In support of innovation – clarification of the legal nature of cryptoassets and the enforceability of smart contracts

2 December, 2019
by: Cripps Pemberton Greenish

The UK wants to make things easier for businesses at the forefront of developing innovative solutions using blockchain or other distributed ledger technologies, like cryptocurrencies and “smart” contracts.  Although grants and funding are clearly a big part of this, so is creating the right legal and regulatory environment.  Understandably, businesses don’t want to be constrained by unnecessary red tape, but legal certainty and an effective and potentially supportive regulator can bring benefits to businesses, helping them improve their practices as well as allowing potential investors and customers to have confidence in their end products.

 

The opinion published by the UK Jurisdiction Taskforce is one such move in this direction.  Although many commentators would have predicted the position reached in the opinion if asked, and there is a general acknowledgement that the UK legal system is flexible enough to deal with most new technologies and developments which arise through case law, having clear confirmation, along with reasoned arguments to support the conclusion, helps bring better understanding of the issues and acceptance of the opinion. The opinion doesn’t have the force of law, so the position can only be definitively determined by the Courts or through specific legislation, it will however be persuasive authority for the Courts and therefore carry substantial weight.

The Taskforce was looking at cryptoassets, which would include cryptocurrencies such as Bitcoin, but also platform tokens like (for example) Ethereum blockchain, utility tokens and security tokens.  They were also looking at smart contracts (contracts made automatically, without the intervention of humans), which underpin transactions on distributed ledger technologies (DLTs) and thus are an integral part of on-chain trading in cryptoassets, with the aim of clarifying their legal enforceability.

  • on cryptoassets:  this is quite a technical legal area, but basically the Taskforce was looking at what exactly a cryptoasset is in legal terms.  Is it tangible (real) property – like a book? Or intangible property – like an idea which you could own through copyright for example, but can’t physically hold in your hand?  Or a personal right like a debt? Or is it something different altogether? The question has arisen because cryptoassets are at their heart information, but unlike other forms of information which are currently protected under law such as confidential information or trade secrets, the information forming the cryptoasset is not complete or valuable itself without the private key, it cannot be freely transferred in the same way, and it has other unusual characteristics such as being distributed and decentralised (so the exact same information is held by each participant in the system at the same time) which means cryptoassets don’t readily fall within existing legal classifications.  The conclusion reached however was that, although classification would ultimately depend on the nature of the cryptoasset, the rules of the particular system, and the purpose for which the question was being asked, in principle cryptoassets should treated as property.

 

  • on smart contracts: the opinion held that smart contracts could be legally binding contracts, even where parties are anonymous or pseudo-anonymous.  Where law requires contracts to be signed (in a small number of circumstances) the authors felt that a private key intended to authenticate the document would be OK.  Where there is a requirement for a contract to be in writing, this might be satisfied if the contract is in a form that can be read (through source code or object code).

Cryptoassets: whether something is or is not “property” affects how it can be owned, transferred or otherwise used and enjoyed, so it is important to get this clear.  Legally, the classification is principally significant to business in the area of insolvency, because those with proprietary rights have priority over creditors, but it also has implications in the areas of trusts, theft and succession following death.  It may also be relevant to the determination of jurisdiction for legal proceedings and to claims under insurance contracts. For example, in the U.S., in one insurance contract case, stolen Bitcoin was classified as property (as opposed to currency), meaning the insurer had to pay out. It is also relevant for its regulation.

 

Smart Contracts: knowing that a smart contract is valid and binding is clearly critical to users having the confidence to carry out transactions on the blockchain and other distributed ledgers. Smart contracts are predicted to become widely used across most if not all industries in one form or another.

For those directly involved with innovation in the areas of cryptoassets and smart contracts, the increased certainty over the legal position should be a positive development, reducing or even removing what is often cited as the biggest barrier to adoption, investment and development and increasing market confidence.

 

For other businesses and industries, whilst not yet all-pervasive, cryptoassets and smart contracts are predicted to transform almost every industry in some way, from financial services to pharma. Having certainty of legal relations when trading using cryptoassets or smart contracts will be critical.

  • in relation to security, as cryptoassets are virtual and not capable of physical ownership they cannot be the object of a bailment, or a pledge or a lien (types of security relating to physical things), but can be subject to a mortgage or charge;
  • the owner of the cryptoasset is the person who has lawfully acquired “knowledge and control of a private key” – although there may be issues where there are multiple keys or if keys are held on behalf of a third party or where addresses are anonymous, in which case ownership rules would need to be determined by the particular circumstances and the rules of the relevant system;
  • the “asset” making up the cryptoasset is the set of arrangements that gives rise to the ability to update or spend certain data, to the exclusion of others, not the keys or the distributed ledger data;
  • transfers can be “on-chain” or “off-chain” (although off-chain transfers are at risk from a supervening on-chain transfers) but because of the nature of the DLT, transfers are not strictly transfers as commonly understood, as the asset isn’t the same pre and post transfer.  The property of the transferor is consumed or destroyed and a new cryptoasset is created;
  • questions may still arise over the governing law relating to decentralised cryptoassets (because they are not located in any single place).

The UK Jurisdiction Task Force is part of the Lawtech Delivery Panel – an industry-led, government-backed initiative, established to support the transformation of the UK legal sector through technology.  The UK is currently the second biggest legal jurisdiction in terms of revenues – estimated at £26 billion in 2017 – and the Government wants to maintain this position. It sees that making the UK the first choice of law and jurisdiction for the growing number of digital transactions on the blockchain is key to this, and is looking to increase its success on this front by promoting certainty about the law and regulation applicable to the sector.  The Taskforce asked 4 leading barristers in the field to look at the issues and deliver their opinion in a “Legal Statement”, but in framing its consultation and the parameters of the opinion requested, the Taskforce took on board comments from a broad range of academics and lawyers but also businesses.

  • issues the Taskforce didn’t cover included regulation of dealings in cryptoassets, monetary policy, or the nature of cryptoassets as money, which are probably the next big issues;
  • the tax position for companies has recently been clarified by HMRC: https://www.gov.uk/government/publications/tax-on-cryptoassets/cryptoassets-tax-for-businesses; and
  • remedies (in relation to theft for example) are to be developed as necessary over time, but in principle will follow those available for other property assets.

 

The next step is for the Law Commission to consider whether any legislation is needed in this area. 

 

For further information about cryptoassets, cryptocurrencies, distributed ledger technology, blockchain or smart contracts, please contact Irfan Baluch on +44 (0)1732 224 006 or irfan.baluch@crippspg.co.uk

 

For a guide to personal tax on cryptoassets see here.

 

For an introduction to all things blockchain, visit our software portal,  where you will also find a wealth of resources to guide you on the legal issues surrounding software more generally.