With the explosion of new cryptocurrencies in the last few years, federal agencies have increased scrutiny of their creation and transfer. While the cryptocurrency industry has begun to comply with the rules of the IRS, SEC, and other government agencies, the industry has not yet faced much enforcement from state unclaimed property administrators. But, as the use of cryptocurrencies increases and state unclaimed property administrators and third-party auditors became more knowledgeable about them, the cryptocurrency industry should be aware of its potential obligations under current unclaimed property laws.
Are Cryptocurrencies ‘Property’ for Unclaimed Property Purposes?
States’ unclaimed property statutes require companies holding “intangible property”—usually defined very broadly to include bank accounts, brokerage accounts, refundable credit balances in other kinds of customer accounts, uncashed checks, and almost any kind of fixed and certain obligation to pay money to another—to turn over custody of the intangible property to the state if the property is presumed abandoned due to failure of the owner to claim the property or have contact with the holder concerning it during a specified period of time, known as the “dormancy” period. Different types of property are presumed abandoned after different dormancy periods of owner inactivity, depending on the specific state’s law that applies. Therefore, determining which category of property cryptocurrencies fall under is critical, and not always easy.
The 2016 Revised Uniform Unclaimed Property Act (the Revised Uniform Act) lists “virtual currency” as an escheatable property type. The Revised Uniform Act defines “virtual currency” as “a digital representation of value used as a medium of exchange, unit of account, or store of value, which does not have legal tender status recognized by the United States,” but expressly excludes from the definition “the software or protocols governing the transfer of the digital representation of value,” “game-related digital content,” or “a loyalty card [or gift card].” The commentary to the Revised Uniform Act notes that this definition is from the draft of the Uniform Regulation of Virtual Currency Act, with the intention “that the two definitions should be harmonized.” Four states (Illinois, Kentucky, Tennessee, and Utah) have adopted the Revised Uniform Act’s definition of virtual currency. More states will likely follow as they adopt versions of the Revised Uniform Act.
The exclusion of game-related digital content, a loyalty card, or a gift card from the Revised Uniform Act’s definition of virtual currency is significant, signaling that something that might otherwise be considered virtual currency will not be treated as such if it also falls within the definition of in-game digital content, a loyalty card, or a gift card—all of which are expressly exempt from unclaimed property reporting in many states. So the first step in the analysis of a particular potential type of virtual currency should be to determine if it also falls within the definition of those other property types. If so, the unclaimed property treatment should be based on the state’s treatment of in-game digital currency, loyalty cards, or gift cards, as the case may be.
There is the real possibility that many—perhaps most—cryptocurrencies could fall under a broad definition of gift certificates or gift cards. A common definition of gift certificate or gift card in state unclaimed property laws is “a record evidencing a promise, made for consideration, to provide goods or services of the value stated in the record to the owner of the record.” Many retailers offer stored-value cards that customers can load value to and redeem for goods and services of that retailer. Instead of denominating the card value in U.S. dollars, a retailer could permit customers to load bitcoins (or some other proprietary cryptocurrency that may be usable only on that retailer’s platform) onto their cards. Should a state unclaimed property administrator treat a stored value card with 10 bitcoins of value the same for unclaimed property purposes as a card with $10 of value, if the card is redeemable solely for goods or services, even if the value of the 10 bitcoins in U.S. dollars fluctuates? In states that exempt gift cards from unclaimed property reporting, we think so—whether the “value” on the card is fixed in terms of U.S. dollars, or fluctuates based on some reference mechanism, the fundamental nature of the “property” interest represented by the card is the same—it is not an obligation by the issuer to pay money, but rather a prepayment for goods or services to be delivered upon request of the cardholder in the future. Because of this, many, and likely most, private or proprietary cryptocurrencies that can only be redeemed to purchase goods or services and cannot be redeemed for cash from the issuer likely will qualify as gift cards and should be treated as such for unclaimed property purposes. And the form of the instrument shouldn’t matter—the Federal Reserve has made it clear that a gift card can be a card, or it could be a code, or it could be any other device through which the owner of the prepaid funds may access the funds to redeem them for goods or services.
