Law Commission publishes final report on digital assets

On 28 June 2023, the Law Commission published its final report on crypto-tokens and other digital assets, which included law reform recommendations to the Government.

The report is aimed at providing some much-needed clarity within the legal system of England and Wales in light of the burgeoning use of digital assets. As made clear within the report, the recommendations made are intended to feed into the Government’s clear plans to “make the UK a global hub of cryptoasset technology.

Recommendations

In March 2020 the UK Government asked the Law Commission to make recommendations for reform to ensure that the law is capable of accommodating both crypto-tokens and other digital assets in a way which allows the possibilities of digital assets to flourish. 

Notwithstanding the detailed consideration that the Law Commission has clearly applied to this task over the past 3 years, the report makes very few recommendations for law reform. The reasons for this are that:

• The common law of England and Wales is, in general, sufficiently flexible, and already able, to accommodate digital asset
• The aim is that recommendations are “highly practical and achievable”

The report takes what it labels a “tripartite approach” to law reform and recommendations in its report:

1. Common law development

The report concludes that the current state of the common law surrounding digital assets is relatively certain and that any areas of residual legal uncertainty are “highly nuanced and complex”. There is an acknowledgement of the need for the iterative development of the applicable law in a sector which is rapidly evolving. As such, the Commission identifies that the priority should be development of the common law, which is well placed to deal with many issues which may arise. 

2. Targeted statutory law reform

The report does make some recommendations for statutory law reform:

• Legislation, which expressly confirms the existing common law position relating to digital assets attracting personal property rights. 
  • The report discussed a “third category” of thing to which personal property rights can relate. Property disputes traditionally centre around a “thing in possession” or a “thing in action”. However, the Law Commission concluded that digital assets are neither things in possession nor things in action, but common law treats them as things that are capable of attracting personal property rights, therefore creating a “third category thing”. 
  • The report recommends that legislation should confirm that digital assets will not be deprived of legal status as an object of personal property rights due to the fact that they are neither a thing in possession nor a thing in action.  However, it also recommends that legislation should not define hard boundaries as to exactly what would constitute a “third category thing”, but that common law is the place where such distinctions should be examined and determined, as the application of personal property rights to digital assets will be decided on the particular facts in question at the time. 
  • The report does discuss a number of factors which could be relevant to the development of such legislation, such as criteria which may be considered when determining whether or not a digital asset will constitute a “third category thing” (without setting hard boundaries) and the concept of control over “third category things”.
• As a matter of priority, the Government should set up a project to put in place a bespoke statutory legal framework that better facilitates the entering into, operation and enforcement of crypto-token and cryptoasset collateral arrangements. 
  • The report concludes that many crypto-tokens are likely to fall outside of the scope of the current Financial Collateral Arrangements (No 2) Regulations 2023 (FCARs). It therefore recommends law reform to clarify this position, although it does not provide any view on what the scope of any reformed FCARs regime should be.

3. Industry guidance

Whilst concluding that common law development is generally better able to keep up with an area as fast moving as digital assets, the final report recognises that it would be a huge task for the judiciary to remain alive to the complex, multi-faceted developments in this area. It, therefore, recommends the creation of a panel of industry experts, legal practitioners, academics and judges to provide non-binding guidance on the factual and legal issues relating to the control of digital assets. The report concludes that such “detailed and technology-specific” guidance will facilitate “clear, logical and consistent” application of legal rules and reasoning over time. 

Other findings

The report considers a number of other areas concerning digital assets and, whilst it recognises that there are subjects which could benefit from further clarification, it returns to the view that these are best addressed through the development of common law. By way of notable example:

Transfers

The report looks at legal transfers of crypto-tokens and notes, in particular, that strong arguments have been made in favour of the development of a common law special defence of good faith purchaser for value without notice applicable to crypto-tokens (and “third category things”). It concludes that such a defence can be recognised and developed by the courts though development of the common law.

Causes of action and associated remedies

The report also considers some of the causes of action and associated remedies that may be pursued in the context of digital assets, or “third category things”, including proprietary restitutionary claims, tracing actions and related trust law. 

It concludes that much of the current law in this area can be applied to digital assets without law reform, as in the majority (but not all) of cases the law does not distinguish between things in possession or things in action when considering causes of action and associated remedies. Therefore, there is no reason why these should not therefore extend to “third category things”. 

Comments 

It is the opinion of the authors that the Commission has adopted a well-considered but nuanced approach to a sector that is both complex and rapidly evolving. There is a strong emphasis on the need for the iterative development of the jurisprudence relevant to digital assets, which is to be driven by the Courts of England and Wales. In recognition of the challenges that this may present, the Commission also proposes the formation of a panel of experts to provide non-binding guidance to assist with the Courts’ understanding of this sector. This may be in recognition of the Courts’ reliance upon guidance provided by the UK Jurisdiction Taskforce in recent years.  

The report, and potential future implementation of its recommendations, should go some way towards providing further clarity and consistency in a fast-paced, technically complex environment. There is seemingly some form of consensus within the industry that the ongoing development of the legal framework and guidance in the arena of digital assets is to be welcomed on the basis that it provides certainty to market participants and reassurance to those contemplating entry. The report is therefore likely to be viewed as supporting the Government’s plan of positioning England & Wales as an attractive location for crypto and other digital businesses.  

Next steps

The Government will review and consider the recommendations made by the Law Commission. There is no information available as to any timeframes for this to occur, but we will be watching with interest. 

_{*You can access the full report here.}