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Bitcoin, Cryptocurrencies And Divorce
***Updated in March 2021 to reflect the massive interest in cryptocurrencies***
Millions of people have purchased Bitcoin and other cryptocurrencies. Millions of people have also gotten divorced. Therefore, several Bitcoin owners got divorced and had to address the division of their marital assets…which include cryptocurrencies which are difficult to verify and difficult to value.
Disclosing Bitcoins And Cryptocurrencies In An Illinois Divorce
In an Illinois divorce the first step in regards to division of marital assets is a full disclosure of all assets both marital and non-marital.
All assets should be listed on the financial affidavit. The financial affidavit does not include a spot to declare cryptocurrencies like Bitcoin. But there is a section for “Cash or Cash equivalents.”
“Bitcoin clearly qualifies as “money” or “funds”…Bitcoin can be easily purchased in exchange for ordinary currency, acts as a denominator of value, and is used to conduct financial transactions.” United States v. Faiella, 39 F. Supp. 3d 544, 545 (S.D.N.Y. 2014)
Cryptocurrencies must be disclosed on the financial affidavit. Failure to do so will result in sanctions.
“If a party intentionally or recklessly files an inaccurate or misleading financial affidavit, the court shall impose significant penalties and sanctions including, but not limited to, costs and attorney’s fees” 750 ILCS 5/501(a)
Typically, the opposing party’s attorney will scour the financial affidavit and ask for documents to verify the claimed assets.
The opposing party’s attorney will issue a “Notice To Produce” asking for copies of statements for your 401k, bank accounts, etc. If you have access to those documents, you must provide the opposing party a copy of those documents if they request it. Failure to do so can result in a finding of contempt of court.
But, how would you verify Bitcoin holdings? Would you print a screen grab from Coinbase or other online platform through which you hold Bitcoin or other cryptocurrencies? Would you entrust your ex or their attorneys with the password to your accounts?
Some U.S. based coin exchanges such as Coinbase and Kraken will issue a 1099-K each year if there have been $20,000 or more in exchanges of cryptocurrency.
Illinois Department of Revenue requires that “Starting with the 2020 tax year and after, Forms 1099-K must be submitted electronically to Illinois when four or more separate transactions exceed $1,000 or if you are required by the IRS* to electronically file Forms 1099-K.” So, virtually any 4 crypto-currency purchases, sales or trades will trigger a 1099-K in Illinois and the cryptocurrency holder will have those 1099-K as part of their standard tax packet.
If your spouse will not fully disclose their cryptocurrency holdings, you will have to turn to third parties to discover those holdings.
Subpoenaing Cryptocurrency Exchanges
If you cannot provide adequate evidence of your assets, the opposing party may issue subpoenas to third parties in relation to your case. For example, the opposing party may issue a subpoena to your 401k account provider who will summarily provide any records asked for if there is no written objection. But, in the case of Bitcoin and other cryptocurrencies, who can be subpoenaed? Cryptocurrencies by their very nature exist on a peer-to-peer network that is not held by any one individual. There is no holder of the asset to subpoena. But, you can subpoena cryptocurrency exchanges for the records of transactions.
The most popular cryptocurrency exchange, Coinbase, allows themselves to be subpoenaed. Coinbase’s website invites you to send subpoenas to their local Illinois registered agent: CT Corporation System (Chicago), 208 S. Lasalle Street Suite 814, Chicago, IL 60604.
Coinbase and other exchanges do not hold cryptocurrency. They merely effectuate the transaction. So, a subpoena to Coinbase will be like subpoenaing a bank and asking not “what’s in your accounts?” but rather “what checks have your clients issued.”
Websites like Localbitcoins.com allow anonymous transactions of bitcoins. These sites don’t take any information from their users and merely connect a cryptocurrency seller with a cryptocurrency buyer. These sites don’t have terms of service. These sites don’t issue 1099s. Nor could they as the sites don’t even know who is using them. It is tough not to describe these sites as facilitating money laundering via cryptocurrency.
