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Legal statement on cryptoassets and smart contracts – the breakdown

5 minute read

Published 22 November 2019

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Key information

The UK jurisdiction taskforce of the LawTech Delivery Panel (LTDP) issued a statement this week, in which they asserted that Cryptoassets can be treated in principle as property; and that smart contracts are capable of satisfying the requirements of contracts under English law and are enforceable by the courts.

Chancellor of the High Court Sir Geoffrey Vos, issued his own statement about the launch of the legal statement on Monday 18 November, in which he outlined the thinking behind the statement and the approach. He referred to it as ‘ground-breaking’ and a ‘watershed for English law and UK’s jurisdictions’ and urged everyone to ‘take the half an hour needed to read the document’ even though it ‘sounds nerdy and hard to understand’.

From Vos’s statement it is apparent that the LDTP have tried to take into account the diverse plethora of cryptoassets and cryptocurrencies, which is arguably one of the biggest hurdles in attempting to create a legal framework which accommodates them all.

The basis of the statement is to create certainty in the legal status of cryptoassets and smart contracts under English law, with a view to supporting market confidence and legal certainty.

The taskforce

The UK Jurisdiction Taskforce is made up of various individuals from the legal world including representatives of barristers, solicitors, the judiciary, the FCA, the Law Commission, city corporation groups with Sir Geoffrey Vos as Chair.

The legal statement was drafted by four barristers, including two QCs from London Chambers.

The conclusion?

Cryptoassets

The legal statement concludes that in general terms, cryptoassets have the requisite properties to be treated as a matter of legal principle as property. They considered that the novel features of cryptoassets (i.e. intangibility, distributed transaction ledger use, and decentralisation) did not disqualify them from being property.

Cryptoassets were also not disqualified for being things in action or pure information. In regards the latter, the statement concluded that a cryptoasset contrasted trade secrets, business ideas, private communications or personal information, in that it does not convey anything. They also cannot be transmitted freely in the way information can. Conversely, a private key (the unique code which conveys ownership of a cryptoasset) is not to be regarded as property, as it is pure information, or the means to an end, as opposed to the means in itself.

With regards to ownership, the legal statement declared that a person can acquire knowledge and control of a private key, and therefore become owner of the associated cryptoasset. This is considered to be the same as a person lawfully being in possession of a tangible asset and therefore being presumed to be the owner. In much the same way, a person can hold the key on behalf of another e.g. an employer or client or on trust; and ownership can be shared through multiple keys. A person who unlawfully acquires a key through hacking is not the lawful owner, in the same way as someone who steals property is not the legal owner of that property.

The effect of this will be seen in insolvency and succession (where they can be included if they are considered to be property at common law); trusts; and cases of theft. Cryptoassets will be classified as ‘things in action’ under the Sale of Goods Act 1979. The statement also concluded that legal security can be granted over cryptoassets, but they cannot have bailment over them, be physically possessed, and they are not negotiable instruments, or documents of title.

Governing Law

The statement took an interesting and progressive approach to the potential issue of determining whether English law governs the proprietary aspects of cryptoassets. The courts have traditionally applied the law of the country where the property is situated at the relevant time. In regards intangible property, the court usually allocates an artificial location based on which country can exercise control over the property. This is problematic for decentralised cryptoassets. The taskforce took the stance that they should not try to allocate a location to fit the current rules, and instead should apply the purpose of the rules to identify a different approach. They considered the application of the law which applies to the agreement between the parties; the potential location of a related off-chain asset; and the location of a controller. However, they were inconclusive on which law should be used and indicated that new legislation would be required.

Smart contracts

The legal statement concludes that smart contracts are capable of satisfying the basic requirements of an English law legal contract. Quite simply, the statement says that in so far that: two or more parties have reached an agreement, intend to create a legal relationship by doing so, and there is consideration for it, smart contracts are capable of satisfying the requirements. Whether the requirements are met will be a question of agreement, conduct and words in the same way as would be the case with any written or verbal contract.

