On 28 July 2022 the Law Commission of England and Wales published a Consultation Paper setting out its recommendations for law reform in respect of certain digital assets as objects of property rights. The Law Commission invited responses and conducted feedback sessions from 28 July to 4 November 2022.
Our response to the Consultation Paper consists of overarching considerations and observations as well as direct responses to specific issues and questions raised by the Consultation Paper. A summary of the key points of our response is provided below.
- We are supportive of a statutory codification of digital assets as property under the law of England and Wales and believe that any legislative intervention should be framed in broad terms only as we do not believe that detailed legislation can appropriately or effectively be tailored to all the current and potential future use cases of digital assets.
- It is foreseeable that an overly prescriptive statutory regime might soon be anachronistic. This could lead to a process of statutory amendment which is unlikely to be sufficiently quick to keep abreast of technological change.
- It is critical that any legislative intervention considers the full spectrum of commercial applications of digital assets including the ways in which digital assets are used in conjunction with existing categories of property. In order to achieve legal certainty, definitional clarity of different categories of property and the boundaries between them is crucial.
- There is a risk that law reform could inadvertently create parallel legal frameworks for different or overlapping digital assets which are substantially the same. We suggest that further and deeper analysis in certain areas (for example, in respect of linked digital assets, composite digital assets and securities) is advisable to mitigate this risk materialising.
- Regulators such as the Prudential Regulation Authority and the Financial Conduct Authority should be involved in conversations relating to any proposed legislative changes as soon as possible because any subsequent regulatory classification of digital assets will be informed by their legal classification.
- Ideally financial regulators will propose and implement regulatory classification/taxonomy in respect of digital assets in short order once enabling legislation has been formally proposed.
- Once enabling legislation and regulatory classification/taxonomy is in place, we believe the common law should be left to determine further concepts and principles relevant to the status of digital assets under the law of England and Wales.
- We also think it would be helpful to establish a panel of experts to produce guidance that will assist courts in analysing digital assets. The constitution of the panel should be broad to ensure that there is comprehensive and appropriate debate (and should, for example, include technologists and market participants as well as academics and legal professionals).
- The thrust of developments in digital assets in the international arena combined with the ambitious scale and reach of the digital assets phenomenon provides broad support for the introduction of statutory reform rather than waiting for authoritative case law to settle the foundational questions at stake.
- Due to the global application and impacts of digital assets and their underlying technologies, it is also of critical importance to be mindful at all times of international legal and regulatory developments to ensure harmonisation is achieved. Statutory developments in England and Wales must be consistent with and reflect the latest consensus in international law and regulation.
Co-ordination of digital assets initiatives in the UK
- We consider that there could be a more joined-up approach to legal and regulatory reform and pronouncements on digital assets in the UK to facilitate coherence and consistency of thought in respect of the UK's approach to digital assets overall.
Recognising digital assets as "data objects" under the law of England and Wales
- Although we understand the desire to introduce a third category of personal property into the law of England and Wales in order to accommodate certain digital assets which meet specified criteria, enshrining a third category via statute could prove counterproductive to achieving legal certainty. In particular, we consider that the third category proposal could be unworkable in practice and could lead to a wide range of unintended consequences that would likely cause more problems than would be solved.
- This is primarily due to the uncertainty that would remain in respect of the boundaries between different categories of property. Also, the proposed "data object" criterion of "rivalrousness" would likely be burdensome, prohibitively expensive or impossible to establish in many cases due to the high degree of technological and legal analysis and opinion that would likely be required.
- For the reasons summarised in the "Statutory reform" section above, we consider that the best approach to achieving legal certainty is to introduce enabling legislation, consisting of broad principles only, which confirms that digital assets are property.
Crypto-token transfers in fact and in law
- We believe that it is important not to overemphasise the technological idiosyncrasies of crypto-tokens as this risks misconstruing the key legal question of transfer.
- The suggestion that each crypto-token is replaced upon transfer with a wholly different (albeit derivative, causally-related) crypto-token seems to us to be wrong and antithetical to the concept of a crypto-token system being an immutable record of ownership of crypto-tokens passed between participants. It is also likely to create unintended or undesirable legal consequences.
- We suggest that the consensus protocol should be considered both a social and legal contract as between system participants and that most cryptoasset systems meet the essential criteria for a multilateral contract to arise.
- We do not believe that it is necessary to create new definitions based upon the technological/operational features and functions of crypto-tokens and crypto-token systems to create legal certainty around when, what and how a transfer of a crypto-token occurs, and any applicable defences.
Custody of crypto-tokens
- We think that a presumption of trust in respect of crypto-token custody facilities should be introduced as a new interpretative principle on the basis that it is the most effective means of achieving the Law Commission's objectives to improve user protection and incentivise greater clarity, particularly to address the complexity that would otherwise arise in custodian insolvencies.
- We agree that clarification of the scope and application of the statutory formalities set out in section 53(1)(c) of the Law of Property Act 1925 ("LPA 1925") would be beneficial, and consider that the best way of achieving this would be via the Law Commission's proposed Option 2(a) (i.e., directly amending section 53(1)(c) LPA 1925 to incorporate express revisions to the law applied as a matter of general principle, not by reference to categories of assets).
- We agree that legislation should provide for a general pro rata shortfall allocation rule in respect of commingled unallocated holdings of crypto-tokens/crypto-token entitlements in a custodian insolvency, consistent with HM Treasury's (proposed) general development of a bespoke insolvency regime for custodian insolvencies (as set out in HM Treasury, Managing the failure of systemic digital settlement asset (including stablecoin) firms: Consultation, May 2022).
Crypto-token collateral arrangements
- We are supportive of efforts to ensure legal certainty in relation to collateral arrangements involving digital assets. We therefore support the Law Commission's suggestion of establishing a legal framework that facilitates the entering into, operation, rapid priority enforcement and/or resolution of crypto-token collateral arrangements.
- We believe that the primary impact of such a framework, from the perspective of the law of England and Wales, will be in the context of security collateral arrangements over crypto-tokens. This is because law reform would not be necessary, from a purely domestic legal perspective, to ensure robust and effective title transfer collateral arrangements.
- We believe that expanding the Financial Collateral Arrangements (No 2) Regulations 2003 ("FCARs") or adopting a bespoke collateral regime for crypto-tokens gives rise to complexity, both in law and in practice. As such, either solution would require further, detailed consideration. Subject to the broader private international law impact, we believe that expanding the FCARs is a more logical development and likely to be easier for market participants to adopt in practice.
Causes of action and remedies in relation to digital assets
- We do not perceive the need for radical reform of existing causes of action to take account of disputes arising in respect of digital assets.