The third-party cryptocurrency service like Coinbase holds securely the customer’s cryptocurrency and his digital key. Coinbase accounts cannot be forgotten, lost, or stolen.
Coinbase uses the customer’s digital information to facilitate transactions on the customer’s behalf. Coinbase provides a procedure to exchange cryptocurrency for traditional hard currency at current market value. The customer can liquidate all or part of a Coinbase account and receive hard currency. Most cryptocurrency exchanges are lesser known and are located outside the United States.
Do Debtors Have To Disclose Their Bitcoin and Cryptocurrency To Creditors?
A judgment creditor discovers the debtor’s financial accounts and other assets through post-judgment discovery. Debtors are required to testify under oath about the nature, value, and location of all their assets, including, for example, their bank accounts and securities accounts. A judgment creditor may ask the debtor under oath about the debtor’s ownership of cryptocurrency and his history of crypto transactions. The creditor may ask the debtor to reveal his digital passwords during post-judgment discovery and testify about any third-parties that hold his cryptocurrency wallets.
The court may hold a debtor in contempt of court if the debtor does not testify truthfully and fully about his holdings of cryptocurrency. There would not generally be any objection that a debtor could make to the disclosure of digital passwords or the location of digital passwords.
Can Creditors Garnish Bitcoin and Other Cryptocurrency?
Creditors have various tools to collect money judgments. Garnishment is the collection procedure whereby a judgment creditor can levy upon or intercept debts that a third party (the “garnishee”) owes to the judgment debtor. Serving the writ of garnishment requires that the third party owing money to the debtor to pay the debt to the judgment creditor.
Writs of garnishment are most often served on banks. The bank is indebted to the customer for the amount of deposits, and upon the customer’s demand the bank must pay money in the debtor’s account to the debtor or to a third party designated by the debtor by means of a check or online payment authorization. The bank owes a debt to its customers for the customer demand deposits, and a judgment creditor may garnish the bank’s debt by seizing the debtor’s account.
There is truly little case law pertaining to garnishment of cryptocurrency accounts. Clearly, if a judgment debtor maintains privately his digital keys and passwords in self-storage there can be no garnishment of the crypto because there is no third-party servicer, like Coinbase, that owes a debt to the debtor. Generally, a judgment debtor would have great difficulty discovering and accessing a debtor’s private records of cryptocurrency ownership and cryptocurrency transactions.
The relationship between Coinbase and its customers is similar to, but yet different from, a banking relationship. To the extent Coinbase agrees to liquidate return a customer’s crypto currency upon request, the relationship with its customers resembles a banking relationship.
Yet, the Coinbase customer agreement is different in material ways from the traditional agreements governing banking demand accounts. While there are statutes and legal history in every state that define and regulate banking account relationships, there is little legal history and no statutes pertinent to Coinbase cryptocurrency accounts.
Most likely, a court would find that there is a sufficient obligation on Coinbase (and other exchanges) to its customers to warrant garnishment of an account owned by a judgment debtor unless the account was otherwise exempt from process under applicable state law.
Garnishment of Coinbase may be feasible because Coinbase is a U.S. company subject to U.S. court jurisdiction. Even then, Coinbase is located in California. It maintains a registered agent in Florida, but it has no business address in Florida. Florida courts have held that money is held at the bank branch where the account was opened, and creditors may not garnish bank accounts opened and located outside of Florida. The same rule probably applies to cryptocurrency exchanges. The location of the debtor’s Coinbase assets, ledger, and keys, likely is at the Coinbase office in California where the account was opened and maintained. A judgment creditor may first have to domesticate a judgment in California before attempting to garnish a cryptocurrency exchange in that state.
Can a Creditor Take Offshore Bitcoin and Crypto Accounts?
Garnishment may be even more difficult when the judgment debtor utilizes foreign cryptocurrency exchanges. A U.S. judgment creditor definitely could not use a Florida court to garnish a cryptocurrency exchange, or an account operated overseas. Domesticating a judgment in another country, and then using that country’s remedies to go after a cryptocurrency exchange in that country, is both expensive and likely impractical.
How Can a Creditor Take a Judgment Debtor’s Bitcoin and Crypto?
An aggressive creditor may try collection tactics other than garnishment to reach the debtor’s cryptocurrency. If the judgment creditor domesticates a Florida judgment in California, the resulting judgment lien may give the creditor the right to levy on digital records maintained at the Coinbase account.
Also, a creditor may seek a court order requiring Coinbase or other cryptocurrency service to release the debtor’s digital currency information. A court could also compel a debtor to reveal under oath his passwords and digital keys to privately maintained cryptocurrency not held at Coinbase or any other third-party exchange. Enforcement of such order would be difficult.