The fundamental issue with blockchain

One of the most important developments in the regulation of digital assets is found in the private commercial law world. Consider the monumental consultation paper issued last year by the England and Wales Law Commission on Digital assets. That consultation has closed but we await the final legal proposals. That consultation paper is one of the most comprehensive consultation documents published - close to 600 pages with detailed legal analysis and explanations of things such as tokens and other issues to do with digital assets. It is an excellent primer, if not bedtime reading.

The fundamental issue the Law Commission tackles is the lack of proprietary rights in ‘digital assets’ on a blockchain ledger. That is to be compared, for example, to the deposit of money into a bank which creates an account, a debt owed by the bank (a regulated entity) to the depositor. This is old and firm law. The consequence for digital assets is that there is created neither a chose in possession (you cannot ‘posses’ a digital asset) nor a chose in action (there is no one against whom to take action, as the entry on a ledger is simply that). It is also old and firm law that there are only these two classes of assets.

This is a major problem for those who invest in digital assets such as cryptocurrencies. Blockchains are a helpful device when all is right with the commercial ventures they encapsulate, but when things go wrong the failure of blockchains (in origin seeking to remove the need to trust the power of State control, instead trusting solely in the blockchain mechanism) proves true a saying that was (probably falsely) attributed to Lenin: “Trust is good, but control is better.”

The proposed solution suggested by the Law Commission is that a third class of asset be created with statutory backing. This will revolutionise personal property law. More information will be provided as the final report by the Law Commission is issued later this year.

This position should be carefully distinguished from third party intermediaries who hold digital assets in that third party’s accounts. There is a wealth of case law, but all at first instance or even on ex parte basis without the other side putting a counter argument, that tackles the issue of what remedies can be given to preserve those assets. Every case is different and a careful study of the terms of those accounts needs to be studied: most recently see Celsius Network LLC (United States Bankruptcy Court, 4 January 2023) in which the contract made it clear that the asset remained those of the central depository.

But these are not the only issues. Many consequential issues arise. One important one, for example, is that of taking security. Most security laws around the world depend on the concept of ‘possession’ but that has no obvious meaning in a digital world. A number of proposals are surfacing globally suggesting important changes to securities law, such as making the concept of ‘control’ the central concept. Whatever that means, it will include the concept of ‘intention’, distinguishing it in that respect at least from the concept of ‘possession’. The US Uniform Law Commission is suggesting an amendment to the Uniform Commercial Code to make this change. Comparison might also be made to the Australian Personal Property Securities Act 2009.

UNIDROIT

There is now a new consultation taking place by UNIDROIT. One of the forgotten international law bodies, UNIDROIT - International Institute for the Unification of Private Law, was an entity within the League of Nations but ran into the little problem that the League disappeared post the Great War. It has however been reconstituted under international statute and is now an extremely active body dealing with international law reform. Based in Rome, its purpose is to study needs and methods for modernising, harmonising and co-ordinating private and in particular commercial law as between States and groups of States and to formulate uniform law instruments, principles and rules to achieve those objectives.

One of UNIDROIT’s major projects over 2020 to the present is a working group studying Digital Assets and Private Law. It has developed a set of principles intended to provide guidance in transactions in order to give certainty to practitioners, judges, legislators and market participants. It is also intended to be the basis for State legislation so that not only within the State but across State borders there is a common language and principles that govern the transaction. They include discussion and restatement of principles dealing with the definition of a digital asset, the importance of control, matters related to transfer of digital assets, custody relationships, conflicts of law, secured transactions, enforcement, and insolvency.

These principles are an important and definitive statement of legal concepts and worth studying if you are involved in any way with digital assets. To follow up on one aspect only, Principle 6 provides a good definition of ‘control’, which is being adopted by other law reform bodies, including the Law Commission. The language set out in this document will be helpful in drafting transaction documents even if the Principles are not adopted under local law.

The UNIDROIT Consultation

The UNIDROIT document is now open for consultation. The deadline to submit comments is 20 February 2023. All comments should be provided using this online form.