Senior Associate Guy Robson and Associate Elliott Fellowes discuss the adaptation of English law to cryptoassets and smart contracts.
Guy and Elliott’s article was published in Law360, 12 July 2019, and can be found here.
When thinking of cryptoassets, many people are likely to immediately consider bitcoin and other cryptocurrencies such as litecoin which entered the public’s consciousness due to the huge price increases they experienced in 2017 and the subsequent collapse in their price in 2018 (followed by something of a recent rebound).
However, cryptoassets cover far more than simply bitcoin and significant development has been made in the cryptoasset sphere, which now encompasses a range of assets, including security tokens and stablecoins. In parallel to this, the technology behind smart contracts has continued to evolve apace, in some cases being built on a blockchain to allow parties to transact instantaneously with the new cryptoasset classes.
Yet, despite this technological progress, there has been little in the way of clarification from legislators and the English court in relation to the legal rights and obligations that attach to cryptoassets or which concern parties that seek to transact via smart contracts. It goes without saying that continued uncertainty in respect of such rights and obligations will limit investment in the technology and therefore slow future development and mainstream adoption.
It is against this backdrop that the LawTech Delivery Panel, established by the U.K. government, judiciary and the Law Society of England and Wales, has set up the U.K. Jurisdiction Taskforce with the objective of demonstrating that English law and the jurisdiction of England and Wales provide a state-of-the-art foundation for the development of distributed ledger technology, smart contracts and associated technologies.
This is distinct from the endeavors of the Cryptoasset Task Force, which is considering the regulatory position in relation to cryptoassets in conjunction with the Financial Conduct Authority and the Bank of England. The UKJT launched a public consultation, which closed earlier this month, in order to gather feedback on a series of questions relating to cryptoassets and smart contracts and encouraged law firms and market participants to provide feedback on whether the proposed questions are the “right” questions, or whether other issues should be considered by the UKJT.
Intended Outcomes of the UKJT’s Consultation
Judge Geoffrey Vos, chancellor of the High Court, led a public discussion in London on June 4, 2019, regarding the UKJT’s consultation. The UKJT is to produce a legal statement following the consultation and Judge Vos said that he hoped that this will be accepted by the fintech industry and stakeholders as reflecting the current status of English law with respect to cryptoassets and smart contracts and that in due course the legal statement will be affirmed by the English court.
Judge Vos himself has spoken recently regarding his belief that the English common law system is in a good position to provide the necessary framework in which new technologies can develop, and is on record as calling cryptoassets one of the most important legal subjects for our generation. It is therefore anticipated that the UKJT’s conclusion will be positive for technological development in the U.K.
To the extent that the UKJT concludes that any new legislation is needed to address any issues in respect of DLT, smart contracts or associated technologies which cannot already be addressed by the English common law, it is envisaged that such legislation will be concise and focused. In this respect, it is understood that the UKJT has already contacted the U.K. government to raise the possibility that any proposed bill in respect of cryptoassets and smart contracts can take advantage of the process for fast-tracking legislation, and it seems that the government is open to this possibility.
Focus of the UKJT’s Consultation
The questions posed in the UKJT’s consultation are aimed at establishing the nature of the legal rights and obligations that holders of cryptoassets, or parties to smart contracts, have. To this end, there are two fundamental questions posed by the UKJT. The first is in relation to cryptoassets and the second in relation to smart contracts. Ancillary questions, such as whether cryptoassets can be given as security, or whether smart contracts written in code satisfy statutory “in writing” requirements, flow from both. The principal questions are set out below and some of the key issues that arise from these are discussed in turn.
Under what circumstances, if any, would the following be characterised as personal property: a cryptoasset; and a private key?
As mentioned above, cryptoassets are not confined to alternative currencies, such as bitcoin, and a variety of cryptoassets are now available to market participants, some of which appear to more closely resemble traditional assets than others. For example, some commentators and investors consider types of security tokens as being the digital equivalent to owning shares in a traditional company. However, it is not clear as to what extent the English court would find such security tokens to provide investors with the same rights as if they held shares in a company incorporated under English law.
