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On June 28, 2023, the Law Commission of England and Wales published its final report on how UK law recognizes and protects cryptoassets.
Digital Property: The final report contains recommendations including the creation of a new category of personal property and the application of the concept of control – rather than ownership – to property of this type.
You can find the full report here. You can also find further elliptical analysis here.
Recommendation 1: “third” category for personal property rights
With the adoption of digital assets in the UK, personal property laws in England and Wales need to align. The report addresses the legal treatment of digital assets and confirms that certain digital assets may be considered objects of personal property rights, even though they may not fall into traditional categories.
The traditional categories are “things in possession” (such as a car) and “things in action” (such as debt). Cryptocurrencies are neither, but have sufficient legal substance to be recognized under English law.
The report reveals that digital assets can be considered in three ways. First, they can be considered things of value. Second, they can function as registers of interest, eliminating the need for separate ledgers or databases. Finally, tokens can represent claims on obligations, such as providing access to performances or venues. This makes digital assets a “third” category of things.
The recognition of a “third” category acknowledges the diverse nature of digital assets, including crypto-tokens, private blockchain systems, voluntary carbon credits, in-game digital assets and digital files.
This highlights the importance of understanding the legal status of digital assets and establishing appropriate frameworks to govern their use. While the report suggests that legislation should be enacted to confirm and support this position, it also emphasizes the importance of the common law in determining the specific cases that fall into this third category and stresses that “the common law is the most appropriate vehicle for dealing with difficult boundary questions”. . Rather than prescribing firm boundaries through statutory law, the common law is seen as more appropriate to deal with these complex issues.
Recommendation 2: control and a new industrial panel
Control plays a key role in shaping the treatment of digital assets that fall into the “third” category.
- Fact control: this refers to a person’s ability to exclude or allow access to a digital asset and use its functionality. As a concept, it is highly dependent on the specific technology being used.
- Legal control: the report concludes that control should be seen as an integral part of broader legal principles and mechanisms. Control alone cannot comprehensively determine the outcomes of complex legal arrangements. These include legal transfers, intermediary holding arrangements, collateral agreements, and actions and remedies specific to digital assets. As different digital assets possess unique characteristics and functions, control works differently in different types of assets, requiring a nuanced approach.
According to the Law Commission report, the complexity of control and its implications for digital assets require the establishment of a panel comprising industry-specific technical experts, legal practitioners, academics and judges. The report highlights the importance of this panel in providing non-binding guidance on the complex factual and legal issues surrounding the control and other aspects of digital asset systems and markets.
By offering improved descriptions and practical examples of factual control, the expert panel would improve market participants’ understanding of the concept and its real-world implications. The expert panel would contribute to the development of a more comprehensive and adaptable legal framework that is in line with the reality of digital assets and their control mechanisms.
Recommendation 3: strengthening financial collateral arrangements
The report looks at how intermediary holding arrangements relating to crypto-tokens can be structured within the legal framework of England and Wales. The legal consequences of “custodial holding arrangements”, “non-custodial holding arrangements” and “non-holding arrangements” have significant consequences in the case of bankruptcy proceedings involving a holding intermediary.
Trusts can facilitate various intermediary custody arrangements, including the consolidation of unassigned rights to crypto-tokens for the benefit of multiple beneficiaries. However, the report does not support the assumption of trust for intermediary holding arrangements involving crypto-tokens.
Recommendation 4: specialized legal framework for crypto-assets
The report proposes the establishment of a special legal framework for certain collateral arrangements of crypto-tokens and crypto-assets. The establishment of a multidisciplinary project to formulate and implement this framework is recommended, given the high demand for law reform expressed by consultants, market participants and industry bodies.
Transfer of ownership and non-possessive security-based arrangements are assessed in the report as viable options for structuring collateral arrangements without the need for law reform. It clarifies that security-based arrangements do not currently apply to crypto-tokens and crypto-assets.
The applicability of the Financial Collateral Regulation (No. 2) 2003 (FCAR) to the various types of collateral associated with public, permissionless crypto-token systems and private, permissioned blockchain systems is also assessed in the report, to enable more effective collateral enforcement in crypto-lending transactions. While many crypto-tokens are likely to fall outside the scope of the FCAR regime, other collateral associated with these systems may fall within its purview. The report recommends reforming the law to provide more clarity.
Conclusion
Recognizing the legal status of digital objects and proposing legal confirmation – along with the evolution of common law – are key steps in accommodating the unique characteristics of crypto-tokens as a “third” category. The report’s emphasis on the establishment of a technical expert panel also confirms the need for specialized expertise in dealing with issues related to cryptoassets.
The report serves as a guide to the future of the UK crypto-asset industry. The implication of the recommendations is that crypto-tokens will have more legal certainty under UK law than in other jurisdictions. This will improve clarity, protect investors and preserve market integrity, establishing the UK as a flexible and fair market for crypto-tokens.
Charles Kerrigan is a partner in the Finance team and is part of the expert team for crypto and digital assets at CMS London.
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