The following article is excerpted from Family Lawyer Magazine.com and was written by Doug Fredrick (BBA, JD).
Bitcoin, Blockchain, Cryptocurrency, and Family Law
The Birth of Bitcoin and Blockchain
The Internet is a platform on which countless applications and products have been built – e-mail, social media, and online shopping, and smartphones are conduits for these products and services. Similarly, blockchain technology is a new platform on which cryptocurrencies, smart contracts, and other financial products and services are being created.
The genesis of Bitcoin and blockchain technology was in October 2008, when Satoshi Nakamoto published a nine-page white paper on a cryptography email list titled “Bitcoin: A Peer-to-Peer Electronic Cash System.” In that publication, he introduced the world to blockchain technology and, simultaneously, a new unit of value called Bitcoin. He described Bitcoin as a “purely peer-to-peer version of electronic cash.” In January 2009, Nakamoto released the software on which the first units of Bitcoin were created.
The identity of Satoshi Nakamoto only contributes to Bitcoin’s ethereal nature, because it remains a mystery to this day. Theories have abounded as to the gender, age, and nationality of the person behind the screen name. Some have even postulated that Satoshi Nakamoto is actually the product of a conglomerate of individuals. Regardless of whether Satoshi Nakamoto is a person or many people, what is undeniable is that blockchain technology and cryptocurrency are very much part of our reality, and they are proving to be the next evolution in digital transactions. For example, Ripple has licensed its blockchain technology to more than 100 banks, and in October 2017, American Express adopted Ripple’s blockchain technology.
Blockchain Technology
For all of its merits, Blockchain technology is not entirely a new technology. Rather, it is a combination of proven technologies applied in a new way. It was the particular orchestration of three technologies (the Internet, private key cryptography and a protocol governing incentivization) that made Satoshi Nakamoto’s idea so useful. Essentially, blockchain is an open, public, decentralized ledger that records transactions between two parties in a permanent manner.
Traditional electronic payments such as credit cards, PayPal, ApplePay and Automated Clearing House (ACH) payments move through phone lines, cellular networks or the Internet, and utilize the software and hardware that is created and installed by the company that is facilitating the transaction. The same company that facilitates the transactions maintains a central ledger that keeps track of all transactions that flow through their network, software, and hardware.
To the contrary, transactions sent through a blockchain enable one person or entity to send cryptocurrency directly to another person or entity without the use of a third-party intermediary. The ledger that records the transactions is public and available to all of the computers that are connected to that particular blockchain network. As a means of comparison, a similar file-sharing system, called Napster, was created in 1999 that allowed users (albeit illegally) to share music directly with one another. Although Napster had no central ledger of any kind, it was a way to transfer digital files directly between two people.
There are many different blockchain networks; each one has its own unique unit of value that is tailored to a particular use. Bitcoin is one of many different cryptocurrencies. As of the time of writing, the most popular “cryptos” are (in order of market capitalization) Bitcoin, Ethereum, Ripple, Bitcoin Cash, EOS and Litecoin.[7]
How Cryptocurrency Transactions Work (Generally Speaking)
In a practical sense, transferring cryptocurrencies is no different than paying bills or transferring money between accounts online or through an app on your smartphone; the process takes just a minute or two to complete (the actual transmission of funds can take anywhere from a few seconds to several days). Technically speaking, a transaction begins when User 1 initiates a request to send cryptocurrency to User 2. This is typically done through a smartphone app or a website. The supercomputers that are connected to that particular blockchain network first validate that User 1 owns the amount of cryptocurrency requested to be transferred. Next, they validate that User 1 hasn’t previously sent/spent the currency that will be transferred. This prevents cryptocurrency from being spent more than once.
Once a majority of computers on the network confirm that User 1 owns the amount of cryptocurrency requested to be transferred and hasn’t previously spent it, the transaction gets added to the public ledger as a “block” in the chain of transactions. Since there is no intermediary that controls the ledger, transactions cannot be reversed or changed in any way, because it would require undoing all of the blocks that came before the block being altered. This unique attribute of blockchain technology prevents the same cryptocurrency from being fraudulently transferred.
