Legal update for blockchain

Posted on 22 October 2020

Tom Grogan, Head of MDRxTech, gave an overview of blockchain technology and the legal developments over the last 12 months. The session includes an overview of the latest guidance from the FCA, HMRC, HM Treasury, and the Law Society, amongst others.

The Mishcon Academy Digital Sessions

Tom Grogan

Welcome to this session and thanks very much for coming.  As many of you know, we’ve now opened up the Academy to external participants so we’re joined today by some external listeners which is really exciting.  By way of reminder to those of you that don’t know the Academy offers University quality education across a wide range of areas covering the issues that matter most to us and hopefully also to our clients and the range of topics is really broad, it spans and law and non-law; today we are talking about the section between law and technology in blockchain.  A couple of weeks ago we heard from Alistair Campbell talking about mental health, specifically depression and anxiety and we are currently benefitting from some other fascinating and thought provoking talks that form part of our Black History Month programme.  It’s all really, really good stuff and I encourage all of you to check out the website and register your interest in anything and everything speaks to you. 

Right, to today.  I’m going to try and cover three areas.  We’re going to do the blockchain basics, a relatively high level look at the technology, what it is, why it matters and where it’s being used and we are then going to look at the legal and regulatory updates, some of the key areas of development over the last twelve months including the analysis of cryptoasset, so that’s property, security law analysis and derivatives and some on smart contracts and some on tax.  It’s worth saying at the outset that this isn’t everything that’s happened, that’s impossible in 45 minutes and there we don’t even begin to touch on the data protection analysis, for example, the competition law analysis, for example.  All of those things are really important and are things that your organisation should be thinking about when you are looking to implement blockchain within your business but they fall outside the scope of this talk but we are of course on hand to pick those up afterwards if helpful.  And we will then finish off with some trends and developments in space, perhaps make a couple of predictions as to what we expect to see in the coming weeks, months and years.  There is a Q&A function on this Zoom so please do feel free to use it, I’ll probably pick all those up at the end and if we don’t have time, we’ll follow up with you after the talk. 

So, blockchain basics.  So at its most basic, a blockchain is a ledger and ledgers aren’t exactly new concepts.  Our earliest ledgers have been around since ancient Mesopotamia circa 4000BC and they looked like the centralised ledgers on the left, they were clay scripts or they were sewn tablets upon which the ownership of crops in storage was recorded and in the most part it worked.  If a farmer wanted to check how much grain he owned, he’d go to the scripts or the stone and he’d check.  But that has challenges.  What if a farmer perhaps disagrees with what that centralised ledger said from time to time perhaps because that ledger was tampered with by a rival?  As society has grown more and more complex, the issues relating to maintaining centralised ledgers have become more and more pronounced and that’s led to an increase in a decentralised model for ledgers.  We – and if we look at the middle diagram, we are represented by the dots on the outside – we delegate our trust, every single day, to trusted intermediaries, the core dots who then in turn connect us to wider networks.  Think for example about a finance institution like a bank to whom we delegate our trust regarding our financial records and they connect us to a wider financial system.  Think also about social media giants who connect us to wider social networks.  This decentralised model is better and more resilient but it still has its downsides.  That intermediary, be it finance institution or social media giant, still holds the key to the truth at any point in time.  If they fail or they go rogue, we’re in trouble and we have limited recourse.  At the more innocent end of the spectrum, look at the high profile examples of IT outages within major banks over the last two years but a twenty minute out can cause real pain and real loss to thousands or millions of people.  On the more nefarious end, if you’re a customer of a bank who’s owned by the Government and the Government fall out with you, you are in trouble if all of a sudden they decide that your bank needs to be empty all of a sudden.  Who is your recourse, again it’s limited.   So, we move to the diagram on the right, distributed network model.  They are difficult to maintain but no single points of failure and are theoretically infinitely scalable.  Crucially though, this model eliminates the need for a trusted intermediary and the network polices itself by maintaining a universally held view of the world from time-to-time.  Open, consensus driven method of maintaining a ledger state.  A quick word on binology, I am talking about blockchain during this session but a blockchain is just one way of structuring a ledger in a distributed manner.  The umbrella term for the technologies that enable this are called Distributed Ledger Technologies, or DLT.  I will use blockchain for the purpose of this session because it’s snappier and the points we are covering are totally applicable to DLT and blockchain interchangeably but there are a number of nuances that exist between blockchain and other forms of distributed ledger technology and you need to think about them in some detail when considering an implementation.  Again, they fall beyond the scope of this session but it’s something we are absolutely on hand to talk you through and weigh up the merits of different solutions afterwards. 