This creates special challenges, however, in states that require the reporting of unredeemed gift card balances as unclaimed property. For example, when a stored-value card loaded with cryptocurrency rather than dollars is presumed abandoned, the retailer must decide not only whether the card balance is escheatable but also, if so, how to escheat it. Does the retailer escheat 10 bitcoins to the state in kind (something most states are not currently equipped to accept), or convert the bitcoins into U.S. dollars before escheatment? If it converts bitcoins to U.S. dollars before escheatment, what date should the retailer use to apply the conversion rate? Or, if the owner of the card is not entitled to redeem the balance on the card for cash, but may only redeem the cryptocurrency for goods or services of the retailer, would the result be that the card and its cryptocurrency balance are exempt from escheat altogether in a state that exempts gift certificates or gift cards? Perhaps the card and its cryptocurrency balance are exempt from escheat under the “derivative rights doctrine,” a constitutional principle that the states’ power to take custody of abandoned intangible property is derived from the rights of the owner of the property and cannot exceed the rights of the owner. Therefore, if the owner of the stored-value card loaded with private cryptocurrency cannot demand and receive cash for the unredeemed card balance, a state may not require the issuer of the stored-value card to remit cash to the state if the balance is not redeemed.
But if the virtual currency does not also qualify as in-game video content or a loyalty card, gift card or gift certificate under the laws of a particular state, and the state does not separately define virtual currency, are cryptocurrencies escheatable property? If so, under which category of property do they belong? In Notice 2014-21, the IRS clarified that it treats virtual currency that can be converted into real currency as property, not foreign currency, for federal income tax purposes. The SEC has published guidance that it will treat some cryptocurrencies as securities and has blocked the sale of virtual tokens and initial coin offerings (ICOs) as offers of unregistered securities. Does this suggest that cryptocurrencies should be treated as securities for unclaimed property purposes? Although cryptocurrencies may not fit neatly within the standard statutory definition of securities, they do share many of the same attributes. As the SEC has noted, purchasers of many cryptocurrencies appear to purchase them as an investment, rather than as a medium of exchange, anticipating that they will appreciate in value. Most cryptocurrencies can be easily sold for U.S. dollars or other fiat currencies. Many of the issues that plague the escheatment of securities—specifically, liquidating the property at a price lower than the owner intends—can apply equally to cryptocurrencies.
In states whose unclaimed property statutes do not expressly address virtual currencies, cryptocurrencies may also potentially fall under the catch-all provisions for all other intangible property, if they do not constitute another type of property expressly addressed by the statute. The catch-all or “miscellaneous intangible property” provisions of most state unclaimed property laws apply to property that is unclaimed for the relevant dormancy period after the property becomes “payable or distributable” to the owner. But most cryptocurrencies are not payable or distributable because they are not redeemable for cash, and the owner has no right to receive cash from the holder of the cryptocurrency. Arguably, the state unclaimed property administrator should not be able to claim such a cryptocurrency’s value under the catch-all or miscellaneous intangible property provision because the unredeemed cryptocurrency balance is never payable or distributable by the holder to the owner.
When Is Someone a ‘Holder’ of Cryptocurrency?
Even if cryptocurrencies are considered potentially escheatable property for unclaimed property purposes, they are subject to escheat only if they are in the possession or control of a “holder” for the benefit of the owner. Whether a business has possession or control of cryptocurrency, and thus is considered a holder, likely depends on the technological ability of the business to access and transfer the cryptocurrency, and perhaps its legal right to do so.
For example, presumably bitcoins recently mined by an individual have no holder. The record of the miner’s bitcoins is stored in the decentralized block chain; no bank, exchange, or online platform has access to the bitcoins or is storing the bitcoins on the miner’s behalf. Similarly, a purchaser of bitcoins who holds it in a private online “wallet” to which no custodian or third party has access is not a holder of the bitcoins because they do not hold it for the benefit of, or owe it to, any other person. In contrast, 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. Therefore, because these custodians have the ability to transfer cryptocurrency that is presumed abandoned to the state, they may be considered holders for unclaimed property purposes. There are many types of exchanges and cryptocurrency wallets that fall between these two extremes.