A smart contract can be identified, interpreted and enforced using ordinary and well-established legal principles. English law does not struggle with the concept of anonymity or contractual relations being formed around subscription to a set of rules (for example, much like a club). In regards requirements of signatures, the statement concluded that this could be met with use of a private key intended to authenticate a document and the way that this is recorded in source code.

The statement describes smart contracts as having a characteristic feature of automaticity, in that they are, at least in part, performed automatically and potentially without the need for human intervention. The obligations contained within the contract may be defined by computer code or the code may implement an agreement outlined elsewhere.

The taskforce set out the approach to issues such as interpretation, which will be very useful to the Court, practitioners and contractors. Smart contracts should be open to the same interpretation as standard contracts, and the Court should look at the parties’ intentions. This does somewhat raise the issue of the Court’s ability to determine these issues without expert evidence. Where there is code involved, part of the exercise will be determination of whether the code was intended to define obligation or implement them.

Issues

Cryptoassets

Some issues are still likely to arise in defining cryptoassets as property. Ownership will depend on the circumstances, as how a cryptoasset is originally created depends on the rules of the system (for example bitcoin’s mining process); and there may be difficulties identifying the owner in systems where transactions take place by reference on to an anonymous address.

The taskforce did not fully address the issue of the law applicable to a decentralised cryptoasset and this has the potential to be problematic before legislation is implemented. Without certainty over the governing law, parties may be more reluctant to transact.

Smart contracts

It is still to be seen how certain issues will be dealt with by the Court and practitioners. In regards smart contracts, there are questions as to how we will deal with the construction elements of contract law such as:

  • which terms are incorporated into the contract, including communications beyond the code itself;
  • how to deal with any amendment to the terms; and
  • whether accompanying explanations are incorporated.

Since smart contracts self-execute pre-determined code, it has been argued that they cannot be breached. In regards contractual disputes, issues raised have included:

  • how we will determine which terms are fair and reasonable when the contract is automatically fulfilled;
  • which party is responsible for coding errors;
  • jurisdictional issues, particularly in regards performance. Where ledgers are decentralised pinpointing the point of failure or breach can be difficult and complicated; and
  • the potential mismatch between what the parties have agreed and what the smart contract’s code executes, which may lead to disputes in regards performance of the contract.

What’s next?

This all comes just in time for the EU’s Fifth Money Laundering Directive which is set to be implemented on 10 January 2020. The Directive adds a role of anti-money laundering supervisor to the FCA’s responsibilities. The FCA has published a webpage outlining their new role. It states that from 10 January 2010 they will be the anti-money laundering and counter terrorist financing (AML/CTF) supervisor of UK cryptoasset businesses.

The FCA have not yet published their response to the consultation on 5MLD, but they list activities and cryptoasset businesses which carry on these activities and say that these businesses should assume they must comply with the MLRs from January 2020.

Cryptoasset businesses will therefore have more certainty in their status and regulation.

In regards smart contracts, their acceptance by the Court should lead the way to development in interpretation and increase public confidence in their use.

If and when smart contracts become more standardised, such as with boilerplate terms, smart contract implementation is likely to become faster and cheaper.

Smart contracts have the potential to be incredibly beneficial to the legal world, and in particular when considering disputes. Smart Contract time-stamping, when the ledger stamps data to store a hash, would change the way we use evidence. In other jurisdiction, there has been consideration of blockchain based evidence platforms and online courts. There is also potential for smart contracts to be used in Judgments to assist enforcement.

Conclusion

The UK is taking steps to embrace the growing market of cryptoassets and blockchain businesses. It is important for our legal and financial infrastructures to accommodate these advances to ensure that the area is properly regulated whilst not stifling development.

The authors of the Law Tech Delivery Panel were established to support the transformation of the UK legal sector through tech. With this in mind, we would hope to see not only growth in the UK’s stance on the legal position of cryptoassets and smart contracts, but also a development in how the UK legal sector uses this tech.

A key take away appears to be the keenness to establish the English law as flexible and able to deal with technological developments. The LTDP appear to want to present the English legal system as a forward thinker in technological advances. This will certainly be well received by developers, especially in light of the recent, potentially stifling, contributions of the US to the debate, in which they found cryptocurrencies to be securities.

