The time has come to consider blockchain-based trusts
I have been asked on a few occasions in recent years, 'should we put trusts on a blockchain?' My answer is invariably "no", as there is friction between the discretionary, flexible world of trusts and the fixed, certain world of blockchain-based smart contracts. Life assurance on a blockchain? Possibly. But trusts? That's a tricky one.
Yet as we grapple with the slow but inexorable process of tokenisation, whereby real world assets are moved onto blockchains and represented by "tokens", it is only a matter of time before trust practitioners need to look at blockchain-based trusts, or 'smart trusts'.
As with all blockchain innovation, we will need to distinguish between centralised and decentralised models:
- A centralised trust where a trust is managed by a body of individuals, or a corporate trustee. This is the traditional model.
- A decentralised trust, where every day trust management is entrusted to a decentralised application run on a blockchain.
Back in 2015, when I executed my will, I embedded it onto a blockchain. The advantage of doing so is to provide a failsafe way to protect the will, and enable the executors to guarantee that it has not been altered. Since then, we have been able to offer clients this service.
If trust documents, such as letters of wishes, can be uploaded onto a public blockchain (in an encrypted form, of course), then this affords a certain advantage. That is a simple and effective, if unexciting, prospect for trust fiduciaries.
Entrusting a blockchain with trust documents is one thing, but creating a decentralised application (or "d'app", if you'd rather use the portmanteau) to run a trust is quite another. Yet if trustees find themselves managing a tokenised asset, it is not as huge a leap as we might initially think.
Let's suppose that X Trust, located in Jersey, decides to invest in a fund domiciled offshore which invests in US real estate. The trustees are surprised to learn that in exchange for their investment they receive tokens rather than a traditional fund interest such as units. The fund offers more attractive terms if dividends are received in tokens, rather than cash.
The trustee now finds itself holding tokenised assets (the fund interest) and periodically receiving token dividends. The traditional means of handling blockchain assets – using a private key to access the public key – is unacceptable from a risk management perspective, in terms of securely custodizing the private keys, ensuring no individuals associated with the trust steals the keys, and practically handling the keys for day to day management and transactional purposes. Hence the need for a decentralised application to manage this process, tailor made for trustees, and we are now seeing start-ups targeting this business need.
Once trustees hold assets which are stored on blockchains, it is then a question of how far they wish to harness blockchain technology. Where trusts have fixed characteristics (capital at the age of 30, or outright to heirs on the death of X), then why should clients not be given the option to write this into a smart contract, so that the title (and not just the beneficial interest) to tokenised trust assets can vest automatically at the relevant date. Reserved powers could be programmed to devolve directly to heirs on the settlor's death.
There are certain roles (such as enforcers of purpose trusts, or protectors of discretionary trusts) whose roles would be reinforced in a smart trust. A protector could for example have a power to veto certain trustee decisions, if indeed that is written into the trust, and the terms of the trust have been successfully embedded into the smart contract.
The implications for this are wide-ranging: will tax residence be affected if trusts are being run by a network of nodes dotted around the globe? How can the trustee fiduciary role, sustained as it is by personal relationships, be transmuted into the blockchain format? How can offshore substance rules be satisfied if de facto control is delegated to nodes? How will tax authorities construe these arrangements and is there a greater risk of nomineeship? Will divorce courts be more willing to bring smart trusts within the matrimonial pot than conventional trusts?
There are, I am sure, technical solutions to these questions. Yet the real question is my original one: the beauty of the modern Trust is its flexibility, and the beauty of blockchain is its pre-programmability and immutability. Can these two worlds really come together?
James is a senior associate in our Private Client team.