Cryptocurrencies are stored in accounts commonly referred to as wallets, which are essentially digital accounts that can be accessed by logging into a website or using a smartphone app. Unlike bank accounts, they are not insured by the FDIC. However, it does insure up to $250,000 of United States Dollars in Coinbase wallets, if held by a United States citizen. Most wallets are not designed to contain U.S. Dollars or Euros.
Each wallet is randomly assigned a unique public key that is comprised of thirty-four alphanumeric characters that cannot be changed. Each public key has a corresponding private key which is a series of sixty-four alphanumeric characters. Using the example from above, User 1 would type in or scan User 2’s public key into their request to send funds, and then User 1 would authenticate and finalize the transaction with their private key. This history of the public keys of both Users on the blockchain is then reviewed and approved by multiple supercomputers connected to the blockchain network.
How Are Cryptocurrencies Created?
Cryptocurrencies are created one of two ways: by issue or by mining. Some companies, through massive amounts of computer code, have created their own currency and/or blockchain network, such as Ethereum and Ripple. These companies simply release a fixed number of their unique units of value (“coins”) onto their networks. Coins can also be released by the mining process. The term “mining” is misleading because the process is nowhere near what the average person thinks of when they picture minerals being dug or blasted out of the earth. Every ten minutes or so supercomputers (called “nodes” or “miners”) collect a few hundred pending bitcoin transactions (a “block”) from the network and turn them into a mathematical puzzle. The first node/miner to find the solution announces it to others on the network. The other miners then check whether the sender of the funds has the right to spend the money and whether the solution to the puzzle is correct. If enough of the nodes on the network agree with the solution and announce their approval, the block is cryptographically added to the ledger and the miners move on to the next set of transactions (hence the term “blockchain”). The miner who found the solution gets 25 Bitcoins as a reward, but only after another 99 blocks have been added to the blockchain ledger. This gives miners an incentive to participate in the system by validating transactions.
Understanding the Value of a Cryptocurrency
In order to begin to understand the value of cryptocurrency, one must first ask, “Why does anything have value?” The rhetorical answer is, “Because people believe it does.” The reason a yellow-colored mineral called gold has value is because people collectively believe it does. Why is a piece of paper produced by a slot machine with a bar code and numbers printed on it worth the stated value? Because people believe it is. Will the casino guaranty the exchange of that piece of paper for U.S. currency? In most cases, yes. Can you take that certificate to the gas station next door and trade it for fuel? No.
The reason fiat currencies such as the United States Dollar have been successful is because governments have convinced a critical mass of people that a rectangular piece of paper is worth the amount printed on the bill.
Moving on to digital transactions, if money is fraudulently transferred out of a bank account, the FDIC will put money back into that account – but is that what really happens? A series of digital transactions occur and people believe they have their money back because that’s what it says on their computer screen. If you want to buy a cup of coffee with a credit card, you swipe a plastic card in an electronic device, a series of computers in different locations communicate with each other to verify available funds and complete the transaction, and then based on the faith in that computer system, the barista hands you a cup of coffee. We have been living in a digital economy for quite a while now, and in that sense, cryptocurrencies do not require a very large leap of faith.
The two most common aspects of cryptocurrency that challenge the traditional notions of monetary value are:
- The absence of a centrally controlled ledger and an entity that controls all of the data, and
- The lack of an entity that will replace or refund your money if it is stolen or if the entity that holds your money collapses.
The cryptography and mathematical certainty of blockchain transactions negate the necessity of those two concepts.
