In the age of blockchain, funds associated with death, divorce, taxes, and fraud are susceptible to the perils of forks in Bitcoin’s blockchain, in ways that can allow foul play to go undetected. Blockchain forks have opened up new avenues for money to be hidden in plain sight. But what is a blockchain fork?
A blockchain fork is created when a cryptocurrency protocol is altered, and miners decide to maintain both the old and the new protocol. Both chains share legacy data, but at the time of the fork (when the new protocol is adopted), the network splits into the old protocol (A), and the new protocol (B). The letter “Y” provides a good visual of how a fork behaves. Blockchains create tokens which are ascribed names such as “bitcoin”; when there is a fork, a new name is ascribed to the new token such as “Bitcoin Cash”. The code or protocol, defines the difference between the two cryptocurrencies. In the case of Bitcoin Cash, a segment of the community proposed a solution for addressing Bitcoin’s scale problem, which the majority did not buy into. This resulted in the creation of Bitcoin Cash – a cryptocurrency that increased transaction throughput in a controversial way; by increasing block size. Cryptocurrency protocols continually undergo code improvements, and in most cases the majority of miners agree to adopt the new code and the blockchain continues its linear progression.
When a cryptocurrency blockchain forks, things get interesting. Anyone who owned a bitcoin or a fraction of a bitcoin at the time of the fork, is automatically entitled to an equal number of the new cryptocurrency. The owner of 1 bitcoin at the time of the Bitcoin Cash fork – now owns 1 bitcoin and 1 Bitcoin Cash. This is often referred to as an airdrop or simply free cash. Recall that prior to the fork, all bitcoins were stored in the chain segment represented by the stem of the letter “Y”. After the fork, the stem was inherited by the new chain. Along with this inheritance came all the tokens (formerly referred to as bitcoin), that were controlled by a private key in the possession of a bitcoin owner. That same private key controls a token in the new chain; a token referred to as Bitcoin Cash. When a bitcoin holder looks at their bitcoin wallet app after a fork, they only see the bitcoin. In order to access their Bitcoin Cash, they would first need to import their private key into a Bitcoin Cash wallet, and voila – the Bitcoin Cash appears.
According to forkdrop.io, Bitcoin has forked 74 times, resulting in active projects (such as a new cryptocurrency). The most successful fork of Bitcoin’s blockchain was Bitcoin Cash, a cryptocurrency which advanced to a high of over $3,000 in late December 2017. But how does all of this impact death, divorce, taxes, and fraud?
Death: The market cap of bitcoin is currently $140 Billion according to Coinmarketcap.com. When holders of bitcoin die, their family members are not always aware that they owned cryptocurrency. There are some interesting cases of post-death surprise discovery. However, even in cases where the family is aware that a deceased member owned bitcoin, and the family have access to the private key – not being aware of forks, could result in a substantial portion of the inheritance being shelved on the blockchain for all eternity.
Divorce: Courts and family law practitioners around the globe are witnessing the small edge of the wedge when it comes to divorces where cryptoassets are a factor. Numerous articles such as this Bloomberg piece, articulate the challenges of unearthing undeclared cryptocurrency during a breakup. Absent from the discussion, however, is the fork. The owner of a healthy stash of bitcoin may be willing to disclose it, while withholding the fork.
Taxes: When a cryptocurrency forks, it is not always advantageous for owners to claim the new cryptocurrency. The process for claiming the new cryptocurrency can be daunting, as it involves exposing a private encryption key. Some crypto holders are simply not comfortable with the process. Seeking a trusted party to perform the task creates another barrier. Moreover, if the total value of the new cryptocurrency is not significant, many crypto holders simply forego claiming the new cryptocurrency, and never execute the transaction to become owners. Those who do claim their new cryptocurrency come into a dividend of sorts. What are the disclosure and tax implications of forks?
Fraud: Here are a couple of ways in which forks open up innovative opportunities for criminals to defraud victims. A corporate private key can be used by an administrator to claim a forked cryptocurrency and pay a kickback or bribe without the corporation ever realizing that the activity took place – because no funds are missing. A custodial entity managing cryptocurrency for others can claim forked coins and never report or distribute the proceeds to the client.
As adoption of cryptocurrencies continues to grow, I suspect that the impact of blockchain forks will become more prevalent. Keep your eye on the fork in the road ahead.