Simon Deane-Johns summarises the Law Commission's recent consultation on digital assets - "a veritable textbook on the English law of personal property" - and gives a personal angle on some of the proposals put forward.
The Law Commission has been consulting on its proposal that the law of England & Wales recognise and protect property rights in 'digital objects' (with crypto-tokens as the only eligible item at this stage). Aside from the Commission impressively producing a veritable textbook on the English law of personal property, this process has involved three 'roundtable' discussions relating to custody of digital assets, using them as security for finance; and whether they should be the subject of a new class of personal property. I participated in the roundtables and submitted my thoughts in answer to questions in the consultation paper, the substance of which I've summarised here. My numbered references are to the paper itself.
A new category of personal property
It would seem helpful for English law to recognise 'data objects' as a new category of personal property, since its clear that the courts see 'crypto-tokens' (for example) as a form of property that does not fit neatly into existing categories.
The Commission proposes that data objects would need to meet the following criteria:
(a) be composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals;
(b) exist independently of persons and the legal system; and
(c) be rivalrous (the use by one person/group inhibits the use by another).
The Commission believes that only 'crypto-tokens' would meet these criteria at present, noting that this concept is more restricted than 'cryptoasset' (as commonly used in financial regulation). A crypto-token comprises the limited 'internal' set of data that is "instantiated" within a crypto-token system or 'distributed ledger'. In terms of the Bitcoin protocol, the token is the data that says how much is available to 'spend' (unspent transaction output or UXTO); while in terms of Ethereum, it would be the amount of value available in an 'account' (Appendix 3).
Where a token is linked to something else, like a right or an asset (14.5), the crypto-token will not include that "linked thing" (14.6), but together they would form a 'cryptoasset'.
Criteria for a data object
To the first of these criteria, I would add that the data should also be "capable of being retrieved and capable of being subject to control" (in the sense of actual/electronic control rather than 'legal control'). It would also be likely to be 'divestible' (see 5.54, 5.142).
I struggle with the idea that a data object must 'exist independently of persons and the legal system'. While deserving of protection as a form of property, I think it is arguable that crypto-tokens, for example, are not independent of persons and/or the legal system on the following grounds:
While a 'data object' should need to be rivalrous, I do worry that this may be 'fragile' and liable to be broken in certain circumstances, absent specific exception or clarification that might open the door to other items. A crypto-token, for instance:
Examples of electronic things that would not qualify as data objects
The Commission helpfully analyses why it believes certain electronic things would not qualify as 'data objects':
I have some concerns about ruling out 'digital records' generally, even if one includes among the criteria the requirement that they be 'independent of persons and the legal system':
It also seems possible to me that accounts in encrypted messaging systems might satisfy the requirements for digital objects (referred to in the EU's Digital Markets Act as "number-independent interpersonal communication services (or NIICS)").
In-game assets generally do not seem likely to be divestible from the game in which they are issued/hosted, but what if they were to become interoperable with other games, whether voluntarily by the games developers or as mandated by competition or consumer protection authorities?
Emissions allowances and voluntary carbon credits could be tokenised as cryptoassets, such that they benefit from the tokens being property.
Crypto-tokens as digital objects
While I agree that crypto-tokens should be viewed as a form of property, I can see there may be cases where that would not be appropriate, such as where:
Process and validity of crypto-token transfers
The transfer of a crypto-token usually involves a transfer operation that effects a state change within the relevant crypto-token system. This typically involves replacing, modifying, destroying, cancelling, or eliminating the pre-transfer crypto-token and a resulting, corresponding, causal creation of a new, modified or causally-related crypto-token. The corresponding causal creation is evidenced within the dataset that constitutes pre-transfer and post-transfer tokens, i.e. in the metadata that persists between the two tokens or the associated smart contract under which the transfer occurs.
Accordingly, it should not matter that transfers of crypto-tokens are not "characterised as the transfer of an unchanging thing" (12.16); and that "the law should leave room... for characterising particular transaction arrangements as transfers of an identifiable and persistent thing, even though the crypto-token itself is modified or extinguished on transfer" (12.54).
The Commission believes this should be recognised in English law on the basis of 'freedom of contract'. However, in my view it may be helpful if basic enabling legislation were also to provide that, say:
No transfer of a crypto-token shall be deprived of its effect solely on the ground that the crypto-token itself is modified or extinguished on transfer and the transfer results in the corresponding causal creation of a new, modified or causally-created crypto-token, provided that the corresponding causally created crypto-token is evidenced either in meta-data that persists between the original crypto-token and the corresponding crypto-token or otherwise in the transfer mechanism (see 12.38, 12.54-12.60).
Legislation could also recognise participants' ability to use any other methods to attribute specific importance to specific crypto-tokens or not, so there would seem to be no substantive difference between attribution as an "NFT" (linked to certain data/images the subject of intellectual property rights/licences) or a fungible token (whether or not linked to some other external legal right).