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Longer Reads

Legal statement on cryptoassets and smart contracts – the breakdown

Published 22 November 2019

The UK jurisdiction taskforce of the LawTech Delivery Panel (LTDP) issued a statement this week, in which they asserted that Cryptoassets can be treated in principle as property; and that smart contracts are capable of satisfying the requirements of contracts under English law and are enforceable by the courts.

Chancellor of the High Court Sir Geoffrey Vos, issued his own statement about the launch of the legal statement on Monday 18 November, in which he outlined the thinking behind the statement and the approach. He referred to it as ‘ground-breaking’ and a ‘watershed for English law and UK’s jurisdictions’ and urged everyone to ‘take the half an hour needed to read the document’ even though it ‘sounds nerdy and hard to understand’.

From Vos’s statement it is apparent that the LDTP have tried to take into account the diverse plethora of cryptoassets and cryptocurrencies, which is arguably one of the biggest hurdles in attempting to create a legal framework which accommodates them all.

The basis of the statement is to create certainty in the legal status of cryptoassets and smart contracts under English law, with a view to supporting market confidence and legal certainty.

The taskforce

The UK Jurisdiction Taskforce is made up of various individuals from the legal world including representatives of barristers, solicitors, the judiciary, the FCA, the Law Commission, city corporation groups with Sir Geoffrey Vos as Chair.

The legal statement was drafted by four barristers, including two QCs from London Chambers.

The conclusion?

Cryptoassets

The legal statement concludes that in general terms, cryptoassets have the requisite properties to be treated as a matter of legal principle as property. They considered that the novel features of cryptoassets (i.e. intangibility, distributed transaction ledger use, and decentralisation) did not disqualify them from being property.

Cryptoassets were also not disqualified for being things in action or pure information. In regards the latter, the statement concluded that a cryptoasset contrasted trade secrets, business ideas, private communications or personal information, in that it does not convey anything. They also cannot be transmitted freely in the way information can. Conversely, a private key (the unique code which conveys ownership of a cryptoasset) is not to be regarded as property, as it is pure information, or the means to an end, as opposed to the means in itself.

With regards to ownership, the legal statement declared that a person can acquire knowledge and control of a private key, and therefore become owner of the associated cryptoasset. This is considered to be the same as a person lawfully being in possession of a tangible asset and therefore being presumed to be the owner. In much the same way, a person can hold the key on behalf of another e.g. an employer or client or on trust; and ownership can be shared through multiple keys. A person who unlawfully acquires a key through hacking is not the lawful owner, in the same way as someone who steals property is not the legal owner of that property.

The effect of this will be seen in insolvency and succession (where they can be included if they are considered to be property at common law); trusts; and cases of theft. Cryptoassets will be classified as ‘things in action’ under the Sale of Goods Act 1979. The statement also concluded that legal security can be granted over cryptoassets, but they cannot have bailment over them, be physically possessed, and they are not negotiable instruments, or documents of title.

Governing Law

The statement took an interesting and progressive approach to the potential issue of determining whether English law governs the proprietary aspects of cryptoassets. The courts have traditionally applied the law of the country where the property is situated at the relevant time. In regards intangible property, the court usually allocates an artificial location based on which country can exercise control over the property. This is problematic for decentralised cryptoassets. The taskforce took the stance that they should not try to allocate a location to fit the current rules, and instead should apply the purpose of the rules to identify a different approach. They considered the application of the law which applies to the agreement between the parties; the potential location of a related off-chain asset; and the location of a controller. However, they were inconclusive on which law should be used and indicated that new legislation would be required.

Smart contracts

The legal statement concludes that smart contracts are capable of satisfying the basic requirements of an English law legal contract. Quite simply, the statement says that in so far that: two or more parties have reached an agreement, intend to create a legal relationship by doing so, and there is consideration for it, smart contracts are capable of satisfying the requirements. Whether the requirements are met will be a question of agreement, conduct and words in the same way as would be the case with any written or verbal contract.