So, at its heart, blockchain’s governance technology that imbues trust in a system and from that understanding really most of it is utility flows.  Smart contracts sound great and they are cool but automation isn’t exactly the new.  What’s innovative about a blockchain based smart contract is that the scope for automation is so much greater when everybody has that neutral trust in the ledger that underlies the automation.  It’s the shared consensus ledger that is the real innovation and what really is quite exciting. 

Finally, on blockchain basics, where is it being used?  This graphic is something we’ve prepared for one of our central bank clients a few weeks ago looking at central bank blockchain projects.  Interestingly it’s being used everywhere.  One flag that doesn’t appear on here is the Bahamas which those of you who are monitoring the news closely will have seen that yesterday they announced the launch of their digital currency, what they are calling the Sand Dollar.  It’s a fast moving space and we are really lucky to be at the heart of a few of the more interesting projects globally. 

Right, though the title of this session is Legal Update 2020, I have cheated a little bit and I’m going to look back a full twelve months.  I’ve done this for, I hope, a good reason as last November saw the publication of the UK Jurisdiction Taskforce which is part of the LawTech Delivery Panel in the UK and they released a legal statement on cryptoassets and smart contracts and one of the key things at the heart of that was what exactly is a cryptoasset at property law.  Are they even property at all?  That is probably a huge a question with some pretty significant ramifications.  If it’s not property, it can’t be owned.  If it can’t be owned, it can’t be stolen.  It can’t be settled in a trust, it can’t be inherited on death etcetera, etcetera.  Now traditionally, at law, there are two classes of property, a chose in possession and a chose in action.  Broadly speaking, if you can kick it, it’s probably a chose in possession.  If it’s a physical thing, it’s probably in possession.  Clearly, a cryptoasset is unkickable so that rules that one out.  The legal statement therefore spent a long time and looked in great detail at the chose in action which it first gave the definition of a right that can be enforced by Court litigation.  And this is also pretty challenging though in the cryptoasset world against whom could a right be enforced, there is no central issuer or maintainer of the ledger meaning the system is properly distributed.  The legal statement therefore conducted a pretty deep dive into the case law and actually adopted a broader definition of chose in action which they called a catch all to refer to any property which is not a thing possession.  Now if this feels a bit of a cop out, it’s because it is albeit a pretty fair one.  The legal statement in fairness did conclude that cryptoassets might actually constitute a third class of property altogether but the important thing for our purposes is that the legal statement found that cryptoassets are not disqualified from being property on the basis that they constitute pure information.  Pure information at English law is not property and the reason they found that is because cryptoassets, they say, have the characteristic of certainty, exclusivity, control, assignability and permanence and those are five characteristics of property as set out in National Provincial Bank and Ainsworth which is a 1965 case and it distinguishes those five characteristics as held by cryptoassets as against information, pure information, which does not.  The legal statement is well worth a read, it’s one of the more formative pieces of law we have in the UK on this but it is quite dense.  Anne Rose, my colleague, has written an excellent summary which is on the website which you can access using that link there.  It’s worth noting that all the graphics on this deck are actually hyperlinks to the source material and this slideshow will be published afterwards so you can always go back and click that if you want an easy reference point. 