A similar question arises in relation to private keys. The UKJT consultation defines a private key as being “a string of data that is generated based on a random number (known as a ‘seed’).” This is used to form a digital signature which allows a party to transact on a blockchain. It is essentially a personal identifier used to verify that one party to a transaction is in fact the originator of the transaction.
An issue arises if cryptoassets and private keys are not classified as property in that it will be necessary to understand what entitlement the holder of the cryptoasset/private key has and what rights and obligations this provides to the holder (if indeed any).
For example, what remedies are available to the holder in the event that impropriety occurs in relation to these assets, such as fraud? If cryptoassets are not clarified by the court as property, but rather as some other “bundle of rights,” can an investor who has been defrauded, or has had their cryptoasset/private key hacked, seek restitution of the asset? Or is the only remedy available to the investor damages for unlawful interference in whatever rights the cryptoasset entitles the investor to? Furthermore, can a victim of cryptoasset fraud seek to trace the proceeds of this fraud through the blockchain? The answer to this is likely to be “no” if cryptoassets and private keys are not classified as personal property.
In what circumstances is a smart contract capable of giving rise to binding legal obligations, enforceable in accordance with its terms (a “smart legal contract”)?
The term smart contract typically refers to provisions in a contract written in computer code. Such smart contracts have the potential to drive efficiencies in a number of business sectors by automating contractual provisions between the contracting parties in the event that certain defined conditions are met.
The question posed by the UKJT set out above seeks to determine whether it can be said that smart contracts satisfy the constituent elements required to found a contract under English law. These elements are: offer and acceptance; consideration; intention by the parties to create legal relations; and “certainty” of terms.
However, in the case of smart contracts, satisfying all of these elements presents a number of potential challenges, not least as the concept of offer and acceptance has traditionally been held by the English court to require two legal persons (i.e. a natural person or a corporate with legal personality) to enter into a bilateral agreement. Smart contracts on the other hand can be fully automated with little or no human (or corporate) input, so on one view could be said to fail the first element required for establishing a valid contract under English law.
A further potential issue arises as to whether nonoperative contractual provisions can be included in smart contracts. Operational clauses, ie those which effectively state that ‘when event X occurs, action Y is required’ are relatively simple to express in computer code. This is because these can be expressed in Boolean logic, the foundation language of modern computer programming.
However, nonoperational clauses are not so easily expressed in Boolean logic as they do not always give the binary “true/false” output required. There may be easy solutions available to deal with this particular issue, such as drafting a written (or hybrid) master agreement to which subsequent smart contractual agreements refer. The nonoperational provisions for the subsequent smart contracts can be contained in the referenced master agreement. Regardless of this, careful thought needs to be given to how jurisdictional questions and subsequent disputes can be resolved in the event that nonoperational clauses are not contained within a smart contract or are ineffective if written in computer code.
The UKJT consultation is a welcome step in the direction of clarifying some of the fundamental legal issues which arise from the current unlegislated status of cryptoassets and smart contracts under English law. It appears that the UKJT wants to reassure stakeholders in the fintech industry that English law offers an amenable framework in which technology can continue to develop, with the aim being to provide a light-touch, high-level legal basis for cryptoassets and smart contracts and to only recommend new legislation as a last resort.
If this turns out to be the case, the U.K. may be in a position to establish itself as a leading jurisdiction for cryptoassets and smart contracts. This can be contrasted with other jurisdictions which have sought to legislate or regulate the fintech industry first without necessarily fully understanding or appreciating the potential of the activities which are proposed to be regulated. It was suggested at the recent UKJT public discussion in London that this approach risked putting the cart before the horse and is not the recommended approach for the U.K.
Whilst the focus of the UKJT is on encouraging the development of fintech products in the U.K., Judge Vos commented that it was necessary for market participants to have access to effective dispute resolution methods in order for the U.K. to stand out as a preeminent jurisdiction for developing technologies. Recourse to effective remedies where a dispute arises is the other side of the coin when it comes to the U.K. being perceived as an attractive jurisdiction for market participants to operate and invest in.
Participants need clarity as to their rights and remedies in the inevitable event that disputes arise. However, what exactly those remedies are will very much depend on whether cryptoassets are considered to be personal property and whether smart contracts are considered to be effective and legally binding under English law. These issues are rightly at the heart of the questions posed by the UKJT.