The purpose of the draft legislation is to confirm that cryptocurrencies, and potentially some other assets such as voluntary carbon credits, can be treated as property by the law. This will allow courts to consider a number of issues, including:
If digital assets are the subject of litigation and there is a risk that the owner may spend or dispose of them before the end of the litigation, the court could prohibit the disposal of the assets to prevent this from happening. Such injunctions already apply to things that are recognised as property. It is not yet clear whether such injunctions can apply to digital assets.
If someone takes away or destroys someone else's digital assets, the victim will have stronger ways to protect their rights if those assets are considered to be their property. Right now, the law is not clear on whether digital assets are property. However, there are already active transactions in the digital asset market, and most investors believe that when they buy digital assets, they are acquiring property rights just like when they buy ordinary things.
Property law in England and Wales has traditionally been divided into ownership of real property and personal property. The law of England and Wales previously recognised two separate categories of personal property rights: rights relating to 'things in possession' (tangible things) and rights relating to 'claims' (legal rights or claims subject to judicial enforcement). A nineteenth-century decision is often cited to confirm that these two categories of personal property rights are exhaustive, so that any subject matter of personal property rights must fall within one of them.
Court decisions over the last ten years show that the common law of England and Wales is moving towards recognising a 'third' category of objects of personal property rights which do not fit into the traditional categories. This development has been linked to the emergence of objects such as cryptocurrencies. Most experts interviewed by the Commission agreed that a third category already exists or should be recognised. Some judges were also of the view that explicit recognition of such a category would confirm existing law and facilitate its development.
Property in possession and property in action are subject to different types of legal regulation. In the 1885 case of Colonial Bank v. Winnie, Lord Justice Frye said: "All personal property is either in possession or in action. The law does not recognise a third category between the two."
However, as Professor Fox and Professor Gullifer rightly pointed out in their joint response to the Bill, this provision was largely accepted as reflecting the correct position in the law, but is probably no longer correct (as far as it ever was).
The term "third category", is used to describe a category of property distinct from both property in possession and property in action.
Digital assets do not fit into the traditionally recognised categories of property in possession or property in action, at least in a narrow sense. They are not tangible property in the usual sense, which means that courts are likely to find it impossible to recognise them as property in possession.
In general, analysis of case law shows that courts in England and Wales now treat cryptocurrencies as a separate type of property to which property rights may apply.
Cryptocurrencies such as bitcoin will continue to exist even if:
The law will cease to recognise them as objects of property rights.
A law will be passed prohibiting cryptocurrencies.
Their basic characteristics, such as transferability, storage and use by owners, will remain unchanged.
People will still be able to use and benefit from cryptocurrencies and interact with each other when using them.
The blockchain technology itself and the operation of cryptocurrency systems will not be affected by the lack of recognition as objects of ownership or prohibition.
That is, cryptocurrencies function independently of legal recognition as independent objects. Their existence does not depend on their legal status.
Moreover, the consistent application of AA v Persons Unknown (as opposed to any other approach) has resulted in the courts deliberately making cryptocurrencies a separate third category of common law property. That is, the courts have recognised cryptocurrencies as a separate type of property.
The consistent application of one judicial precedent (AA v Persons Unknown) has led to the designation of cryptocurrencies as a separate third category of common law property.
Thus, the jurisprudence has created a special status of cryptocurrencies as property.
Courts in other jurisdictions have reached the same (or similar) conclusion. For example, countries in the Anglo-Saxon legal system, such as Australia, Canada, Hong Kong, New Zealand, Singapore and the United States, now uniformly hold that cryptocurrencies can be subject to property rights and therefore subject to the various legal consequences that come with it.
For example, cryptocurrencies:
May be seized under interim injunctions pending resolution of a dispute;
May be held in trust;
Fall under common statutory definitions of "property".
That is, courts in these countries now uniformly hold that cryptocurrencies are property and can be subject to property rights like other valuables.
