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The UK Provides Legal Certainty For Smart Contracts And Cryptoassets In Its Landmark Legal Statement

Clyde & Co | Karen Boto | Nov 26, 2019

legal statement crypto and smart contracts - The UK Provides Legal Certainty For Smart Contracts And Cryptoassets In Its Landmark Legal StatementEarlier this week the UK Jurisdiction Taskforce (UKJT), part of the LawTech Delivery Panel of senior solicitors and barristers headed by Chancellor of the High Court, Sir Geoffrey Vos, published a landmark "Legal Statement" providing long awaited clarity as to how cryptocurrencies, distributed ledger technology (DLT) and smart contracts might be treated under English law.

The statement follows several rounds of public and private consultation, conducted to address the perceived legal uncertainties of these innovative technologies.

For the first time, the Panel has recognised that cryptoassets, including but not limited to, digital currencies, can be treated as property in principle, and that smart contracts are capable of satisfying the requirements of contracts in English law, making them enforceable by the Courts.

Highlights Below - What is a cryptoasset?

In summary, the Panel explains that a cryptoasset is defined by reference to the rules of the system within which it exists. It is typically represented by a pair of data parameters: one public (disclosed to all participants in the system) and one private. The public parameter contains encoded information about the asset, such as its ownership, value and transaction history. The private parameter (the private key) permits transfers or other dealings in the cryptoasset to be cryptographically authenticated by a digital signature. The private key should be kept secret to the holder.

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Dealings in cryptoassets are broadcast to the entire network and, once they are validated, they are added to the digital ledger. Most commonly the ledger is decentralised meaning no one person or entity has control over it. It is also immutable and cannot be changed. The most common type of ledger being used today is blockchain, although other models do exist. The rules governing the system are established by the informal consensus of the participants.

The novel features of cryptoassets are therefore broadly summarised as follows:

  • intangibility;
  • cryptographic authentication;
  • use of a distributed transaction ledger;
  • decentralisation; and
  • rule by consensus.

Can cryptoassets be characterised as property?

The Panel has considered what property is, as a matter of English law. As no general or comprehensive definition of property exists in statute or case law, the Legal Statement focusses upon the necessary characteristics of property as identified in a number of authorities. The Legal Statement provides that before a right or interest can be admitted into the category of property: "it must be definable, identifiable by third parties, capable in its nature of assumption by third parties, and have some degree of permanence or stability. Certainty, exclusivity, control and assignability have also been identified in case law as characteristic of property rights."

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Although whether English law would treat a particular cryptoasset as property will be fact sensitive and require a consideration of the nature of the asset concerned, and the rules of the system in which it exists, in general, the Panel concluded that "cryptoassets have all of the indicia of property."

The Panel also concluded that the "novel or distinctive features possessed by some crypto-assets" set out above, did not "disqualify them from being property.....nor are cryptoassets disqualified from being property as pure information, or because they might not be classifiable either as things in possession or as things in action."

Why does it really matter if a cryptoasset is property?

It is important to determine whether a cryptoasset is capable of being property because it means that it can be owned, which gives rise to important proprietary rights that can be recognised against the whole world. The owner of a thing is entitled to control and enjoy it to the exclusion of anyone else.  Proprietary rights are of particular importance when it comes to issues relating to succession on death, the vesting of property in personal bankruptcy, and the rights of liquidators in corporate insolvency, as well as in cases of fraud, theft or breach of trust.

So, what is the asset and who owns it and how is it transferred?

The Legal Statement confirms that whilst cryptoassets can be transferred either via an "on chain" transfer (with the ledger being updated in the usual way) or by way of an "off chain transfer" (another type of transfer outside the ledger which is vulnerable to a superseding on-chain transfer i.e. double spending by the transferee)) these will not constitute transfers in the legal sense. This is because of the way the distributed ledger technology operates: unlike a tangible asset, the same cryptoasset does not pass, unchanged, from one person to another. Instead, the transferor typically creates a new cryptoasset, with a new pair of data parameters: a new or modified public parameter and a new private key. The data representing the "old" cryptoasset persists in the network, but it ceases to have any value or function because the cryptoasset is treated by the consensus as spent or cancelled so that any further dealings in it would be rejected.

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What consequences does this classification have?

The Legal Statement concludes that it is possible to declare a trust over an ownership interest in a cryptoasset.

However, as the Panel found that a cryptoasset is not a physical thing, it cannot be subject to a possessory relationship, such as a bailment, a lien or a pledge. That said, the Panel expressly states that it could see no obstacle to the granting of other types of security such as charge or mortgage.

It is also clear that cryptoassets are not documents of title, documentary intangibles or negotiable instruments (though some form of negotiability may arise in future as a result of market custom), nor are they instruments under the Bills of Exchange Act.

Nevertheless, as the Panel was of the view that cryptoassets can be property at common law they were in no doubt that they may therefore also be property for the purposes of the Insolvency Act 1986 (IA 1986) which contains a very wide definition of property. Indeed, even if a cryptoasset was deemed not to be property at common law, it might still be deemed to be property under the IA 1986.

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