A Forensic Guide to Finding Cryptocurrency in Divorce Litigation

By:
Mark DiMichael, CPA, CFF, ABV, CFE and Katerina Gaebel, CPA
Published Date:
Sep 1, 2018

I. Introduction

In recent years, awareness and use of Bitcoin and cryptocurrency has risen dramatically. Cryptocurrency transactions are fast, global, decentralized, secure, and irreversible. Although cryptocurrency and blockchain technology have the ability to revolutionize commerce, cryptocurrency’s anonymous nature has made it a haven for illicit activity. This is because while cryptocurrency transactions are all publicly viewable on a “blockchain,” the individual participants of each transaction cannot be easily determined.

Cryptocurrency can also be held without reliance on any third parties, making it difficult to subpoena meaningful information. In divorce cases, it is a common theme for individuals to hide or attempt to hide assets from their spouses. Therefore, it is important for attorneys and forensic accountants to be aware of this risk and take steps to investigate the possibility that their client’s spouse might own cryptocurrency.

II. Investigating Cryptocurrency Existence

The first step in the process should take place during the initial client interview. It is important to find out if the client is aware of their spouse buying, selling, or otherwise transacting in cryptocurrency. If the client is aware, what information does the client know? Below are some examples of questions to ask during the initial client interview.

1. Is the spouse very tech savvy?
2. Has the spouse ever owned cryptocurrency?
3. If so, did he or she buy and sell on an exchange, or did he or she receive cryptocurrency for goods and services?
4. If so, how did the spouse store and transact in cryptocurrency?
5. Did the spouse use cryptocurrency as part of their trade or business?
6. Where does the spouse keep their important records? Does the client have access to them?
7. What electronic devices does the spouse own?
8. Does the client still have physical access to his or her spouse’s electronic devices, such as computers, phones, and tablets?

III. Relevant Information Regarding How Cryptocurrency Works

A major attraction of cryptocurrency is that it does not require any third party agent, such as a bank. While there are over 1,600 cryptocurrencies, over 60% of the cryptocurrency market cap is represented by the top three cryptocurrencies: Bitcoin, Ethereum, and Ripple. In order to investigate a spouse’s potential ownership of cryptocurrency, one needs a basic understanding of how an individual holds and transacts in cryptocurrency.

A. Blockchain – With regard to cryptocurrency, a blockchain is a historical, public ledger of every transaction since inception of that cryptocurrency. The blockchains for cryptocurrencies are maintained in a “decentralized” manner - meaning that copies of the blockchain are maintained on many computers globally, rather than a centralized computer controlled by a third-party financial institution. The blockchain activity can be viewed on various publicly available “block explorer” websites, such as www.blockchain.info for Bitcoin.

B. Public Addresses - An individual stores his or her cryptocurrency in a “public address,” which is represented as a string of alphanumeric characters. The public address acts as an account number that exists only as an entry on the blockchain. One individual can have a near infinite number of public addresses.

C. Private Keys - The funds in each public address are controlled through the use of another string of alphanumeric characters called a “private key” (e.g., KqDCQGETTSLcxgbbJU2wwqTtNqG4Hyv8o). The private key acts as the secret password required for the spending of funds in a particular public address. Anyone who possesses the correct private key can spend the funds in the associated public address.

If a private key is ever lost or destroyed, the funds are locked away permanently (since no one has the private key needed to spend those funds). If hackers steal the private key, the hackers can take the funds, and the original owner has no recourse.

D. Wallet Seed - An individual’s private keys are usually generated from a string of 12, 15, 18, 21, or 24 randomly generated words called a “seed” (e.g., crash noise pluck unique elbow hero income coyote emotion modify service alter). One seed can generate an endless supply of private key/public address pairs.

Because spending cryptocurrency requires control of the correct private key, individuals should go to great lengths to protect their private keys. There are many different methods for storing private keys, including the following:

A. Paper Wallet - A paper wallet is simply the act of maintaining one’s private keys, public addresses, or wallet seed printed on physical paper. While this is very safe and effective for long-term storage of cryptocurrency, it is not practical for individuals who regularly transact in cryptocurrency because a computer or cellphone is needed to implement transactions.

B. Software Wallet - A software wallet is a phone or computer application that that can generate private keys/public addresses and can interact to initiate transactions. Software wallets provide easy use of and access to cryptocurrency funds but are potentially susceptible to hackers.

C. Hardware Wallet - A hardware wallet is a password-protected electronic device that looks similar to a USB flash drive. A hardware wallet is specifically designed to generate and store private keys. A hardware wallet is generally immune to hackers because it is not physically connected to a computer or the Internet.

D. Exchanges – Third party websites that facilitate the buying and selling of cryptocurrency. Exchanges generally control the private keys and users do not have access to the private keys. Instead, the exchanges initiate all transactions, and the user will merely have an account with that third-party exchange, similar to keeping one’s money at a bank.

IV. Gathering More Information

If it is suspected that the spouse owns cryptocurrency, it is time to gather more evidence. Additional evidence can be found in many different places.

