News
Law Commission Proposes Breakthrough Rules for Ownership of Crypto Tokens and NFTs | Burundi | Global law firm
First published in TechCrunch on August 19.
introduction
A major earthquake is occurring in the digital asset sphere, which is expected to create shockwaves that will impact technology not only in the real world but also in the metaverse.
These potentially game-changing changes appear in an innocuous-looking, if lengthy, consultation document titled “Digital Assets: Consultation paper,” published by the Law Commission of England and Wales, the UK’s public law reform body.
What this paper proposes is that digital assets be recognized as a new form of personal property, potentially creating an “internet of property”, which could have huge implications for the UK’s position as a hub for distributed ledger technology (DLT ) and fintech.
Why are property rights important?
Property rights are indispensable for the creation and distribution of capital. An appropriate legal basis for ownership of digital assets will have a number of real-life consequences, such as enabling the creation of security over digital assets – meaning they can be used as collateral for loans – providing people or businesses with greater protection in case of fraud and allow the distribution of digital assets like other property in the event of insolvency.
For example, if someone takes your NFT, you may want to take legal action to get it back, try to stop the buyer from transferring it to another account, report it to the police for theft, or take action against someone who helped them. None of this is possible without clear recognition of digital assets as property. If your NFT is then transferred to an innocent buyer, should they keep it? There is no answer to this question without knowing what type of property a digital asset is.
The entire decentralized finance (DeFi) industry, which includes cryptocurrencies like bitcoin, is based on the transfer of crypto assets to other accounts where they can then be distributed in accordance with smart contracts or other sets of rules.
Do these movements count as some sort of legal transfer of the asset or as a security deposit or as a form of safekeeping? These questions may seem unimportant when everything is working well, but as soon as something goes wrong, participants will suddenly care enormously about them. They will determine who will recover the remaining assets and whether anyone else – cryptocurrency exchanges, developers, and so on – could be responsible for any losses. And once again, there is no clear answer to any of this until the nature of digital assets as personal property is established.
Capitalism is based on the clear recognition of property rights. A functional economy involving digital assets will ultimately depend on a clear and sensible approach to property rights over those assets. Despite being so critical to the success of digital assets and the technology industry as a whole, the proper treatment of digital assets as personal property has been the subject of intense legal debate and uncertainty in many jurisdictions. One wrong turn could lead to inadequate and inconsistent laws that will harm the development of NFTs, DeFi and similar areas.
What does the Law Commission document say?
The Law Commission’s consultation document considered the many conflicting views and settled firmly on one option: treating digital assets as a new form of property. This would be similar to real-world tangible ownership, but with “control” replacing the concept of “possession.”
Astutely, he rejects analogies to intangible assets such as legal rights, recognizing that digital assets have more in common with physical objects: Bitcoin functions more like electronic money than an electronic bank account. But it has decided not to assimilate digital assets en masse into the category of things that can be owned (with the exception of some digital assets used in e-commerce finance): they are sufficiently different that they have their own space to develop alongside existing forms of ownership .
In adopting this approach, the Law Commission draws on English law’s ability to expand into new areas through judicial innovation by working on a case-by-case basis: it defines the broad scope of the rules and allows judges to fill in the details as they emerge new facts.
What does this new form of ownership include?
NFTs, game assets, email addresses, domain names, media and program files, and other forms of data are all considered by the Law Commission. Of these, only digital tokens such as NFTs and similar native crypto assets, including cryptocurrencies such as Bitcoin, fall under their definition of ownership. But this only affects the NFT itself, not any real-world objects or legal rights attached to it.
Recognition of ownership interests in an NFT, the Law Commission points out, does not directly enhance the owner’s rights to any related object. Owning an NFT of an image, for example, does not necessarily give you copyright to the image or ownership of any paper copy of the image, or even rights to the digital copy attached to the NFT.
As well as providing comfort to digital asset owners, the Law Commission’s consultation also highlights the fragility and uncertainty of asset rights linked to NFTs. These changes will have ripple effects on the regulation of crypto finance. Regulators are increasingly focused on cryptocurrencies, particularly in regulating DeFi and tokens that may be linked or analogous to securities. The scope of regulation will be affected by the treatment of cryptocurrencies as property.
For example, the regulator would need to know how cryptocurrencies bundled into omnibus accounts by exchanges or custodians, or as part of a DeFi agreement, might be treated in property law before it can impose sensible regulations on them. Likewise, how NFTs or other digital assets are distributed in the event of insolvency will influence insolvency regulation for participants in cryptocurrency markets.
Cross-border law
Cross-border laws and regulations will also be affected. Blockchain tends to work regardless of borders between countries. Laws tend to be national. Formulating legal rules that can successfully support cryptocurrencies and blockchain transactions within a single jurisdiction is a challenge for lawmakers, and making them work across borders is even more difficult.
The Law Commission is careful to state that the proposed rules are limited to the UK. It proposes a further consultation that will address how to decide which country should apply the rules to digital assets (other international organizations such as UNIDROIT are currently grappling with the same issue).
Inconsistent rules between countries make this process more difficult and create a further brake on the development of international cryptocurrency financial markets. If the Law Commission’s approach to digital assets as property is followed by other countries, it will make the task of achieving cross-border consistency much easier.
Conclusion
Importantly, even before legislative changes are made, the consultation document is likely to be followed up by the English courts. This new approach will set the benchmark for the future legal treatment of digital assets and, combined with the inherent flexibility and other advantages of English law, will increase the attractiveness of the UK as a location for digital asset businesses.