16 September 2022
In recent years, digital assets including cryptocurrencies and non-fungible tokens (NFTs) have commanded considerable media attention. Speaking extra-judicially in the foreward to the UKJT Statement on Crypto-assets and Smart Contracts in November 2019, the Master of the Rolls, Sir Geoffrey Vos, has stated that: “In legal terms, cryptoassets and smart contracts undoubtedly represent the future”. To what extent should the law of the future grant property rights in respect of crypto assets? Will the inalienable right to peaceful enjoyment of possessions apply to tokens existing only on the blockchain? Or to NFTs residing only in the ‘metaverse’?
These are the questions addressed in depth by the Law Commission’s recently published consultation paper on Digital Assets (July 2022). In this article, the author offers a number of predictions about the future direction of English law based upon the Law Commission’s paper.
1. The law of England will protect legal ownership of digital assets.
English law has traditionally recognised two categories of personal property (as distinct from land or “real” property). First, “things in possession”. This is composed of physical tangible things such as coffee mugs and bars of gold. Second, “things in action”. This consists of intangible things which can only be enforced through legal proceedings. Examples might include a debt or shares in a company.
However, digital assets such as cryptocurrency do not fit neatly into either category. They are neither “tangible” objects nor creatures of the legal system. The Law Commission has therefore proposed the explicit recognition of a third category of personal property, to be known as “data objects”.
The explicit recognition of data objects as a distinct legal category of personal property is important. Property rights are useful because they can be enforced against the whole world, whereas other legal rights can be enforced only against someone who has assumed a relevant duty in contract or tort. The concept of property is widely used in statutes and case law, assuming a central role in proceedings concerning bankruptcy or insolvency, tortious or criminal interference with property, and death and succession. More generally, it is the author’s view that explicit legal recognition of crypto assets as digital property provides them with an additional layer of legitimacy.
2. So will the law in the rest of the world.
It is likely that national legal systems around the world will also follow suit in recognising digital assets as legal property. Crypto assets are already traded on global markets and are not tied to individual jurisdictions. It is crucial, and therefore likely, that a consistent global framework will be developed. The Law Commission’s proposals align with work being performed by other international work bodies concerned with law reform: the American Law Institute, the Uniform Law Commission (also in the US) and the Digital Assets Working Group of UNIDROIT.
3. To be property digital assets must be “rivalrous”
The Law Commission grapples with the problem of how data floating in cyberspace can constitute property. Pure information is not normally capable of attracting property rights as a matter of English law. This is because, unlike tangible objects, information can be easily duplicated and freely disseminated. If A delivers a car to B, then A no longer has any control over or access to the car. Moreover, A and B cannot drive the same car at the same time. However, if A provides B with information, both A and B now have access to the same information at the same time. The information can be disseminated and exploited without limit.
The Law Commission argues that electronic data can, in principle, attract property rights so long as it is “rivalrous”. A resource is rivalrous if its use by one person necessarily prejudices the ability of others to use it at the same time. For example, if Alice uses a Game Boy to play Pokemon, Bob cannot use the same Game Boy at the same time to play the same game.
The Commission points out that one of property law’s principal functions is to allocate rivalrous objects between people and to protect their ability to use them free from the interference of others. In a world without property law, a person’s liberty to make use of rivalrous resources would depend upon their ability to keep others away from them. Few would be secure in their property rights and security would come at the cost of use.
It follows that the crypto assets such as crypto-currency and other digital assets can and should be capable of attracting property rights so long as they are rivalrous. Crypto tokens such as Bitcoin are likely to satisfy this definition because they can be created so as to be mathematically scarce. Moreover, the use by one person a crypto asset may necessarily inhibit the use of the same asset by another.
4. To be recognised as property digital assets must exist independently the legal system
English law already recognises “things in action” as property. That is things which can only be asserted by taking legal action. They are creatures of the law because the derive their existence or enforceability from the legal system. Examples may include debt claims or intellectual property rights. What differentiates digital assets is that their existence does not derive from or depend upon the law. Data objects exist independently of (and cannot be created or extinguished by) legal rules. They are more analogous to tangible objects such as cars or coffee mugs. This justifies their characterisation as property which fall with a previously unrecognised third category of “data objects”.
5. The law of code is not necessary the law of the land
Ownership on the blockchain will not equate to ownership in law. Protocols which use blockchain technology, such as Bitcoin, involve an immutable record of “ownership”. The transfers of tokens from one party to another is recorded on a decentralised database or “distributed ledger”. However, the Law Commission argues that the state of the distributed ledger should not necessarily be regarded as the definitive record of legal title. It may provide a definitive record of the link between transactions within the crypto token system. However, this is a factual as opposed to legal account of the world. By analogy, if a car is taken unlawfully from the gated driveway of House A to the gated driveway of House B it is factually true that the car is on House B’s driveway. It does not follow that the owner of House B is the legal owner the car. Similarly, if one Bitcoin is transferred from A’s wallet to B’s wallet, B is not necessarily the legal owner of the Bitcoin. This distinction makes obvious sense considering that crypto currency exchanges and wallets can be hacked and assets stolen. However, this will add an additional layer of complexity when determining the ownership of digital assets.