Where Are Bitcoins Kept?
Once it’s been determined that an exchange of Bitcoins or other cryptocurrency has occurred. The next step is to determine what cryptocurrency a divorcing spouse currently holds. This again is a herculean task.
Bitcoins are not a physical thing. A bitcoin is a string of digital signatures, which can be accessed/sent through the use of addresses. One address is a private address used to send Bitcoins. The other address is the public address which is used to receive Bitcoins.
A private Bitcoin address starts with a 5 and looks like this: “5Pl9tLf9zgWQnofmnQA76MzQL6LsYZY36hWXMssStNvdYZYC9LF”
A public Bitcoin address starts with a 1 and looks like this: “1VABe6T4Kz3unMAxJ457mA52fkXhrF7kZm”
The addresses can be written on a piece of paper, stored on a computer, etc. If the address is forgotten or misspelled…well, the Bitcoin is gone forever.
Because of the risk of the Bitcoin disappearing should the address be lost, most Bitcoin holders have a “software wallet.” Companies such as Breadwallet or Edge provide such “wallets” and back up the data. Most cryptocurrency exchanges provide their own software wallets.
A bitcoin wallet can be carried separate from any computer on a memory stick made by companies such as Trezor and Ledger. The advantage of having a physical Bitcoin wallet is that it cannot be hacked…but it can be lost. A lost hardware wallet has a recovery seed which allows the owner to retrieve the bitcoin addresses.
If you are able to obtain your spouse’s private key. You will be able to examine the blockchain to determine all of the transactions associated with that Bitcoin.
This tracing can be stymied by sophisticated Bitcoin holders who do “bitcoin mixing.” There are services such as CoinMixer and UltraMixer, which allow a Bitcoin owner to break the link between addresses by either creating temporary addresses or by swapping coins with other addresses of the same value.
Furthermore, there are cryptocurrencies such as Dash, Monero, and Zcash which qualify as “private coins.” When using private coins, the identity of users and the origins of their transactions are completely protected.
Searching Your Spouse’s Computer For Cryptocurrency
Because of these various ways to mask cryptocurrency use and possession, it may be necessary to search through a spouse’s phone or computer (that’s the only way to buy, sell and trade cryptocurrency).
“[A] party may obtain by discovery full disclosure regarding any matter relevant to the subject matter involved in the pending action, whether it relates to the claim or defense of the party seeking disclosure or of any other party, including the existence, description, nature, custody, condition, and location of any documents or tangible things, and the identity and location of persons having knowledge of relevant facts.” Ill. Sup. Ct. R. 201(b)(1)
“Any documents” includes computer files and computer history.
“The word “documents,” as used in [the Illinois Supreme Court Rules] includes, but is not limited to, papers, photographs, films, recordings, memoranda, books, records, accounts, communications and electronically stored information as defined in Rule 201(b)(4).” Ill. Sup. Ct. R. 201(b)(1)
The Illinois Supreme Court Rules further specify as to what “electronically stored information” will be deemed to be.
“Electronically Stored Information. (“ESI”) shall include any writings, drawings, graphs, charts, photographs, sound recordings, images, and other data or data compilations in any medium from which electronically stored information can be obtained either directly or, if necessary, after translation by the responding party into a reasonably usable form.” Ill. Sup. Ct. R. 201(b)(4)
A spouse can object to having their phone or computer searched, however.
“A party served with the written request shall…serve upon the party so requesting written objections on the ground that the request is improper in whole or in part.” Ill. Sup. Ct. R. 214(c)
The basis of such an objection would be that the search would be so broad as to give up all private information contained on the computer or phone.