These principles apply not only to common law countries but also to civil law countries. They extend the concepts of ownership to "electronic records", meaning digital files and data.
Digital assets are a subset of such electronic records. Thus, the UNIDROIT principles effectively establish the possibility of treating digital assets as objects of ownership.
This means that they can be categorised not only under the traditional categories of things in possession and things in law, but also under a new, third category. This is appropriate for both common law and civil law countries.
Thus, international law also recognises the need to separate digital assets into a separate category for the purposes of property law.
Our conclusion is as follows:
Property should not be deprived of the legal status of an object of property rights simply because it is neither property in possession nor property in right.
It is recommended that a third category of property be explicitly established in the law, which could include new property that does not fit into the existing property framework, such as cryptocurrencies.
This will allow courts to consider such property based on their features and characteristics, rather than trying to apply rules designed for traditional types of property.
Enshrining a third category of property will ensure that the law is more flexible and fair in dealing with new emerging types of digital assets that do not fit within the existing framework.
The questions of which assets would fall into the third category and what legal regulation would apply to them should be decided by the courts on a common law basis, rather than by legislation.
The courts already have a great deal of experience in dealing with such issues, built up over centuries. They will be able to apply established case law and assess all the circumstances of each particular case to determine:
Whether a particular asset falls into the third category;
What legal regulation is applicable to it.
This would allow for flexibility to be applied on a case-by-case basis without over-extending the boundaries of the third category. Issues of categorisation and legal status of assets should remain within the competence of the courts.
Legislation would reduce the time spent by the courts on issues of categorisation of objects of personal property rights and, conversely, allow them to focus on the substantive issues before them. It clearly enshrines:
A compelling argument for revisiting the dichotomy between property in possession and property in action and recognising a third category of intangible property
The Draft Law explicitly refers to property of a "digital nature" as property that can potentially attract property rights, even though they are not property in possession or in action.
The Draft Law confirms that property that does not fall into the categories of property in possession and property in action can be objects of property rights. As stated above, the Act leaves a number of questions to be resolved by the common law, including:
what property falls into the third category;
what property rights are assigned to the third category and what consequences this carries (e.g. liability for harm, applicable remedies, etc.).
These are questions for the courts to resolve as customary law develops. Let us consider some of the arguments in favour of this approach.
What falls into the "third category"?
Our recommendation and this draft law relate to recognising the existence of an additional category of personal property, which may include property that does not fit into the existing categories - including cryptocurrencies.
In general, property would fall into the third category if it is capable of giving rise to property rights but is not properly property in possession or property in action
Cryptotokens, for example, are so fundamentally different from other types of software or digital assets that this distinction alone is worth enshrining in law. Such enshrinement would facilitate and encourage innovation based on the fundamental principle that certain digital items can now be 'owned'.
The ability to give rise to property rights.
What is an object of property rights in general?
While the author does not recommend criteria for determining what falls into the third category, it is important to remember that any potential third-category object must be capable of giving rise to property rights.
And some digital assets do not have this capacity. There is no single definition of property in the law of England and Wales, either in legislation or in common law. However, the courts have extensive case law to help them determine whether an object - digital or otherwise - is capable of giving rise to property rights. Our Advice Note and Report considers various attributes of property, including:
the characteristics described by Lord Wilberforce in National Provincial Bank v Ainsworth:
certain
identifiable by third parties,
capable by its nature of being accepted by third parties,
possessing some degree of permanence or stability;
possessing exclusivity;
rivalrous;
distinguishable;
possessing value.
Rivalry is a particularly useful indicator of property in the context of certain digital assets. A resource is rivalrous if one person's use of that resource necessarily infringes on the ability of others to simultaneously make an equivalent use. For example, if Alice uses a Game Boy to play her Pokémon Red game, Bob cannot simultaneously use the same Game Boy. Alice's use of the Game Boy inevitably infringes on Bob's ability to use it.