6. Ownership of digital assets will be recognised as a public economic interest
Underpinning the Law Commission’s proposals is the idea that legal recognition of digital assets is in the public economic interest. This is because digital ownership opens up new and innovative opportunities for economic activity and wealth creation by enabling the tokenization of and trade in all things of value. To quote the Law Commission directly:
“We consider that the advancement of crypto-tokens, crypto-token systems and related technology have the potential to expand the process of fixing and deploying capital. Crypto-tokens and crypto-token systems potentially offer an alternative means by which persons can convert their resources and products into fungible, liquid forms that can be differentiated, combined, divided, and invested to produce surplus value. In turn, this could facilitate more distributed and equitable access to property rights and to the legal recognition and protection they provide. This would allow a more diverse range of people, groups, and companies to interact online and to benefit more widely from their own productivity. Crypto-tokens in particular enhance this process by enabling alternative options for communication of value via electronic means, which broadens the scope of, and access to, markets and increases the transferability, composability and liquidity of things of value.”
Summary of Consultation Paper on Digital Assets, para. 1.37
Similarly the Law Commission considers that non-fungible tokens (“NFTs”).
“can become a powerful technological structure that can be used to link to – and transfer – other legal rights external to the NFT itself or the crypto system in which it is instantiated”
Potential use cases include to confer intellectual property rights in music or art on the holder of an NFT. Alternatively, NFTs may constitute evidence of legal title to something tangible such as a car or piece of land. Some commentators have suggested that crypto tokens will radically change the way in which intangible assets such as shares and debt securities are issues and traded. These ideas are not new. However, it is of interest to see these benefits being advocated openly by a public body responsible for proposing law reform.
7. The law will evolve to recognise legal links between digital assets and things in the real world.
In order to realise the Law Commission’s vision of a world in which things of value may be tokenised, the law will need to evolve. The bond between crypto-tokens and the things of value that they represent must be recognised by the law and must be capable of being enforced by token holders.
The Law Commission notes the wide variety of ways in which the law may constitute a link between tokens and other tangible or intangible objects in the world. Crypto tokens might be used to create a register and/or a record of transactions between legal owners. In this scenario, ownership of a crypto token would act as evidence of ownership of the underlying asset. Alternatively, a token-based register could be established by legislation which could reinforce (or qualify) the evidential status of a token as proof of ownership of the underlying asset. Commercial parties might also devise bespoke contractual arrangements so as to create a system in which the holder of a given crypto-token is regarded as having legal title to a thing external to the token system.
Another option would be for the law to draw an analogy with “documentary intangibles”. These are paper documents which embody a right to performance of the obligations they contain. The right can be transferred by transferring physical possession of the paper document. A crypto token could therefore be taken in law to “embody” the rights recorded by it.
It will be the work of lawyers of the future to design, build and enforce legal bridges or bonds between digital assets and corresponding tangible and intangible assets in the world.
8. Crypto assets will give rise to new legal remedies and a need for new legal expertise.
Under the law of England and Wales, where a person’s tangible property is interfered with a person can sue for conversion. It is a strict liability tort with limited defences. However, the law of conversion does not presently extend to intangible property such as intellectual property or information stored electronically on a computer hard drive. The Law Commission suggests that the tort of conversion can and should be extended to digital assets. It is acknowledged that this will create novel and technical questions in respect of how to determine the equivalent of “possession” in a digital context and what is necessary to constitute “interference”.
More broadly, the Law Commission suggests that the Courts could look to a panel of industry experts, legal practitioners, academics and judges to provide non-binding guidance on complex and evolving issues arising from the application of property rights to data objects and crypto tokens. This approach would strike the best balance between creating legal certainty for the market and maintaining the dynamism and flexibility that characterises the law of England and Wales in respect of the facilitation of novel technology.
The precise direction and content of the law on digital assets remains to be seen. However, technological developments in the fields of cryptography, smart contracts and distributed ledger technology are set only to continue. If we increasingly see ourselves as the owners of things in the digital world, we will expect that that ownership to be recognised and protected by law. In the author’s view, the Law Commission is correct to observe that reforming the law will would lay a strong foundation for the development and adoption of digital assets in the UK. It will also incentivise the use of England and Wales as a jurisdiction of choice for transactions and enterprises concerning digital assets.
Robert Kellar KC is a Barrister at 1 Crown Office Row