A smart contract can be identified, interpreted and enforced using ordinary and well-established legal principles. English law does not struggle with the concept of anonymity or contractual relations being formed around subscription to a set of rules (for example, much like a club). In regards requirements of signatures, the statement concluded that this could be met with use of a private key intended to authenticate a document and the way that this is recorded in source code.

The statement describes smart contracts as having a characteristic feature of automaticity, in that they are, at least in part, performed automatically and potentially without the need for human intervention. The obligations contained within the contract may be defined by computer code or the code may implement an agreement outlined elsewhere.

The taskforce set out the approach to issues such as interpretation, which will be very useful to the Court, practitioners and contractors. Smart contracts should be open to the same interpretation as standard contracts, and the Court should look at the parties’ intentions. This does somewhat raise the issue of the Court’s ability to determine these issues without expert evidence. Where there is code involved, part of the exercise will be determination of whether the code was intended to define obligation or implement them.

Issues

Cryptoassets

Some issues are still likely to arise in defining cryptoassets as property. Ownership will depend on the circumstances, as how a cryptoasset is originally created depends on the rules of the system (for example bitcoin’s mining process); and there may be difficulties identifying the owner in systems where transactions take place by reference on to an anonymous address.

The taskforce did not fully address the issue of the law applicable to a decentralised cryptoasset and this has the potential to be problematic before legislation is implemented. Without certainty over the governing law, parties may be more reluctant to transact.

Smart contracts

It is still to be seen how certain issues will be dealt with by the Court and practitioners. In regards smart contracts, there are questions as to how we will deal with the construction elements of contract law such as:

  • which terms are incorporated into the contract, including communications beyond the code itself;
  • how to deal with any amendment to the terms; and
  • whether accompanying explanations are incorporated.

Since smart contracts self-execute pre-determined code, it has been argued that they cannot be breached. In regards contractual disputes, issues raised have included:

  • how we will determine which terms are fair and reasonable when the contract is automatically fulfilled;
  • which party is responsible for coding errors;
  • jurisdictional issues, particularly in regards performance. Where ledgers are decentralised pinpointing the point of failure or breach can be difficult and complicated; and
  • the potential mismatch between what the parties have agreed and what the smart contract’s code executes, which may lead to disputes in regards performance of the contract.

What’s next?

This all comes just in time for the EU’s Fifth Money Laundering Directive which is set to be implemented on 10 January 2020. The Directive adds a role of anti-money laundering supervisor to the FCA’s responsibilities. The FCA has published a webpage outlining their new role. It states that from 10 January 2010 they will be the anti-money laundering and counter terrorist financing (AML/CTF) supervisor of UK cryptoasset businesses.

The FCA have not yet published their response to the consultation on 5MLD, but they list activities and cryptoasset businesses which carry on these activities and say that these businesses should assume they must comply with the MLRs from January 2020.

Cryptoasset businesses will therefore have more certainty in their status and regulation.

In regards smart contracts, their acceptance by the Court should lead the way to development in interpretation and increase public confidence in their use.

If and when smart contracts become more standardised, such as with boilerplate terms, smart contract implementation is likely to become faster and cheaper.

Smart contracts have the potential to be incredibly beneficial to the legal world, and in particular when considering disputes. Smart Contract time-stamping, when the ledger stamps data to store a hash, would change the way we use evidence. In other jurisdiction, there has been consideration of blockchain based evidence platforms and online courts. There is also potential for smart contracts to be used in Judgments to assist enforcement.

Conclusion

The UK is taking steps to embrace the growing market of cryptoassets and blockchain businesses. It is important for our legal and financial infrastructures to accommodate these advances to ensure that the area is properly regulated whilst not stifling development.

The authors of the Law Tech Delivery Panel were established to support the transformation of the UK legal sector through tech. With this in mind, we would hope to see not only growth in the UK’s stance on the legal position of cryptoassets and smart contracts, but also a development in how the UK legal sector uses this tech.

A key take away appears to be the keenness to establish the English law as flexible and able to deal with technological developments. The LTDP appear to want to present the English legal system as a forward thinker in technological advances. This will certainly be well received by developers, especially in light of the recent, potentially stifling, contributions of the US to the debate, in which they found cryptocurrencies to be securities.

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