Ultimately, whether a business is a holder likely will depend on whether it has access to customers’ private keys and has the technological capabilities to send the customers’ cryptocurrency to state unclaimed property administrators, or to sell or otherwise liquidate the cryptocurrency in its custody and control and remit the liquidated value of the cryptocurrency that has been presumed abandoned. However, to the extent the holder is subject to restrictions on its legal ability to transfer the cryptocurrencies it is custodian of, it is possible that those restrictions could supersede or limit the application of state unclaimed property laws; it is important to also note the potential for preemption of state unclaimed property laws by federal statute or agency regulation.
What Are the Obligations of Cryptocurrency Holders?
If a cryptocurrency is considered “property” that is presumed abandoned, and if there is a holder with sufficient control over the cryptocurrency that it can transfer the cryptocurrency to a state, what are the holder’s obligations under state unclaimed property laws?
How should the holder transfer the cryptocurrency to the state? States routinely require holders to transfer unclaimed securities to the states’ possession in kind, leaving the responsibility and timing of liquidation up to the states. However, most states’ unclaimed property departments do not have the ability to receive cryptocurrencies. Therefore, it is possible that, in contrast to securities, states would attempt to require holders to convert cryptocurrencies to U.S. dollars before escheatment. How should a holder respond to such state demands for liquidation of the cryptocurrency? Is the holder liable to an owner if it liquidates a cryptocurrency, at the direction of a state unclaimed property administrator, that subsequently appreciates in value? Will the state indemnify the holder for this potential liability? Many state unclaimed property laws address these liquidation issues for securities, which is why it matters whether cryptocurrency is subject to escheat as a security or as other intangible property not addressed elsewhere in the unclaimed property statute.
And even if states do not pursue holders for unclaimed cryptocurrencies, could unclaimed property laws create obligations for cryptocurrency exchanges, wallets and custodians to recipients of cryptocurrency sent through their platforms? In March 2018, two plaintiffs filed a class action lawsuit against Coinbase, a cryptocurrency exchange, claiming that Coinbase unlawfully held cryptocurrency sent to the plaintiffs via email. (Faase v. Coinbase, Inc., No. 3:18-cv-01382 (N.D. Cal. Mar. 2, 2018)). The complaint alleges that Coinbase sent the plaintiffs emails stating that they had received cryptocurrencies from users and directing them to click an email link to create a Coinbase account and claim the funds. The complaint alleges that the plaintiffs were unable to claim the cryptocurrencies after the email links expired, and therefore Coinbase was holding unclaimed cryptocurrencies sent via email in violation of California’s unclaimed property laws. After Coinbase filed a motion to dismiss, arguing that California’s unclaimed property statute does not create a private right of action, the plaintiffs filed an amended complaint removing the claim based on violations of the unclaimed property law but retaining the claim that Coinbase engaged in “unlawful” and “unfair” business practices under California’s Unfair Competition Law because of its failure to comply with the unclaimed property law. Coinbase denies the allegations.
Although states have not yet been aggressive about pursuing potential holders for unclaimed cryptocurrencies, as cryptocurrencies increase in popularity, and as more states adopt versions of the Revised Uniform Act specifically addressing virtual currencies, we can expect states (and their contingency-fee auditors) to target potential holders of cryptocurrencies as sources of revenue. Businesses in the cryptocurrency industry should be ready to defend themselves if they do not believe they qualify as holders and to require states to clearly establish their obligations under the unclaimed property laws.
Kendall L. Houghton is a partner with Alston & Bird LLP in Washington, D.C., and leads the firm’s tax practice; John L. Coalson, Jr. and Kathleen S. Cornett are a partner and associate, respectively, in the firm’s Atlanta office. Ms. Houghton and Mr. Coalson are co-authors of the Bloomberg BNA Multistate Tax Management portfolio (#1600) entitled “Unclaimed Property.”