In May 2019, the UK Jurisdiction Taskforce (the “UKJT”) of the LawTech Delivery Panel published its public consultation paper on the status of cryptoassets and distributed ledger technology, as well as the enforceability of smart contracts, under English private law. While much of the literature around cryptoassets in the legal context has been centred on their regulation, the UKJT’s consultation paper focuses on the legal characterization of these instruments themselves. In this article, we consider how cryptoassets can be defined using the existing vocabulary of English private law and the implications of this characterization.

There is still no single agreed definition of cryptoassets. The consultation adopts a broad definition of the term as being “often used to describe something which is, or of which at least a component is, represented by certain data (often, although not necessarily, recorded on a distributed ledger) which, by virtue of the design of a broader system, can only be updated upon the satisfaction of specific conditions.”

Under what circumstances would a cryptoasset be characterized as personal property?

This question is fundamental to realizing both the inherent nature and the developing potential of cryptoassets as a means of acquiring, holding and trading international securities. Characterizing a cryptoasset as personal property allows the law to recognize the legal rights of investors in this increasingly valuable asset class.

English personal property law developed in circumstances very different from today’s digital age, but has proved itself capable of innovation in the service of commercial practice. Taking that as the starting point, a close examination of cryptoassets reveals a striking resemblance with traditional types of personal property. In particular, “security tokens”[1] “capture” the obligations of the issuer under a security; the token is a means of recording and transferring title to the securities. The traditional analogue is the bearer security, which is a type of “documentary intangible” – which means that, by legal fiction, the instrument is deemed to constitute and not merely evidence the debt of the issuer.[2]

“Exchange tokens”[3] differ from security tokens and bearer securities because they do not represent or constitute financial claims against an issuer. However, they also share functional similarities with recognized types of bearer instruments – for example, they can be lost for all practical purposes.

Let’s alight on the concept of the “documentary intangible”:

Documentary intangibles are instruments or documents that are so much identified with the obligation embodied in them that the appropriate way to perform or transfer the obligation is through the medium of the document. The abstract intangible right acquires such a degree of concretized expression that it takes on some of the characteristics of a chattel. The document recording the right is itself a tangible thing and thus a chattel, and the right is thoroughly fused with the document”.[4]

Documentary intangibles benefit from the principle of negotiability, which gives them a privileged status over and above other types of personal property. It is  possible to acquire good title to a negotiable instrument from a thief![5] This is the feature that allows transactions in bearer securities to take place without the legal uncertainty that might otherwise arise. Indeed, whilst the current ways in which international securities are transferred have significantly reduced the operational risk associated with the settlement of securities transactions, with electronic transfers across the books and records of regulated custodians replacing movements of paper, thereby increasing liquidity in capital markets, they are inferior from a legal certainty standpoint to dealing in negotiable paper instruments[6]. The documentary intangible/negotiable instrument thesis for analyzing cryptoassets would seem to allow us to have the best of the worlds of digitization and negotiability.

An understandable reaction to the documentary intangible/negotiable instrument analysis is to observe that cryptoassets are not documents or even necessarily evidenced by documentation! However, “documentary intangible” and “negotiable instrument” are not concepts that are “fixed” or “stereoptyped”[7] (in other words, the concepts can be expanded to accommodate new types of assets if that accords with the practice of market participants). Therefore, even without legislation, commercial custom may also come to demand that at least some types of cryptoassets be negotiable[8], which would make them a powerful tool for the international capital markets.

If the documentary intangible/negotiable instrument analogy is not considered the appropriate model for analyzing cryptoassets, rest assured that English law recognizes other means of conferring title to intangible assets that could be applied. For instance the UKJT paper asks whether a distributed ledger could be a register of title (like the CREST system operated by Euroclear UK & Ireland for the settlement of UK shares). For the reasons explained above, amongst others, negotiable instrument status is preferable but the registration model is conceivable too.

Ultimately, it should depend on what the market wants.

Implications

Characterizing cryptoassets as personal property has wide-reaching implications on how they can be owned, used and transferred. By refusing to make too much of the formal differences between cryptoassets and traditional asset classes and grounding the analysis of cryptoassets within the established doctrines of English private property law, the secondary questions of how they function, and a starting point for how they should be regulated, fall into place intuitively. For example, the means of transfer of title (arguably, by delivery[9]), whether security can be validly granted over them (yes), how they are to be treated for the purposes of the Insolvency Act 1986 (as “property” within the meaning of section 436), whether they are  “goods” under the Sale of Goods Act 1979 (no because, arguably, they are “things in action”[10]) and whether they are “transferrable securities” (we may first need to reconsider the current regulatory framework for securities settlement) become more straightforward.

The conclusion that can be drawn from this is that the established concepts within English property law already present a robust and viable structure for the classification of cryptoassets. Even if we do have to expand our current understanding of traditional concepts, we may not need to reinvent the wheel. The focus can instead be shifted to developing a suitable regulatory framework to mitigate the risks of dealing in cryptoassets.

Going forward

The UKJT plans to publish its conclusions in the late summer of 2019 which should provide greater legal clarity and investor confidence. Cryptoassets are only in their infancy, but answering the questions the UKJT’s consultation asks will help us pin down what they fundamentally are, and shape the discourse of the how going forward in what promises to be an ever-changing space.

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[1] The Financial Conduct Authority (“FCA”) identifies as “security tokens” cryptoassets whose characteristics means that they constitute shares, debt or other types of regulated investments (see FCA CP19/3 on “Guidance on Cryptoassets”, available at https://www.fca.org.uk/publication/consultation/cp19-03.pdf).

[2] J. Benjamin, Interests in Securities (Oxford, Oxford University Press, 2000) 2.05.

[3] The FCA classifies cryptoassets that are not issued or backed by any central authority and are intended and designed to be used as a means of exchange as “exchange tokens” (FCA CP19/3). Bitcoin is a commonly cited example of an exchange token under this taxonomy.

[4] M. Bridge, Personal Property Law 3rd edn (Oxford, Oxford University Press, 2002) p.18 (emphasis added).

[5] A bona fide holder of a negotiable instrument takes free from any defect in title of predecessors.

[6] See Financial Markets Law Committee, “Analysis of the need for and nature of legislation relating to property interests in indirectly held investments securities, with a statement of principles for an investment securities statute”, July 2004, pg 13, available at http://www.fmlc.org/uploads/2/6/5/8/26584807/3b.pdf.

[7] See Goodwin v Robarts (1875) LR 10 Exch 337, per Cockburn CJ holding that mercantile custom was to be adopted by common law as it evolved.

[8] S. Green & F. Snagg, “Intermediated Securities and Distributed Ledger Technology”, in L. Gullifer and JH. Payne (eds.), Intermediation and Beyond (Oxford, Hart, 2019), p. 348.

[9] If they are negotiable instruments.

[10] Section 61(1) of the Sale of Goods Act 1979: ““goods” includes all personal chattels other than things in action and money, and in Scotland all corporeal moveables except money…”. The category of “things in action” for these purposes is thought to include shares and other securities, debts, bills of exchange and other negotiable instruments. We therefore argue that cryptoassets are things in action.

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The framework and no-action letter are a logical expansion of prior SEC statements and actions applying Howey to digital assets, but raises important interpretative issues for newly issued digital assets.

Please click here to read the full alert memorandum.

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