Okay, so it’s property or capable of being property.  What about derivatives, so hot off the press last week the FCA announced a prohibition of the sale to retail clients of investment products referencing cryptoassets and that applies to derivatives and exchange traded noting tiers.   It enters into force January 2021 and this follows a relatively long period of consultation, this wasn’t necessarily a shock certain parts of the industry, probably understandably, didn’t want this to be the case, interestingly in the policy statement from the FCA they said that of their responses to the consultation 95% of them were opposed to this step.  I’m surprised they actually mentioned that when they ended up ignoring the 95% but it certainly isn’t a shock to many of us this space.  I mean it is worth pointing out that this latest guidance has a number of carve outs so it doesn’t apply to security tokens, i.e. tokens that underlying them ultimately would constitute a security so perhaps a tokenised share, a share constituting a security, tokenised real estate etcetera, etcetera.  It doesn’t apply to tokens that aren’t widely transferrable, i.e. tokens that are only used on a private network that can only be redeemed with an issuer, sort of a pure, pure utility token but not one that you could then trade on a secondary exchange like finance or similar and it doesn’t apply to e-money token and we’ll come on to that in a moment, to cryptocommodities where ownership of the actual commodity is recorded on the blockchain and all currencies issued or guaranteed by a central bank or public authority which speaks to the CBDC point that was on our world map just a moment ago.  All of this sits on top of the FCA’s guidance, again I’m cheating here slight because it was early last year, I think it was July, June or July, 2019 but it’s worth noting that the FCA in that policy statement updated their taxonomy of cryptoassets.  Previously they had categorised cryptoassets as security tokens, utility tokens and exchange tokens.  That created a bit of a nightmare situation where you had everyone that was a security token claiming the utility token and ended up costing a lot people money and unfortunately there was a lot of consumer harm flowing from it.  The new FCA taxonomy is regulated tokens which is essentially their old security token bracket but slightly broader and e-money which is any token that meets the definition of e-money under the e-money regulations and unregulated which is basically anything that doesn’t meet either of the first two, again graphics in here are links to the underlying source material. 

So, smart contracts, we’ve already very briefly touched upon smart contracts.  Worth emphasising they are neither smart nor naturally contracts albeit that the UK Jurisdiction Taskforce did confirm that they are capable of being given legal effect and being legally enforceable.  Though you need to have relatively careful analysis to make sure that is actually the case where you want it to be so.  So it’s a little bit of a plug here.  Tech London Advocates launched, or published, a guidance to practitioners for using smart contracts and that was published in partnership with the Law Society of England and Wales.  This is a little bit of a plug, I am on the steering group of TLA.  TLA to those of you that don’t know is one of London’s largest networking groups for tech professionals but really we can’t take any credit away from Anne Rose, my colleague, who was the driving force behind all of this and runs the legal and regulatory sub working group of Blockchain TLA and she did a hell of a job bringing together all of the lawyers from a number of fantastic firms across the city and which I take it was a bit like herding cats but the end product was some really, really useful guidance to practitioners which I would recommend you check out and read, it’s well worth it.  The guidance covers a number of areas, I wrote the technical annex explaining exactly what is blockchain but it covers from a legal perspective a wide range of areas, dispute resolution, IP, commercial, there’s a whole host of things in there for practitioners to think about when being instructed on advising on smart contract related matters, it’s well worth reading. 

Finally, on the legal and regulatory updates, tax and I don’t intend on dwelling too long here, mainly because I am not a tax lawyer and it terrifies me but it is worth pointing out that in December 2019, HMRC released their latest guidance to tax bases for using cryptoassets.  Interestingly, the main difference here is on a hard fork so for those of you that don’t know a hard fork is when a blockchain is replicated and split to create a new token, the most famous examples probably being bitcoin cash or bitcoin SV which stands for Satoshi’s Vision.  There is quite a key distinction here between the HMRC’s position and the IRS in this so on the HMRC, it doesn’t consider tax to be payable on receipt of the hard fork token and profit made on the disposal of a token is referenced by combining the two.  The IRS on the other hand consider it essentially a windfall and it should be taxed as gross income in the hands of the taxpayer, that’s quite a problematic finding and I’m not entirely certain how that’s being enforced retrospectively but it’s an interesting distinction and difference between two of the world’s more leading tax authorities.  It’s also worth mentioning, and I haven’t spoken about tax for individuals because I think that would be really cheating because that’s 2018 and that’s two years ago, HMRC released some interesting guidance there around the situs of cryptoassets, i.e. when is a cryptoasset deemed to be UK resident for the purposes of tax?  They said that for so long as the individual who has beneficial entitlement to a cryptoasset is resident in the UK, that asset is deemed to fall under a tax jurisdiction.  Again, that’s quite a problematic statement and raises all sorts of questions and some pretty damning commentary about that from some other law firms online which are worth a read but again we are on hand to help with any issues you’ve got in that respect, it’s an interesting area and is rapidly developing and we’re keeping a close eye on things as they unfold. 