Another hallmark of value is scarcity. When Satoshi Nakamoto unleashed Bitcoin, there were a total of 50 coins, and the mathematical formula would (and does) produce batches of new coins every 10 minutes. Nakamoto established a limit of 21 million Bitcoins that would ever be created. If the current rate of mining of Bitcoins sustains itself, that limit is expected to be reached around the year 2140. A total of 60 million Ether were created and Ripple initially created 100 billion of its coins.
Before a thing can be valued, it must first be clearly defined. A dollar is first and foremost a form of currency and means of exchange. A currency/asset hybrid is the American Gold Eagle, which is the official gold bullion coin of the United States. A Gold Eagle is utilized primarily as a store of value and it is regulated and traded as a commodity, but it can also be legally used as a means of exchange if two parties are willing to use it in that way.
Some cryptocurrencies will evolve into commodities, while others will become true means of exchange. As Bitcoin has ascended in value, transactions times have slowed due to a saturation of the network, and government entities have begun to regulate it, it is being treated more like a commodity. By way of comparison, Bitcoin has become the digital cousin of gold, while Litecoin is thought of as the digital cousin of silver; less valuable with quicker transaction times, and thus more amenable as a means of exchange.
Valuing Cryptocurrency in Divorce/Dissolutions of Marriage
A trial court is prohibited from entering a valuation of marital property not supported by evidence at trial, but the trial court, nonetheless, enjoys broad discretion in valuing marital property. The trial court is entitled to believe or disbelieve the testimony of either party concerning the valuation of marital property in a dissolution proceeding, and the court can disbelieve expert testimony. The judicial determination of value must be an informed judgment, but fair “value” is not susceptible of determination by any precise mathematical computation.
Generally, the appropriate date for valuing marital property in a dissolution proceeding is the date of trial. However, where the division of property is not reasonably proximate to the time of trial, the valuation date should be the date of the division of the property, in that it cannot be said that distributions based upon stale valuations are based on value, for value is by no means a constant. Market conditions and changing economic circumstances can render assets that had been valuable months or years earlier virtually worthless in the present, and vice versa. To distribute marital property without regard to such fluctuations would be illogical. Hence, in those cases where the date of trial is not reasonably proximate to the date of the actual distribution of the marital property, the court could hold another hearing to determine the value of the marital property at the time of its division.
Cryptocurrencies have existed for approximately ten years, but in many ways, they are still in their infancy. The wild fluctuations in value they experience should become less frequent as the technology matures, acceptance grows, and regulation increases. Until then, they will continue to have extreme vacillations in value in sometimes unpredictable ways. In order to prevent the value of cryptocurrencies from becoming stale, judgments must be entered in a timely manner; otherwise, subsequent evidentiary hearings may be necessary.
There is no single, universally recognized entity that announces the value of cryptocurrencies. The New York Stock Exchange is relied upon when valuing stocks or bonds; the values published by the NYSE are generally accepted by the public to be the actual, true value of the stocks listed on that exchange. In the same way, several websites have been created to track the values of cryptocurrencies. However, the three largest cryptocurrency exchanges, Coinbase, Kraken, and Bitstamp sometimes assign slightly different values to the same cryptocurrency. A Court could base its valuation of cryptocurrency on a snapshot of one of these exchanges.
In addition to its spot price, a cryptocurrency’s market capitalization (the price of a cryptocurrency multiplied by the total number of coins issued) is displayed on these exchanges. This can be a useful means of valuation, but it is not always reliable, because sometimes the number of available coins on a particular blockchain do not yet exist because they have not yet been mined or are being released slowly over time into the market.
A more specific method of proving the value of a specific crypto wallet would be a screenshot of the wallet, which will display the current value of all cryptocurrencies held in that account, just like a bank account or brokerage account.
It’s possible that a litigant may have developed a proprietary blockchain during the marriage. In order to value the technology itself, Metcalfe’s law may be helpful. While more theoretical in nature, Metcalfe postulated that the value of a network is proportional to the square of the number of users on the network. Common examples of this law are cellular telephone networks and social media platforms, such as Instagram, Twitter, and Facebook; the more individuals who participate in the network, the more valuable the network becomes. If the blockchain that the litigant created has no users and is simply sitting on a hard drive somewhere, it may have relatively little value, but the more computers that are connected to that network and utilizing that blockchain’s technology, the more valuable it may be.