Rivalry is an important characteristic of things that may be relevant objects of property rights. One of the primary functions of property rights is to allocate rival objects among individuals and to protect their freedom to use those objects without interference from others. In a world without property rights, an individual's freedom to use a rival resource would depend largely on the extent to which he could physically keep others away from it. Few would feel secure about their property rights, and security would likely come at the cost of use.
The concept of "rivalry" (as endorsed by the Court of Appeal in the Tulip Trading case) usefully distinguishes this type of digital asset from other digital things, such as ordinary digital files, which are incapable (by virtue of their present device) of attracting property rights under the law.
The authors acknowledge that some consultees have expressed concerns about where the boundaries of things in the third category are drawn and have differing views on the correct analysis of, for example, private authorised blockchain systems, voluntary carbon credits ("VCCs"), digital assets in games and digital files as examples. It is also noted that existing scoping problems will remain, and these scoping problems cannot be solved (but rather will be further exacerbated) by law reform. It is concluded that the most appropriate tool for resolving the complex boundary definition issues relating to digital assets based on different technologies is common law.to determine whether such digital assets can (and should) attract property rights in relation to particular factual circumstances.
Property in possession.
Under current law, a thing in possession is any object that the law considers to be subject to possession. This includes assets that are "tangible, movable and visible and in respect of which possession can be established". The report on electronic trade documents notes that while the concept of tangibility helps to accurately describe the assets that are subject to possession, it is not - and should not be - a necessary criterion for the law to recognise that possession can be established. Thus, in the limited context of electronic trade documents, it is recommended that it should be possible to treat electronic versions of trade documents as property subject to possession, provided that they fulfil certain criteria. The elements of the concept of possession that can be extrapolated to electronic trade documents, despite the fact that they are property that the law regards as intangible, have been identified.
However, it does not mean that the arguments in favour of using possession as an operational concept with respect to electronic trade documents are as compelling with respect to other forms of third-category property. One reason is that other third-category property does not generally seek to replicate the legal functionality of a particular type of tangible property in the same way that electronic trade documents seek to faithfully replicate the legal functionality of paper trade documents. Moreover, many third category items have been designed to avoid reproducing some of these features. The most obvious example is crypto-tokens, which were designed to enable global communication of value on a trust basis without the need for physical exchange of tangible things.
Given the jurisprudence, it is considered unlikely that cryptotokens or other digital or intangible assets would be recognised as property in possession. This would require legislative intervention, which would not be helpful or appropriate.
The speaker concludes that rather than applying the concept of possession directly, English law can develop jurisprudence around the concept of control that better suits the functions of third category things and the technology they use. Third category property may consist of data in an electronic medium, including computer code, electronic, digital or analogue signals, and that such qualities would distinguish them from things in possession. However, it is not necessarily the case that third-category property must be limited to or defined by these qualities, as this may unduly restrict the category. It is also worth noting that while data is an important part of cryptotokens, it is not just data.
As explained above, cryptotokens or other digital assets are properly categorised as property in action. Our report considers independence from persons and the legal system as a factor that may help to distinguish certain types of third-category property from property in action: that is, third-category property is something that is not a right in itself and can be used and enjoyed regardless of whether any rights or claims against it are enforceable through litigation.
It is important to note that recognising property as a legal system does not mean that property does not exist independently of the legal system. The point is that property does not rely on the legal system for its continued existence. Any property can be recognised by the legal system, but property in action can only come into existence and function because of the legal system. A bag of gold, for example, exists independently of the legal system, but rights in relation to it can still be legally recognised. The same is true for cryptotokens. Cryptotokens are not rights in themselves and they exist independently of any rights or claims that may also exist against them. They can also be used and enjoyed regardless of whether any rights or claims against them are enforceable through litigation. In contrast, the same situation does not hold true for debts: their existence depends on and coincides with legal recognition. This means that they cannot function, be used or enjoyed without such legal recognition.