And finally, trends and developments so there’s three things I’ve picked here but they could really be pretty much anything.  The first one is that blockchain is increasingly being seen as a priority for organisations, both public and private sector.  Deloitte, every year release a global blockchain survey which is well worth a read, every year it’s always quite interesting and unbelievably this year, 81% of respondents to that consider blockchain to be important or critical to their organisations in the next 24 months.  I need to check the methodology because I believe that seems high but it goes to show that it is increasingly entering the real economy, it is increasingly being seen to have utility and is being taken seriously in sort of the highest layers of some of the largest organisations in the world.  It’s also worth saying that whilst it’s happening in the largest organisations in the world, some of the most exciting things that are going on are happening in start-ups and scale-ups.  M:Tech which I am sure most of you are aware of is our dedicated programme for early stage businesses.  It’s now on its second cohort, we award a number of places every year to some of the country’s most innovative technology start-ups and we give them free legal advice and free strategic advice for so long as they are part of the programme and we get really, really close to some really interesting industry players there.  Of the second cohort, there’s a couple of blockchain companies, likewise in the first cohort and some of them are doing some really fascinating things so we look forward to seeing them go from strength-to-strength.  The second point here is that merging technologies are converging so as emerging and advanced technologies move to scale, so do they converge with each other, including notably blockchain and AI and blockchain and the IOS.  You’ll see that the word converged there is a hyperlink leads to an article that Anne and I wrote for chambers, blockchain this year and this is the topic that I spoke to the European Commission on last year.  Blockchain increasingly is being looked at and used as a way of transacting servicing data points that’s on the scale of data required to train machine learning models or to enable the transfer of data between IOD devices that may well have been manufactured by competing entities even.  Again, well worth saying that at the very outset of this I said some of the things we are not speaking about during this session includes competition law, it’s well worth emphasising there are some really, really interesting questions that are being raised in that market.  If the whole point of blockchain is to enable trustless transacting and we’re seeing groups of otherwise competitive entities transacting on it, what does that say from a competition and an anti-trust perspective?  It’s a really, really a fascinating debate that we’ll happily have with you if you would like to speak to us about it but it’s well worth bearing in mind and keeping on your radar. 

Finally, compliance and perhaps we are biased and because at the heart of the group is the law firm but compliance really has never been more important, we’ve just seen the SCA last week banning the sale of cryptoasset derivatives.  We’re seeing increasingly regulators in the UK and globally, I’m taking it pretty hard line on non-compliance especially in the blockchain and the cryptoasset space, we cannot recommend strongly enough that organisations looking to adopt or implement blockchain technology ensure that their systems are compliant by design and that is both from a current law and regulation perspective as well as being consistent with the policy and underlying reasoning for the law and regulation and of course making sure that it complies with the company’s own policies and position and data ethics footprint.