“Although our civil discovery rules provide for a broad scope of discovery, parties engaged in litigation do not sacrifice all aspects of privacy, confidentiality, and privilege.” Custer v. Cerro Flow Products, Inc., 136 NE 3d 1108 – Ill: Appellate Court, 5th Dist. 2019
Simply limiting the search of a computer for words such as “Bitcoin” or “wallet” would sufficiently allow for reasonable discovery while preserving the spouse’s privacy.
How Do You Divide Cryptocurrency In An Illinois Divorce?
After determining the existence and quantity of a party’s cryptocurrency, the next step in the analysis is “what portion of the cryptocurrency is marital?”
Illinois law says “the court shall assign each spouse’s non-marital property to that spouse.” 750 ILCS 5/503(d)
“‘[M]arital property’ means all property, including debts and other obligations, acquired by either spouse subsequent to the marriage” 750 ILCS 5/503(a)
Illinois divorce courts then “divide the marital property without regard to marital misconduct in just proportions” 750 ILCS 5/503(d)
While hiding money in cryptocurrency may be “marital misconduct” which the court is not allowed to “regard,” the court has enormous leeway as what exactly is a “just proportion.”
“The circuit court has broad discretion to distribute marital assets, and mathematical equality is not required.” In re Marriage of Hubbs, 843 NE 2d 478 – Ill: Appellate Court, 5th Dist. 2006
Rest assured that a failure to disclose cryptocurrencies, using off-shore exchanges, bitcoin mixing and using private coins will lead an Illinois divorce judge to award the other spouse a much greater proportion of the known marital assets to compensate for what remains unknown.
If the cryptocurrency held by you or your spouse is a mix of marital and non-marital property, you’ll have to unwind the respective values based on when they were purchased (before or after the marriage).
Finally, determining the value of the cryptocurrency will be difficult. The volatility of the price of these assets makes it very difficult to adequately value at the time of the divorce. Discovery and final negotiation of a divorce often takes months and in that time a cryptocurrency could double or halve in value.
A cash out of the cryptocurrency before the finality of the divorce is probably advised to finalize the marital value.
An Illinois divorce court can order “other appropriate temporary relief including, in the discretion of the court, ordering the purchase or sale of assets and requiring that a party or parties borrow funds in the appropriate circumstances.” 750 ILCS 5/501(a)(3)
Dissipation Of Marital Assets And Cryptocurrency In An Illinois Divorce
Cryptocurrencies have no inherent value. Their prices are extremely volatile. An “investment” in cryptocurrency could be deemed a dissipation of marital assets should the value of the particular cryptocurrency collapse.
Illinois case law says that “Dissipation is defined as the use of marital property for one spouse’s benefit for a purpose unrelated to the marriage at a time when the marriage is undergoing an irreconcilable breakdown” In Re Marriage of Tietz, 605 NE 2d 670 Ill Appellate Court, 4th Dist. 1992.
A finding of dissipation allows the non-dissipating spouse to recover the lost money from the marital estate as though it were never lost.
There is a window of time in which you can claim that the cryptocurrency investment was a dissipation of assets.
“[N]o dissipation shall be deemed to have occurred prior to 3 years after the party claiming dissipation knew or should have known of the dissipation, but in no event prior to 5 years before the filing of the petition for dissolution of marriage;” 750 ILCS 503(d)(2)(iv)
So, if you knew about the cryptocurrency trading, you can only reach back 3 years to recover losses. If you didn’t know about your spouse’s crypto accounts, you can go back 5 years.
I originally wrote this article in 2018 and speculated that “in the future, I am certain that we will have new legislation and appellate court cases to guide us in regards to this new asset and how it will be treated under Illinois law.” Three years later, nothing has happened from either the Illinois legislature or the Illinois Supreme Court. Meanwhile, the technology has gotten more sophisticated while the value of cryptocurrencies has gone even higher. So, it’s especially important to have an attorney who understands cryptocurrency as there are literally no rules regarding cryptocurrency and divorce.
Contact my Chicago, Illinois office to learn more about what will happen to your Bitcoin and other cryptocurrencies in your divorce.