Blockchain and DLT systems can be used by different market participants in different ways - for example, simply as a way to register certain "off-chain" assets using tokens. Legal rights (as opposed to things like crypto-tokens) created in blockchain or DLT-based systems or in multilateral contractual frameworks will be treated by law as property in action. This property in action will be different from third category property and will fall under a different legal classification. Some third category property has an even closer relationship to the legal system than crypto-tokens.
With digitalisation trends, there is an expectation that other intangibles and assets will be developed, the parameters of which are difficult to predict and define in the abstract. There will probably be assets that already exist and will still be developed that will be difficult to categorise. Courts will also have to determine whether such new types of assets can (and should) be subject to property rights. The draft laws are technologically neutral as they do not focus on particular types of (digital) assets, protocols, systems, networks or technological features. This will allow the law to consider specific features of an asset when determining its property status. This avoids drawing arbitrary boundaries or forming rigid definitional problems. The emphasis is on success and trust in the common law's ability to evolve sensitively and flexibly in the face of rapidly developing technology. The centrality of the common law to the law of property rights is maintained, reflecting the fact that the legislation does not seek to define property in action or property in possession. This distinguishes the law of England and Wales as a flexible and open system that takes account of the particular characteristics and design principles of particular technologies.
Property in possession, property in action and third category property are different. They function in different ways. Control in the digital context applicable to third-category property may differ significantly from that exercised over traditional tangible objects and remains open to technological evolution. For example, software is often controlled through password protection, while the laptop on which it is stored may be controlled by being placed in a locked drawer. Partly as a result of this, different markets and market practices have developed for tangible property, property in action and third category property. For these reasons, the expected conclusion is that the common law is likely to develop legal principles specific to third category property. These principles are likely to differ, to a large or small extent, from the existing legal principle of possession and the legal constructs applicable to possessions, such as bailement, pledge, collateral loan and the tort of appropriation. The development of the common law in this direction is well justified, and it is not the intention of the legislation to make any provision for these or other matters. Our report is intended to strengthen the legal framework for this process.
Some fundamental defining features and purposes of third category property are that they function differently from property in possession and in action. As Timothy Chan and Professor Lowe have argued:60 it is crucial for courts dealing with disputes involving cryptoassets to avoid a simplistic analogy between the tangible and intangible. A preferable approach is to develop the law by analogy to the principles applicable to things in possession and things in action, while recognising that such analogies will be imperfect.
Instead, the law should focus on the characteristics of the particular asset to which it relates in each case. It should not attempt to rigidly apply to third category property legal principles formulated by analogy to other assets that may be subject to property rights. That would be a common law assessment for the courts to make, guided by existing principles of rights in rem and taking into account the unique nature of third category property. Whilst this represents a significant task for the courts, it reflects the development of the law in relation to things in possession and in action.
The report presents some situations - particularly in the case of legal concepts applicable only to things in possession - where it might be useful to develop a similar equivalent for things in the third category.Collateral: the development of a common law to recognise a control-based ownership interest, potentially analogous to pledge, could facilitate both the holding and provision of collateral for crypto-tokens and crypto-assets and would therefore be useful. The development of such a security interest is unlikely to be a complete solution, as such a security interest is likely to rely on static, all-encompassing notions of control.
Illicit treatment: claims for remedy in rem and unjust enrichment are likely to be applicable in the context of third-category things, while a claim for unlawful treatment would not be available. This is because unlawful conversion only applies to property in possession.
A gap in the applicant's defence is noted where their crypto-token is "burned" by the defendant. Neither a claim in rem, claim for unjust enrichment nor unlawful treatment would be applicable in such circumstances and therefore there is a gap in the law relating specifically to third category properties.
It would be useful for courts to develop specific and clear principles of tort liability along the lines of the cake of unlawful treatment or drawing on some of its elements to address unlawful interference with digital objects and address such gaps.