We’ve really rattled through that very quickly.  I’ve just looked at the time so of course we are very happy to open up to questions.  Contact details on this slide.  I’ve also got a link to the technology hub at Mishcon and the technology platform which is our dedicated tech blog which is updated multiple times a week with some of the latest developments.  I’ve got a link to the blockchain group and a link to MDRxTech.  For those of you that don’t know, MDRxTech is our new business launched this week albeit that we’ve been doing it for a couple of years now which is focussed on delivering digital transformation to clients.  We talk about digital transformation that’s compiled is like making sure that our clients aren’t doing really, really interesting things that they then have to shoehorn into compliance and either risk delays, more money spent or probably worst of all, the paring back of functionality.  We try and make sure that the architecture of whatever they are doing, the exciting things that they are doing, are underpinned by good compliance principles.  Get in touch if you want to hear any more.  I don’t know if there are any questions because I can’t actually see them.  I don’t think there are.  I appreciate that was a real whistle-stop tour and we covered a lot of things at a relatively high level but hopefully it gave an overview of some of the developments over the last few weeks. 

26.25 thank you for the question, ‘Where will the PowerPoint be available?’  It will be uploaded to the Academy website.  If you click the… I was going to say if you click the Academy logo top right, once this has uploaded you will see it but obviously your students are a few of you all there.  If you Google Mishcon Academy it will be one of the first Google searches there and all of the things will be uploaded there.  I will also put it on my LinkedIn later today

‘Can you explain the hard fork cryptoassets again please?’  Yes, of course, thank you, Andy, for the question.  So, a hard fork is where a new cryptoasset is formed or created rather, using the history of an existing blockchain.  So, for example, on… in fact it’s probably easiest if I draw it so a hard fork is where you have a historic chain like that and in a moment in time it splits so that there are now two different versions.  That could be cryptoasset A and that might be called cryptoasset B.  The holder of tokens at that moment in their wallet will all of a sudden have two assets in their wallet, they will receive a split… they will maintain their current holding of A and then they will be credited a token holding of B and sometimes it’s one for one so for every one token of A, you get one token B, sometimes it’s one to five, one to ten, it can be pretty much anything but that is what a hard fork is.  The difference on the tax treatment is that the IRS is saying that at that moment where you are credited these extras, that is classed as a windfall.  The HMRC’s position in contrast is saying that they won’t consider any gain to have been made until you divest yourself of one or both of these two and it exceeds the value of however much you bought that one for. 

Tom Janson, ‘Where do you see regulation heading in the next few years?’  I think the trend globally is towards more stringent regulation, certainly to the extent that cryptoasset is being used as some sort of financial instrument.  I think the… yeah, sorry… so, I think it’s leaning towards more regulation especially where it constitutes a financial instrument.  I personally am not of the view that all of a sudden we need new blockchain legislation or regulation in many instances, sometimes it can be helpful and certainly I know having spoken with Anne, some guidance from the ICO for example around data protection and its relationship with blockchain would be helpful but generally speaking a I think that the use of policy notes and guidance as to what the interpretation of current legislation and regulation is typically suffices but obviously not always.  I think the major carve out to all of that will be if jurisdictions and central banks in particular are really going to go after the concept of digital currencies hard.  If they do that, there is clearly going to have to be a whole sway of legal and regulatory intervention to ensure that the systems are set up properly to manage that.  Again, that’s something we are lucky to be involved in, in a couple of instances. 

Hans, ‘Who do you see as the leading players and the legal blockchain space in terms of internal implementation and adoption?’  I am biased but us.  I think we are right up the breaking edge of innovation in this space.  We’re currently looking at what sort of data transacting of our own that we can do on chain and hoping to finish that this year.  I think the one other firm that I would say I think are very good job and this by no means is to the exclusion of others but what Herbert Smith have done in Australia is really impressive, they’ve really adopted a technology first approach to a lot of the stuff they are doing for the… I think it is called the Australian National Blockchain Project or something like that… but that’s them working in partnership with the government so, yeah, I think what they have done is really impressive but I am biased but I think we’re right, right up there. 

That’s all of the questions we have open now.  I am happy to sit around for a couple of minutes and see if anything else comes in.  Otherwise, thank you all so much for tuning in.  I hope it was helpful and useful.  As I said, contact details are on the slide there and this will be published online later so please do get in touch if you would like to discuss anything further.  Thanks very much. 

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