What is the legal status of cryptoassets and smart contracts?

On 18 November 2019, the UK Jurisdictional Taskforce (UKJT) published a legal statement (the Statement) setting out the best possible answers to the critical questions under English law with regards to cryptoassets and smart contracts. The legal statement can be found here.

Introduction

In preparation for the Statement, the UKJT sought advice from 29 specialist consultees, including the FCA, BoE, HMT, as well as Euroclear, the London Stock Exchange, ISDA, the Law Commission, and the Law Society. It also conducted a public consultation and received over 130 responses.

The Statement, written by Lawrence Akka QC and Sam Goodman (20 Essex Court), David Quest QC (3 Verulam Buildings), and Matthew Lavy (4 Pump Court), is evidently critical of the “often cumbersome, time-consuming and inflexible process of legislative intervention”. It proposes instead to rely on the flexibility inherent to common law to adapt to new commercial mechanisms. It aims to be an authoritative (though not definite) legal opinion with probative value in the English courts.

The Statement has two main parts: what type of property, if any at all, cryptoassets are under English law; and can smart contracts be treated as legally binding under English law. It expressly excludes regulatory considerations, as well as matters of taxation, criminal law, partnership law, data protection, intellectual property, consumer protection, settlement finality, regulatory capital, anti-money laundering, counter-terrorist financing, and monetary policy.

Cryptoassets

Legal Status

The Statement endorses a particularly wide definition of cryptoassets. In its view, the principal novel and characteristic features of cryptoassets are: (a) intangibility; (b) cryptographic authentication; (c) use of a distributed transaction ledger; (d) decentralisation; and (e) rule by consensus.

The Statement explores the distinction between things in possession and things in action – traditionally the only two types of personal property recognised in English law – and concludes that although cryptoassets are certainly not of the former category (due to their intangibility) they could in principle either be: things in action (under a specific interpretation of the case law), or a separate third kind of property (a relatively new concept of common law which has previously included assets such as EU Carbon Emission Allowances).

The Statement favours the interpretation of cryptoassets as a third kind of property, in particular because not to do so would be to fail to categorise cryptoassets as property of any kind, even though a cryptoasset fulfils “all the indicia of property” under English law.

The Statement also concludes that whilst a private key is only pure information (and therefore cannot qualify as property under English law), where a cryptoasset is viewed not merely as the private key, but rather as the system comprising of the set of keys (one private, one public) and an agreed upon set of rules, this system is more than mere information (it is an intangible thing) and can therefore be viewed, in principle, as property under English law.

Consequences

The consequences of this analysis are severalfold:

• On-chain transfers: every transfer of a cryptoasset entails the creation of a new asset and the destruction (or consensus on nullity) of the old one, which would impact available remedies in cases of theft or fraud involving cryptoassets.
• Bailments: these can only apply to things in possession and are therefore inapplicable to cryptoassets.
• Governing law: cryptoassets are caught under the normal rules for conflicts of laws when it comes to governing law and jurisdiction. The Statement treads very lightly on this topic, noting that this is areas is notoriously and necessarily complex, and that it can only take a high-level view.
• Security: cryptoassets can give rise to both mortgages and equitable charges and the means to grant such security are in principle the same as those applicable to other intangible assets.
• Goods: cryptoassets are not to be characterised as goods for the purposes of the Sale of Goods Act 1979, and the statutory protections (such as fitness for purpose) afforded therein are therefore unlikely to apply.
• Insolvency: cryptoassets are property under the Insolvency Act 1986 (which espouses arguably the widest definition of property in English law).
• Register: although a distributed ledger makes it very difficult to manipulate records of ownership, that does not in itself make it a record of legal rights against third parties under English law. Instead, proprietary interests should continue to be created via the usual legal means (e.g. security agreement, or under a trust) but this would need to be off-chain.
• Trade: a cryptoasset cannot be a document of title, a document intangible or an instrument (under the Bills of Exchange Act 1882), as all these concepts require, under English law, some element of possession. A cryptoasset could in theory be negotiable under English law however there would need to be, factually, enough mercantile usage to support this argument.

Smart Contracts

The Statement is clear that the common law rules on contract (offer, acceptance, consideration, and intention to create legal relations) are, in principle, entirely applicable to smart contracts.

The existence of offer and acceptance will be usually made clear from natural language framing the smart contract. Where the smart contract is written entirely in computer code, then extrinsic evidence (such as the parties conduct) ought to be enough to prove agreement of the parties. In cases of anonymous multilateral contracts (enabled by Distributed Autonomous Organisations, DAOs), the common law of unincorporated associations should apply mutatis mutandis. Similarly, unilateral smart contracts (for example a party deploying some code to a distributed ledger that would perform algorithmic investments in exchange for cryptoassets) present no particularly novel legal issues and are for example not so different (legally) from online auctions.

In contrast to natural language, computer code does not, generally, provide any room for ambiguity or inconsistency such that, where a smart contract exists purely in code, it is simply not susceptible to the exercise of contractual interpretation. In a few cases, such as types of computing languages which can produce different results depending on which environment or order they are used, contractual interpretation might be required, though it is suggested that extrinsic evidence should suffice to determine the parties’ intent. The additional complexity of determining whether the code was intended to define the obligation or simply its implementation is seen as a merely evidentiary exercise, creating little legal novelty.

There is no obstacle, in principle, to a private key satisfying a statutory requirement for a document to be signed for it to be valid, mainly because electronic signatures have long been recognised as a valid means of signing under English law, and a public-private key infrastructure is, in principle, simply one type of electronic signature. A similar view is expressed for a requirement that a document be “in writing”, with a caveat for smart contracts which cannot be read or are not intended to be read.

Conclusions

The Statement signposts throughout its analysis that the application of common law will inevitably vary from case to case. This is particularly so given that the most compelling evidence in the early ages of cryptoasset disputes is likely to be extrinsic evidence such as the contemporaneous conduct of the parties. Nevertheless, the commentary it provides is authoritative which can be used as the starting point of any legal discussion on cryptoassets pending the first binding rulings by the courts.