UK businesses involved in crypto-token transactions have an opportunity to shape the future regulation of crypto-assets
The UK’s Law Commission has published (28 July 2022) a consultation paper on digital assets and summary, following an earlier public consultation and subsequent UK Jurisdiction Taskforce legal statement in 2019 that considered the legal status of crypto-assets.
The paper recognises the growing importance of digital assets and its provisional proposals include a third category of personal property, “data objects”, which it illustrates by reference to crypto-tokens.
The characterisation of digital assets is significant, as it will determine what legal rights are available in respect of them. The paper also considers, therefore, what law reform (if any) is required for crypto-tokens and crypto-token markets. The consultation remains open until Friday 4 November 2022.
The Law Commission’s view is that “digital assets cannot be categorised properly in either of the existing categories of ‘things in possession’ or ‘things in action‘” and a new third category of data objects would allow for a “more nuanced consideration of new, emergent and idiosyncratic things“. The paper proposes the following criteria for a new category of data objects:
- They must be composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals.
- They must be capable of existing independently from anyone who may claim to own them and from any legal system that may be relied on for enforcement of rights in relation to them (which would exclude intellectual property rights and other legal property rights).
- They must be rivalrous, meaning that the asset in question “must be something whose capacity for use is not unlimited: people must therefore compete with one another for it“.
The paper goes on to say that crypto-tokens are generally capable of satisfying these criteria and can, therefore, be considered data objects. It also notes that most existing laws that provide rights and remedies in respect of other types of property can apply to data objects.
The Law Commission provisionally finds that “the existing legal rules on…transfers of title [i.e. ownership] can apply to crypto-tokens within crypto-token systems.” In particular, it identifies that “control” of a crypto-token plays an “important (although not determinative) role” in assessing the legal effect of its transfer.
Overall, it concludes that crypto-tokens are sufficiently novel and flexible that they do not fit neatly within existing methods for transferring ownership. It proposes that a token-based register could be established by law to “determine the strength of the evidentiary power of the crypto-record and any transfer formalities.“
The paper explores the ways in which crypto-tokens can be used to represent something external or linked to something outside of the crypto-token system, for example intellectual property rights or a physical asset (as with non-fungible tokens). The Law Commission’s view is that the legal consequences and strength of such a link are “likely to be dependent on several factors [such as] market practice, the evolution of the common law, and any contractual arrangements related to that record“. On balance, it finds that the law is already sufficiently flexible to allow for this type of arrangement.
The Law Commission proposes potential targeted legal reforms on crypto-token custody arrangements. It suggests an exclusion for crypto-tokens from the legal formalities that requires certain transactions to be recorded in writing and signed; instead, transfers of crypto-tokens could take effect by being recorded on electronic ledgers supported by distributed ledger technology and/or smart contracts.
Its view is that crypto-token transactions that are not recorded on a professionally maintained ledger – where the crypto-tokens are either transferred to or held on trust by a crypto-custodian – should remain subject to those formalities. And it concludes that the “records and authentication processes [of crypto-token networks]… are capable of satisfying these formalities“.
However, it advises against reform resulting in “default rule…that direct custody arrangements [of crypto-tokens] take effect as trusts“.
The Law Commission identifies that crypto-tokens are not capable of being possessed, so they cannot be used for certain security arrangements. It concludes that this is unlikely to be problematic in practice and that allowing for these security arrangements could give rise to problems.
It also considers that the extension of existing collateral arrangement regulation to cover crypto-assets would be inappropriate and developing bespoke law would require disproportionate effort; consequently, it does not propose any law reform in that respect.
Osborne Clarke comment
The findings draw attention to ways in which current legislation is sufficient to cater for digital assets, such as crypto-tokens, and how reform would give greater flexibility and certainty, including to the rights a person has in respect of digital objects.
Individuals and businesses involved in crypto-token transactions have an opportunity to shape the future regulation of crypto-assets. We encourage participation and would be happy to discuss any of these issues and support with any proposed response to the consultation. Alternatively, responses to the consultation may be submitted online or comments may be sent by email.