Cryptocurrency Discovery
Generally, cryptocurrencies should be clearly defined. A recommended definition of “cryptocurrency” is: A digital unit of value that utilizes blockchain technology and cryptography and includes, but is not limited to, Bitcoin, Bitcoin Cash, Litecoin, Ether, Ripple, and any other digital coin, token or alt-coin.
Smart Contracts
Smart contracts are digital transactions that incorporate blockchain technology in an “if-then” fashion. For example, the details of the sale of a vehicle (sales price, taxes, and fees, all of the information otherwise contained on a certificate of title, verification of funds of the buyer) could be uploaded onto a blockchain network. Once both parties certify that the vehicle has physically changed possession from the seller to the buyer, the funds are transferred and the information from the sale permanently becomes part of the blockchain’s public ledger; everything happens instantaneously and simultaneously.
Rather than placing trust in the Department of Revenue to keep accurate records that are sometimes difficult to access and/or view, trust would be placed in the blockchain. The only source of error would lie with the individual who is building/coding the transaction by typing inaccurate data, but even much of that information would preexist on the blockchain (previous owners, VIN, make, model, year and possibly maintenance and accident history) making the possibility of error negligible. Smart contracts can also implement business rules, such as transactions that take place only if two or more parties endorse them, or contingent transactions that are triggered only if another transaction has been completed first.
The sequential nature of blockchain networks naturally lends itself to transactions such as recording documents that transfer ownership of real estate or vehicles, as well as maintaining medical records, are processes that could benefit from this technology. The Recorder of Deeds’ office is especially predisposed to implementation of blockchain technology, because a large part of what they do is maintain a public ledger, so it would be a relatively small step to digitize and automate the process of recording real estate documents and even marriage certificates. Several years ago, Missouri transitioned away from a filing system that utilized fax machines and hand-delivered documents and moved to an electronic filing system. The next logical step would be to transition to a blockchain-based system. Each county would likely need to have its own blockchain network, which may be easily implemented, but the technicalities of how that might happen are outside the scope of this article. Obviously, achieving that reality will not happen any time soon, but if Moore’s Law (roughly stated: the speed of computing doubles every two years) is applied to blockchain technology in general, it will not be as far off as one might think.
Smart contracts are already gaining recognition under the law. The governor of Tennessee recently signed a bill that legally recognizes blockchain data and smart contracts under state law. The spread of blockchain networks is bad for centralized institutions and bureaucracies, such as banks and government authorities. It is possible that the need to have documents notarized may eventually become irrelevant or redundant because all of the necessary information could be embedded into the blockchain and transferred instantly and infallibly. The public ledger would also remove the need for reconciling each transaction with a notary book. Given the increase in the hacking and theft of information from large companies such as retail stores, banks and credit card companies, as well as governmental institutions like the United States Office of Personnel Management, transactions that are incapable of being modified or changed and complete transparency of the public ledger could be a good thing.
The Future of Bitcoin, Blockchain, Cryptocurrency, and Family Law
Credit cards and other forms of electronic payments have become an integral part of our nation’s commerce. In 2009 credit cards officially surpassed paper check transactions in the United States. American Consumer Credit Counseling conducted a survey that found 80% of consumers use their debit card to pay for everyday purchases such as gas, meals, and groceries. The difference between ApplePay and credit cards is that ApplePay does not utilize a tangible card to make payments, all aspects of the transaction are facilitated by an iPhone. Paying with a credit card, ApplePay and now Bitcoin are seemingly small, but significant steps away from traditional methods of transacting money and towards a fully digital economy.
For more information contact me at 203-544-9945 or beth@eedwardslaw.com.
