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Key takeaways from the Law Commission of England and Wales Report on Digital Assets

On 28 June 2023 the Law Commission published its final report on digital assets (the Report), which is the culmination of its work since March 2020 on this topic. The Report makes four recommendations as well as proposing a tripartite approach of using the common law, targeted statutory reform, and guidance from industry experts to shape this area of law.

What is a “digital asset”?

“Digital assets” is an increasingly broad and nebulous term, encompassing everything from digital files and records to domain names, crypto-tokens and non-fungible tokens. As a result, the characteristics and features of assets are hard to legislate for and/or regulate.

The Report recognises these challenges, and cautions against a static definition of digital assets, instead proposing three soft ‘indicia’ as to whether an item is a digital asset, namely:

  • It is composed of data represented in an electronic medium;
  • It exists independently of persons and exists independently of the legal system; and
  • It is rivalrous (ie where the use or consumption by a person would prejudice the use or consumption by another).

This approach is deliberately pragmatic, recognising that digital assets are likely to remain an evolving concept, to which it is difficult to apply a catch-all definition.

Law Commission recommendations at a glance

In summary, the Report recommends:

  • Digital assets should be seen as a new third category of personal property, and statute should confirm these assets will not be denied status as personal property because they fall outside the existing categories.
  • An expert advisory panel should be established to provide non-binding guidance on legal issues in this sphere.
  • Existing rules will need to be amended to support digital assets that do not qualify as financial securities.
  • The Government should set up a multi-disciplinary project to work on a bespoke statutory legal framework to better facilitate collateral arrangements involving cryptoassets.

Recommendation 1: A new “third” category of personal property

The common law currently recognises two forms of personal property: ‘things in possession’ and ‘things in action’. The Report proposes recognising digital assets as a new third class of personal property.

The fact digital assets can attract personal property rights has been established by case law, with over 20 cases confirming this since the ground-breaking judgment in AA v Persons Unknown [2019] EWHC 3556 (Comm) in 2019 first confirmed that cryptoassets can be treated as property despite not falling into either of the types of property above. However, the Report proposes statutory confirmation that digital assets will not be deprived of their status as personal property which can attract rights, simply because they do not fit within these two existing classifications, in order to avoid any further debate on this issue.

Recommendation 2: Establishing a technical expert group 

The Report also proposes establishing a panel of industry-specific technical experts, as well as legal practitioners, academics and judges to provide non-binding guidance on developments in law.

A key focus for legal development in the Report is the concept of ‘factual control’, and its consequences. As mentioned above, digital assets constitute a broad class, with different technologies distributing differing levels of control across various participants. For instance, different methods of validating transactions on a blockchain, such as mining and validator staking, create and facilitate different degrees of restrictions on the transferability and use of the digital asset. This was acknowledged as a particular feature of decentralised systems by the courts in Tulip Trading v Van Der Laan  [2022] EWHC 667 (Ch).

Overall, the Report considers that the law should recognise that control works differently for each category of personal property. Coupled with the fact that control will likely remain an evolving concept in the context of digital assets, the Report proposes the expert group guide common law developments rather than seeking to freeze the concept of control in time by way of legislation.

Recommendation 3: Financial Collateral Arrangements Regulations (FCARs) 

The Report considers the applicability of the FCARs regime to crypto-tokens and other digital assets. This regime exempts certain formality requirements and insolvency provisions, which broadly intends to reduce parties’ administrative burden and enable faster enforcement of security interest in the event of insolvency. At the moment, applying this regime to digital assets presents several issues, such as whether certain forms of crypto-token and/or cryptoassets satisfy the definition of “financial collateral” and whether the regime is applicable or useful to those digital assets which fall within its scope. Therefore, the Report recommends statutory amendment to the FCARs to clarify and confirm these points.

The Report goes on to note that even if this regime were to be reformed, it may still either not cover digital assets, or it may be difficult to apply the existing ‘possession or control’ requirement to certain digital assets. 

Recommendation 4: Cryptoasset collateral arrangements 

Given the limitations outlined above, the Report recommends the development of a bespoke statutory legal framework for certain crypto-token and certain cryptoasset collateral arrangements. It goes on to outline some of the key issues that need to be considered. 

Most significantly, the Report positions the reform within the wider context of the crypto-token and cryptoasset markets requiring a distinct legal regime that supports innovation and prevents the systemic importance of certain key intermediaries. The Report further recommends introducing a new perfection requirement and a novel type of security under the bespoke framework based on the concept of “provision” (as opposed to “possession or control”) to accommodate various collateral holding arrangements and management techniques for crypto-tokens. Finally, the report recognises the interaction between the bespoke framework and the existing FCARs framework, which means that the FCARs might need to be further amended.

Conclusions set out in the Report

In addition to the four recommendations, the Report also reaches a number of conclusions. Of particular interest are the conclusions that: 

  • Factual control (plus intention) can found a legal proprietary interest in a digital object, which can, in certain circumstances, be separated from (and inferior to) a superior legal title.
  • It is possible to affect a legal transfer of a crypto-token off-chain by a change of control or on-chain by a transfer operation that affects a state of change.
  • A special defence of good faith purchaser for value without notice can be applied by the Courts to crypto-tokens (or other third-category things) as a development of the common law.
  • It would be constructive for the courts to develop specific and discrete principles of tortious liability by analogy to, or drawing on some elements of the tort of conversion, to deal with wrongful interferences with third category things.

Impact / Key takeaways  

The pragmatic, tripartite approach outlined by the Report offers a practical and flexible proposal for dealing with the challenges of regulating and resolving disputes concerning digital assets (both now and in future). However, it relies on a cohesive approach between the Courts and legislature, with appropriate deference to industry experts, which may be harder to achieve in practice than in principle.

This is the latest development in the crypto-space, with the Treasury publishing its consultation earlier this year on the proposed future financial services regulatory regime for cryptoassets, and the Government having recently introduced new legislation to bring qualifying cryptoassets within the financial promotions regime (see here). It remains to be seen how the Government's existing plans will interact with the Law Commission's recommendations.