As bitcoin becomes increasingly popular, some are starting to ask: should trustees of trusts invest a portion of trust assets in bitcoin? There are very strong reasons why they should not. As I explain below, investing in bitcoin, in most circumstances, could put a trustee at risk of violating the Uniform Prudent Investor Act.
First some background: for those unfamiliar with bitcoin, Wikipedia provides a helpful overview:
Bitcoin is an online payment system invented by Satoshi Nakamoto, who published his invention in 2008, and released it as open-source software in 2009. The system is peer-to-peer; users can transact directly without needing an intermediary. Transactions are verified by network nodes and recorded in a public distributed ledger called the block chain. The ledger uses its own unit of account, also called bitcoin. The system works without a central repository or single administrator, which has led the US Treasury to categorize it as a decentralized virtual currency. Bitcoin is often called the first cryptocurrency, although prior proposals existed. Bitcoin is more correctly described as the first decentralized digital currency. It is the largest of its kind in terms of total market value.
Bitcoin supporters point to numerous benefits that they claim bitcoin provides to consumers and society, including its low inflation risk, its ease of carrying (through digital means), its low transaction costs, and its freedom from governmental regulation (although to detractors, this final point is a significant downside). While there are certainly some upsides to bitcoin, and it appears likely that it will grow more popular in the future, there are sufficiently strong downsides that trustees should avoid bitcoin as a trust investment.
First, bitcoin is not issued by a central governmental authority that can guarantee payment at face value. Rather, the bitcoin owner bears the burden of having to liquidate bitcoins to a national currency. As a corollary, bitcoin exchanges and accounts are not insured by any type of federal or government program, leaving investors exposed in the event of a collapse or failure of a bitcoin exchange (for example, last year, one of the largest bitcoin exchanges, Mt. Gox, was forced to file bankruptcy due to technical problems and stolen bitcoins).
Second, the market value of bitcoins has fluctuated wildly in recent years (with reports stating that the largest one-day price drop in 2014 was around 80%). Third, with bitcoin being a relatively novel phenomenon, it’s possible that a competing virtual currency will gain larger market share, thereby reducing the demand for (and value of) bitcoins.
So what’s a trustee to do? First, understand the laws of your state governing the investment duties of trustees. Most states have adopted the Uniform Prudent Investor Act, or a modified version of it. Under Virginia law, unless a trust provides otherwise (or in certain other narrow circumstances), a trustee is required to:
“invest and manage trust assets as a prudent investor would, by considering the purposes, terms, distribution requirements, and other circumstances of the trust. In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.”
VA Code § 64.2-782(A).
The Uniform Prudent Investor Act has adopted the assumptions of modern portfolio theory, in providing that:
“a trustee’s investment and management decisions respecting individual assets shall be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.”
VA Code § 64.2-782(B).
Virginia law, like the law in most states, provides standards that a trustee should consider in investing and managing trust assets, such as general economic conditions, the possible effect of inflation or deflation, the expected total return from income and the appreciation of capital, etc.
In light of the standards contained in the Uniform Prudent Investor Act, and the history of bitcoin, it would be exceptionally difficult for an attorney to advance a winning argument that an investment in bitcoin would constitute a prudent trust investment. Therefore, trustees should steer clear of bitcoin for the near future.
If bitcoin develops in the future such that its value shows signs of marked periods of stabilization (coupled with a steady increase in value), its exchanges do not fall victim to hacking or fraud, and increasing numbers of merchants and individuals adopt its usage, it’s possible that one could make a more plausible argument that a proportionally small investment in bitcoin may constitute a prudent investment under the standards of the Uniform Prudent Investor Act. However, I think that day is far off. For the near future, trustees would be well advised to entirely avoid bitcoin, and leave their bitcoin investment urges to the sphere of their own personal investment adventures.