A legal framework for digital assets

The term ‘digital assets’ is extremely broad. They are assets which (i) have value, (ii) are stored digitally and (iii) are uniquely identifiable. Obvious examples of these are mainstream digital assets such as digital files, email accounts, domain names and media and graphics, but they also include cryptocurrencies, non-fungible tokens (NFTs) and virtual real estate in the metaverse. With the growing use of blockchain technology and smart contracts, digital assets are much more accessible. It is therefore not surprising that the English courts are seeing many more disputes about this nascent asset class. 

The Law Commission published a 300-page report on 28 June that adopts a tripartite approach involving (i) targeted legislative reform, (ii) continued development of the common law and (iii) guidance from a panel of industry-specific experts. In the report, which was commissioned by the government in light of the increased use of digital assets over the past 15 years, the commission explains that the common law of England and Wales is well placed to provide a coherent and globally relevant regime for both new and existing types of digital assets.

However, the report concludes that certain reforms are required to ensure a clear and consistent framework is provided for the use of digital assets to provide greater clarity and security to users and market participants. The aim is for such reforms to support the government’s goal of attracting technological developments to secure the UK’s position as a global hub for digital assets.

Background

The common law development of digital assets began in earnest in England and Wales in 2019, ahead of most other common-law jurisdictions. The leading judgment that year was AA v Persons Unknown, where the English High Court considered the analysis by the UK Jurisdiction Taskforce. It concluded that crypto assets might not be classifiable as ‘things in possession’ or ‘things in action’, but can be treated as ‘another, third, kind of property’. The court determined this analysis was ‘compelling’ and it subsequently granted an interim proprietary injunction in respect of a bitcoin ransom payment. Hence, cryptocurrencies are now treated as a kind of property.

Common law in this area has continued to develop at pace. Not only are NFTs now also recognised as legal property, but a recent, uncontested, decision has confirmed that digital assets which are held in wallets and controlled by an exchange can also be held on constructive trust for fraud victims in certain circumstances.

It is with these developments in mind that the commission concluded in its report that the common law of England and Wales ‘has already proven itself sufficiently resilient in the face of new technology and flexible enough to answer legal questions concerning digital assets’. It therefore champions the continued development of the common law, in conjunction with some limited law reforms, ‘to provide a coherent, globally relevant legal regime for existing and new types of digital assets’.

Law Commission recommendations

The report makes very few recommendations for law reform. First, it states that ‘the common law of England and Wales is, in general, sufficiently flexible, and already able, to accommodate digital assets’.

Second, it states that the commission wants ‘to impact the law of England and Wales in a positive way and to be as direct and as implementable as possible’ to ensure that its recommendations are highly practicable and achievable.

The two main recommendations the report makes relate to (i) targeted statutory law reform ‘only to confirm and support the existing common law position, or where common law development is not realistically possible’ and (ii) the involvement of further guidance from industry experts, which would support both the common law and statute.

Targeted statutory law reform

The report makes two recommendations for statutory law reform. First, legislation should confirm that digital assets are capable of attracting personal property rights, in support of the existing common law jurisdiction. The proposal is that this type of property should be a distinct, third category of property (ie not a thing in possession or a thing in action) to better recognise, accommodate and protect the unique features of digital assets.

Second, as a matter of priority, it is recommended that the government sets up a multi-disciplinary project to formulate and put in place a bespoke statutory legal framework that better and more clearly facilitates the entering into, operation and enforcement of (certain) crypto-token and (certain) crypto-asset collateral arrangements.

Support from industry experts

In recognition of the fact that increasingly advanced technology is likely to lead to a proliferation of digital assets over time, the report concludes that the development of common law is better able to keep up with these advancements, rather than statutory reform.

To avoid placing such a large task on the judiciary alone, however, it is recommended that the government creates or nominates a panel of industry-specific technical experts, legal practitioners, academics and judges to provide non-binding guidance on the complex and evolving factual and legal issues relating to control involving third-category things such as digital objects.

Next steps

It is now down to the government to decide which, if any, of the commission’s recommendations it wishes to adopt in respect of digital assets.

Regardless of the legislation that it may wish to implement, however, the common law of England and Wales continues to adapt apace to ensure that those dealing in this nascent industry receive protection and assistance when required.

Charlotte Hill is a partner at Penningtons Manches Cooper and committee member of the London Solicitors Litigation Association