Understanding Virtual Asset Wallet

In the realm of virtual assets, a virtual asset wallet serves as a fundamental tool for managing your virtual assets securely. A virtual asset wallet is a digital tool that enables users to store, send, and receive virtual assets. It consists of a public address for receiving funds and a private key for accessing and managing those assets securely.

Let’s delve into the intricacies of these wallets, exploring the meaning of ownership and how to manage it, as well as the different types of wallets.

WalletOwnership 

Understanding the ownership of a virtual asset wallet is crucial in the world of virtual assets.

Public keys and Private keys

Virtual asset wallets consist of private and public keys:

• The public key (which acts like your bank account number) represents the address of the virtual asset on the blockchain and can be openly shared for receiving virtual assets.
• The private key acts as the password affirming ownership of virtual assets, enabling the owner to access the virtual assets. Hence, if you do not possess the private keys to your wallet, you do not have full control over your virtual assets.

Management of Private Keys

The private key is the most critical component of a virtual asset wallet as it grants access to your assets. Safeguarding the private key securely, ideally offline, and refraining from sharing it with others is imperative. Losing the private key could lead to permanent loss of virtual assets access, underscoring the necessity of taking precautions to protect it with backup if necessary.

As private keys are lengthy and intricate, majority of virtual asset wallets generate a “mnemonic” set typically comprising a set of 12 to 24 English phrases for easier recording. Mnemonics serve as an alternative form of private key and must be securely stored, preferably in a handwritten format and kept in a secure location. It is important to note that one should avoid storing the mnemonic using cloud storage, screenshots or photos. You should never share the mnemonic with anyone else as well.

Types of Virtual asset wallets 

Public keys and private keys are stored in virtual asset wallets which are protected by a set of passwords. Virtual asset wallets come in various forms, each catering to different needs and preferences.

Cold Wallet vs. Hot Wallet

• Cold Wallet

Cold wallets refer to hardware devices that are not connected to the network. They store the private keys offline, offering better protection for virtual assets by reducing the risk of cyberattacks.

• Hot Wallet

Hot wallets refer to network-connected virtual asset storage method. The key benefit of hot wallets is that there is no need of purchasing and maintaining physical devices. Another advantage is that it does not require additional network connection steps for each transaction compared to cold wallets. With these advantages, it is more convenient to send and receive virtual assets. However, it is subject to the same risk of any programmes/devices that connect to the internet, that is – once it is invaded by viruses, malware or spyware, the private keys inside are more vulnerable to hacking attempts and potential theft.

There are two types of common hot wallets:

1. Personal software wallets

These types of wallets are software applications, such as desktop software, mobile application, or browser extension, enabling private key generation once downloaded and installed on your computer or mobile phone.

2. Virtual Asset Service Provider (VASP) wallets

These wallets are custodial wallet services provided by VASPs. The difference between these wallets and personal software hot wallets is that the VASPs hold and manage private keys on behalf of the clients.

You should also pay attention when choosing the VASP that hosts your wallet, considering whether the VASP has implemented adequate controls over their key and wallet management, as there is a lack of regulation in the majority of VASPs, potentially those that are located overseas.

Users of these wallets lack control over the private key in VASP wallets, as a result, you are at risk of losing virtual assets if the VASP encounters hacking, collapse, internal fraud or cessation.

Not your keys, not your assets 

You should choose a suitable virtual asset wallet according to your own needs. Given the comparatively lower security of hot wallets in contrast to cold wallets, it is advisable to refrain from storing significant amounts of virtual assets in hot wallets to mitigate potential risks. Moreover, you should be aware that storing virtual assets on a VASPs could result in the loss of all assets should the VASPs face collapse, cessation of operations, or a security breach.

Regardless of the type of wallet chosen, the critical first step in effectively managing virtual asset wallets involves securely storing the private key to minimise associated risks. As highlighted above, the private key serves as the proof of ownership of virtual assets, and its loss equates to the forfeiture of the assets it safeguards. Therefore, it is essential to ensure the safety of both wallets and private keys, create offline backups of private keys using appropriate method, and store them in a secure location.

Legal Considerations on Virtual Asset Wallet Ownership 

The legal landscape surrounding virtual asset wallet ownership is evolving, particularly in jurisdictions like Hong Kong, where recent court rulings have clarified the status of virtual assets as property. This recognition has significant implications for ownership rights, custody, and the treatment of these assets in cases of insolvency or fraud.

Recognition of Virtual Asset as Property

Recent rulings in Hong Kong have established that virtual assets are legally recognized as property. This classification provides participants in the virtual asset market with a degree of legal certainty and protection akin to traditional assets. The implications of this recognition include:

• Transfer Validity: Courts will treat transfers of virtual assets as legally valid and enforceable, which is crucial for transactions involving loans or security interests over these assets.
• Protection from Misappropriation: In cases of theft or fraud, recognizing virtual assets as property allows owners to seek recovery through legal channels.

Jurisdictional Challenges and Ownership

Ownership of virtual assets can be complicated by jurisdictional issues. The lex situs (law of the location) principle states that the jurisdiction governing a virtual asset is typically where the rightful owner is domiciled. However, complexities arise when:

• Assets are held on Exchanges: If a virtual asset is stored on an exchange, determining ownership can depend on the terms of service and whether those terms establish a trust relationship between the exchange and its users
• Misappropriation Cases: In instances where assets are misappropriated, courts may consider various factors including the location of control (e.g., where private keys are stored) to determine jurisdiction

Regulatory Framework in Hong Kong

Hong Kong has implemented specific regulations for virtual asset platform operator, emphasizing the need for proper custody and segregation of client assets:

• Segregation Requirements: VATPs must ensure that client virtual assets are held in dedicated wallet addresses separate from their own assets. This segregation is crucial for protecting clients’ interests, especially in insolvency situations.
• Cold Storage Mandate: A significant portion (at least 98%) of client virtual assets must be stored in cold storage to enhance security against cyber threats.

Implications for Insolvency Practitioners

In cases involving insolvency, determining whether client assets held by a VATP belong to the company or are held in trust for clients is vital. Recent cases illustrate how different interpretations can lead to varied outcomes regarding asset recovery:

• In one case, a court ruled that due to changes in terms and conditions, clients did not have proprietary interests in the virtual asset held on an exchange’s wallet, classifying them instead as ordinary unsecured creditors.

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