In what Sir Geoffrey Vos, Chancellor of the High Court, described as a 'watershed for English law and the UK's jurisdiction', the UK Jurisdiction Taskforce (UKJT) has published its legal statement on the status of cryptoassets and smart contracts under the law of England and Wales.
This statement is a critical step in providing much needed market confidence and a certain degree of legal certainty which is crucial to the successful development of the use of cryptoassets and smart contracts in all sectors (including the financial services sector).
How did the legal statement come about?
In May 2019, the UKJT released its consultation paper, The status of cryptoassets, DLT and smart contracts under English private law. The aim of the consultation process was to address issues of perceived legal uncertainties with respect to these new technologies and to demonstrate that English law and the jurisdiction of England and Wales provides a 'state-of-the-art foundation for the development and use of [Distributed Ledger Technology], smart contracts and associated technologies'.
The consultation intentionally did not cover certain areas of law insofar as they relate to cryptoassets and smart contracts, including their regulatory characterisation and treatment, intellectual property, data protection, consumer law, matters of taxation and anti-money laundering.
The legal statement describes the features of cryptoassets as 'novel' with five key characteristics: (a) intangibility (b) cryptographic authentication (c) use of a distributed transaction ledger (d) decentralisation and (e) rule by consensus.
These characteristics do not preclude cryptoassets from being treated as property. Indeed, the legal statement notes that one of the fundamental aspects of property is 'ownership', and that cryptoassets are capable of being owned.
This conclusion will affect the treatment of cryptoassets at a number of levels, including on insolvency and succession and in cases of fraud, theft or breach of trust.
The legal statement notes that a crypto asset is not a 'thing in possession' (tangible property that can be the subject of physical possession and so physical control), but may be a 'thing in action' where that is taken to refer to any property that is not a thing in possession. However, the statement concludes that a cryptoasset may be best treated as being another third kind of property, which is neither a thing in action nor a thing in possession.
Cryptoassets are the set of arrangements that gives rise to the ability to update or spend certain data, to the exclusion of another party. Interestingly, the legal statement notes that a cryptoasset is not any of the public or private keys, or the distributed ledger data itself. None of those constitute property as they are items of pure information, like a password or telephone number, and therefore cannot be treated as property. Instead, the asset is something that arises from their combination with the relevant system rules (including the embedded cryptography), the exclusive ability to update or spend transaction data. For these reasons, the legal statement concludes that cryptoassets are not disqualified from being treated as property on the basis that they constitute information because "cryptoassets have the characteristics of certainty, exclusivity, control, assignability and permanence that information generally lacks" (these necessary characteristics of property can be found in National Provincial Bank v Ainsworth  AC 1175).
The legal statement describes the owner of a cryptoasset as “a person who has acquired control of a private key by some lawful means”. However, it also confirms that it is possible for the original owner of a cryptoasset to transfer ownership of that cryptoasset "off-chain" where parties enter into an agreement to transfer a cryptoasset, but where the transfer is not recorded in the transaction ledger. As noted in the legal statement, this may cause practical difficulties and is vulnerable to a supervening on-chain transfer.
The legal statement makes clear that an “on-chain” transfer is not analogous to the delivery of a tangible object or the assignment of a legal right, where the same thing passes, unchanged, from one person to another. This is because the asset “spent” by the transferor is a different asset to that received by the transferee (the spent cryptoasset cannot be spent again and so an entirely new cryptoasset is created that can in turn be spent by the transferee).
The legal statement does not address this question directly.
A person may have created or acquired control of a private key quite lawfully whilst unlawfully causing the cryptoasset to be spent in someone’s favour (such as a hacker) on-chain. Given the legal statement confirms that an on-chain transfer creates a new asset, it would seem to follow (subject to remedies being available to the victim of the unlawful spending under law) that such a person would possibly be regarded in law as the owner of the new asset. This would benefit from further clarity in the future.
The legal statement concludes that it is possible to declare a trust over an ownership interest in a cryptoasset.
However, as the legal statement concludes that a cryptoasset cannot be physically owned (as it is virtual), it cannot be the object of a bailment, a lien or a pledge.
The legal statement also makes clear that cryptoassets are not documents of title, documentary intangibles or negotiable instruments, nor are they instruments under the Bills of Exchange Act.
As noted above, a cryptoasset may not be the object of a pledge or lien, but security can be taken over a cryptoasset by way of charge or mortgage.
The key characteristic of a smart contract, according to the legal statement, is “automaticity”. A smart contract is performed, at least in part, automatically and without the need for, and in some cases without the possibility of, human intervention. Smart contracts are written in code and embedded in a networked system that executes and enforces performance using the same techniques (cryptographic authentication, distributed ledgers, decentralisation and consensus) as cryptoassets.
The legal statement concludes that a smart contract is capable of satisfying the basic requirements of an English law legal contract. Those requirements are: (a) that two or more parties have reached an agreement (b) the parties intend to create a legal relationship by doing so and (c) have each given something of benefit.
Whether the requirements are in fact met in any given case will depend on the parties’ words and conduct, just as it does with any other contract under English law.
Contractual obligations may be defined by computer code. However, the code may also merely implement an agreement whose meaning is to be found elsewhere, in which case the code is "unimportant from the perspective of defining the agreement". Either way, the legal statement concludes that a smart contract can be identified, interpreted and enforced using ordinary and well-established legal principles.
The legal statement suggest that English law can deal with bilateral smart contracts and decentralised autonomous organisations (DAO) where the party that deploys the code to set up the DAO has no intention to participate in it or enter into a legally binding agreement with it. By analogy, the legal statement draws on the well-established concept of an unincorporated association which has no legal status but all the members, because of their membership, are bound by the rules.
In principle, yes.
The legal statement proposes that, where a legal rule requires documents to be signed or in writing, such a requirement can in principle be met by using a private key or by a smart contract whose code element is recorded in source code, and to the extent it is in readable format, object code. By analogy, the legal statement draws on an example where expert translators are needed for foreign languages.
It also concludes that the terms of the relevant contract will involve looking at the effect of whatever the code does, rather than what it says.
The next step is for the Law Commission to consider whether any legislation might be desirable in this area.