A. Bank/Credit Card Statements - While there has been limited usage of cryptocurrency for actual commercial transactions, the majority of individuals obtain cryptocurrency through purchases on an exchange. Bank statements might show payments to (or receipts from) cryptocurrency exchange companies. Using the Coinbase exchange as an example, a transaction would appear as a debit or credit on a bank statement like this: COINBASE.COM/BTC DES:8003435845 ID:E452HSO2 INDN:JOHN SMITH CO ID:4593295587 WEB. Finding transfers to or from a cryptocurrency exchange will provide definitive proof the client’s spouse has been transacting in cryptocurrency, and will open the door for additional discovery such as exchange account records.

B. Tax Returns - According to IRS Bulletin 2014-21, cryptocurrency is considered property (and not currency) by the IRS. For tax purposes, cryptocurrency transactions are reported as capital gains or losses on an individual’s Form 1040, Schedule D. While merely purchasing and holding cryptocurrency is not a taxable transaction, each time an individual sells or spends cryptocurrency should be reported on an income tax return. If an individual is paid (as an employee or subcontractor) in cryptocurrency, that individual should also be provided a W-2 or Form 1099 that values the payments in dollars as of the date the payments were made.

C. Legal Discovery - It might be possible to subpoena account records from cryptocurrency exchanges. The most popular U.S.-based cryptocurrency exchanges are Coinbase (GDAX), Kraken, Polinex, Bittrex, and Gemini. Be aware that many cryptocurrency exchanges are not U.S. based; therefore, obtaining documents from them might prove challenging. Furthermore, it might be possible to depose individuals or business partners who might have paid cryptocurrency to the spouse.

D. Net Worth Statement - Any and all assets, including cryptocurrency, should be reported on a Net Worth Statement (“NWS”). Even if, however, the NWS lists cryptocurrency, additional investigation should be performed to make sure the information is complete. A spouse could easily transfer a portion of his or her cryptocurrency to a new public address to obscure the remainder of the cryptocurrency.

E. The Public Blockchain - If you are able to obtain any of the spouse’s public addresses, the historical transactions related to those public addresses are publicly viewable on the blockchain. The blockchain can be searched online via many different free websites. Be aware that each cryptocurrency has its own blockchain (e.g., the Bitcoin blockchain is separate from the Ethereum blockchain). There are also several cryptocurrencies known as “Privacy Coins,” such as Monero, Z-Cash, and Verge that are designed so that the information on the blockchain might be obscured or misleading.

F. Physical Inspection of the Marital Residence - If the client still has legal access to the marital residence, there are items that could be searched for. Clients can be instructed to look for evidence of paper wallets such as private keys, public addresses, and seeds. Specifically, the client should look for any written strings of alpha-numeric characters or random strings of words.

G. The Spouse’s Electronic Devices - If the spouse is making an intentional, careful, well-researched effort to hide marital assets he or she might be able to avoid leaving a paper trail. In that case, the last remaining recourse is to obtain and search the spouse’s electronic devices with the help of a computer forensic expert. This can often be done through the court discovery process. If this is neither preferred nor possible, attorneys should consider the legal implications of potential clandestine forensic imaging of the spouse’s electronic devices (see Byrne v. Byrne) if the client still has legal and physical access to them. Computer forensic experts will be able to search for evidence of cryptocurrency use—such as public addresses, private keys, software wallets, internet history, and emails that might include cryptocurrency trade confirmations or other relevant information—on electronic devices.

V. Conclusion

Cryptocurrency provides an additional tool for spouses to hide large amounts of money from the court with minimal reliance on any identifiable third parties. This makes investigating cryptocurrency difficult and poses new, unique challenges to practitioners. Now that cryptocurrency has gained significant mainstream attention, accountants and matrimonial attorneys should be aware of the possibility of marital asset diversion through cryptocurrency—and should take steps to mitigate that risk.



Mark DiMichael, CPA, ABV, CFF, CFE is a director in the valuation and forensic services department at Citrin Cooperman. He specializes in matrimonial dissolutions, economic damages, cryptocurrencies, shareholder disputes, white collar criminal defense, and business valuations. Mr. DiMichael has prepared and rebutted expert reports and has experience working with companies in a wide range of industries. He has also provided expert witness testimony in federal court, state court, and arbitration proceedings. Mr. DiMichael is also the new chair of the new NYSSCPA Digital Assets Committee. He can be reached at mdimichael@citrincooperman.com.

Katerina Gaebel, CPA, is a semi-senior in the valuation and forensics department at Citrin Cooperman. She specializes in forensic investigations, matrimonial disputes, shareholder disputes, economic damages and employee embezzlement cases.  Ms. Gaebel obtained her Masters in Forensic Accounting from the University at Albany and is a CPA, licensed in the state of New York.

 
Views expressed in articles published in Tax Stringer are the authors' only and are not to be attributed to the publication, its editors, the NYSSCPA or FAE, or their directors, officers, or employees, unless expressly so stated. Articles contain information believed by the authors to be accurate, but the publisher, editors and authors are not engaged in redering legal, accounting or other professional services. If specific professional advice or assistance is required, the services of a competent professional should be sought.