It also seems appropriate that:
It may be necessary, however, for any statutory reform to expressly allow for equitable transfers of crypto-tokens where no state change has occurred (or needs to occur), subject to becoming legal transfers on the occurrence of a state change (similar to the need for notice to perfect a legal assignment under section 136 of the Law of Property Act 1925, for example).
Control of a data object is more appropriate than Possession
The concept of 'control' does seem more appropriate for data objects than the concept of possession. A person could be said to control a data object where that person can:
(1) exclude others from the data object;
(2) put the data object to the uses of which it is capable (including, if applicable, to effect a passing out of, or transfer of, that control to another person, or a divestiture of control); and
(3) identify themselves as the person with the abilities specified in (1) to (2) above.
These concepts can be left to develop through contract, custom, usage and guidance from industry bodies and expert panels, as well as case law, rather than being codified in statute.
A transfer operation that effects a state change (in the ledger) should be a necessary but not sufficient condition for transfer of (superior) legal title to a crypto-token, allowing for contracts and other means of 'derivative title transfer' in tandem (13.18). That would mean a deed or bill of sale would not be enough on its own to effect the transfer of a crypto-token without a state change in the ledger (see 13.19, 13.22 and 13.45-47).
This raises the problem where a purchaser is only aware of the state change in the ledger and is unaware of an associated deed etc.. The state change should set up a defence of good faith purchaser for value without notice (an 'innocent acquisition rule') without automatically applying to anything linked to the token which may require such a document or 'derivative title transfer' (or to effect the transfer of the wilder 'cryptoasset') (13.52, 13.91). This is likely to require legislation, either because there's a perception that such a rule or presumption already applies but courts may not have ruled on it or the need to clarify the position in legislation dealing with the transfer of linked assets/rights.
Conversely, it should also be legally possible to separate (superior) legal title to a crypto-token from the recorded state of the ledger and/or factual control over a crypto-token.
Crypto-tokens are not goods
While crypto-tokens should not qualify as 'goods', it seems important to clarify whether a crypto-token:
Custody of data objects
I do not think it is appropriate to draw a distinction between 'direct' and 'indirect' custody services. A custodian would hold crypto-tokens on behalf of or for the account of other persons with or without capacity to exercise, or coordinate or direct the exercise, of factual control (positive and/or negative), so it should be possible for custodians to agree different service features or levels, or types of control.
The nature of custody relationships and the status of property on insolvency or wind-down
Custody arrangements could be characterised and structured as trusts, even where the underlying entitlements are (i) held on a consolidated unallocated basis for the benefit of multiple users, and (ii) potentially even commingled with unallocated entitlements held for the benefit of the custodian itself.
But there could need to be legislative change, for example, where:
Other issues include:
It may be helpful for legislation to provide for a pro rata shortfall allocation rule in respect of commingled unallocated holdings of crypto-tokens or crypto-token entitlements in a custodian or other institutional insolvency, subject to specific treatment in line with existing regimes for linked assets.
Collateral or security arrangements for data objects
It should be possible for crypto-tokens, as data objects to be the subject of title-transfer collateral or security arrangements, but specific law reform may be required for some regulated collateral arrangements, such as pawn agreements, conditional sale agreements or secured credit agreements under the Consumer Credit Act 1974. That would need to cover entering into, administering and enforcing such arrangements, which are highly prescriptive. So it may be necessary to ensure that existing statutory frameworks facilitate such arrangements, rather than setting up a bespoke collateral regime just for data objects (especially given the likely link between tokens and other things to form 'cryptoassets').
Damages and other remedies relating to data objects
As crypto-tokens are generally not "money", the enforcement of an obligation to "pay" or transfer crypto-tokens should generally be regarded as non-monetary (aside from e-money tokens), and hence claims for unliquidated damages (19.26). But there may be cases for a court to have discretion to award a remedy a remedy denominated in certain crypto-tokens, where traditionally the judgment would have been denominated in money.
The existing rules on tracing (at equity and common law) can be applied to crypto-tokens where there's a state change in the ledger; but that the law on 'tracing into a mixture' may require further development or reform, whether generally or specifically with respect to crypto-tokens (19.52).
Existing legal frameworks do seem applicable to data objects, but statutory or common law reform may be needed in relation to:
(1) breach of contract;
(2) vitiating factors;
(3) following and tracing;
(4) equitable wrongs;
(5) proprietary restitutionary claims at law; and
(6) unjust enrichment.
It seems appropriate top extend the tort of conversion to data objects (or at least a conversion-type cause of action grounded in control rather than possession), subject to a special defence at law of (or analogous to) 'good faith purchaser for value without notice'.
While generally applicable, it is not clear whether the existing principles/provisions relating to injunctive relief, enforcement of court process and judgments adequately apply to data objects without the need for law reform, since so few cases seem to be defended at this stage (19.148).
A key area of uncertainty appears to be what cause of action or remedy would lie or be effective where a distributed ledger, protocol or smart contract does not work as described (e.g. in the related white paper).
Simon Deane-Johns, Consultant Solicitor Keystone Law and a Fellow of the SCL