by Elliot Cowan and Mumuksha Singh of the CMS
In July 2022, the Law Commission for England and Wales launched its consultation proposals inviting comments and acknowledgment for the protection of digital assets such as crypto-tokens, cryptoassets and non-fungible tokens (NFTs).
How the Law Commission’s proposals apply from a company law perspective. Some of the key aspects discussed are:
What are a company’s digital assets?
In its broadest sense, a company’s digital assets could mean all of its data represented in an electronic medium, such as forms of computer code, electronic signals, digital or analog. The Law Commission describes assets as “Data“where they have the capacity for unique instantiation so that it takes on characteristics or attributes that make them function much more like objects rather than pure information. The term ‘instantiation‘ in computing refers to the creation of an object. Normally, all crypto-tokens, cryptocurrencies, NFTs, and other similar types of data would be considered digital assets of a company because they possess an element of ‘instantiation‘.
Digital assets in their nature are neither tangible nor intangible and do not fit neatly into the traditionally recognized categories of personal property. This category of assets is intended to be broader than “crypto-assets” and could include anything from in-game avatars, electronic signatures, cryptography, smart contracts and distributed ledgers to shares of a company. Traditionally, assets are considered either as things in possession Where things in actionbut the Law Commission is now proposing to create a third asset class to capture digital assets.
The criteria attached to this third category are evolving. But any assessment of the identity of enterprise digital assets should be a nuanced consideration of new, emerging, and idiosyncratic things that wouldn’t otherwise be captured as assets. As the law evolves, an analogy between things in possession Where things in action, would be on a case-by-case basis to establish a fixed position. There is enough flexibility in the suggested premises of the Law Commission document to indicate that even when one of the technical characteristics of a digital asset is limited or removed, it can still be classified as a “data object”. and fall within the general scope of the law.
How to manage the transfer of digital assets?
To legally transfer an asset, two critical elements should always be established by a transferor, namely title to the asset and the capacity to contract (see below). Assuming ownership rights to digital assets can be established, digital asset transfer should be possible.
There is currently no standardized method for transferring an electronic record of a digital asset, so developments in this area may be based on the equivalent existing framework of transferable instruments (e.g. stock transfer forms, title deeds, acquisition agreements, etc.).
Like assets documented on paper, an instrument of transfer of a digital asset may reflect similar legal obligations, for example smart contracts transferring a digital asset may entitle a transferor to cash/non-cash consideration and a transferee to claim the performance of an obligation (such as an update of the digital file). However, the Law Commission document notes that crypto-tokens are transferred idiosyncratically, so it is not possible to have a one-size-fits-all approach.
Any method used to transfer digital assets would only be reliable if it (a) identified the “transferable” element of the electronic record associated with that digital asset, (b) identified the person who has control of that electronic record, and (c) maintained the integrity of that asset for that duration.
The Law Commission paper suggests that it is the element of “control” that is possible to establish in legislation and currently the common law in itself already applies to determine the control of data objects.
The transferable essence of digital assets is perhaps best captured by its characteristic of tokenization. In computing, atoken” denotes a programming object that represents the ability to perform an action in a software system. In law, the word generally connotes a tangible object. Money is a “token-based payment system“because banknotes and coins are”tokensrights against the central bank. In a nutshell, tokenization allows for the economically and legally most important characteristics of an asset to be recorded, and for a written record to deal with the rights that embody the underlying asset. Traditional forms of asset securitization rely on the same concept for the transfer of an asset.
Title of digital assets
The requirement of title to contract is based on the basic rule of title in English law that no one can give what he has not. This rule plays an important role with digital assets because their idiosyncratic nature of transfer affects their title differently than normal assets, which means that for digital assets, each on-chain transfer creates a new ownership with a new title and a new digital record. .
In the case of digital assets expressed in the form of tokens, their transfer of ownership takes place by means of an update of the corresponding ledger, which is more akin to the existing systems for assets such as non-certificated securities ( paperless, scriptless) and cash transfers, which involve a change of physical possession.
The Law Commission paper proposes that a crypto token-based ledger could also be established through legislation, which would determine the evidentiary strength of the record and any transfer formalities.
In addition, the Law Commission is also tentatively offering explicit clarification that the special bona fide buyer defense for value without notice should apply to crypto token transactions. This common law defense was generally only available for cash transactions (because it granted legal title to a transferee who purchases “goods” for value in good faith without notice of another party’s claim against that good). The characterization of crypto-tokens as currency is currently the subject of various other debates.
Ability to contract for digital assets
A smart contract is a contract whose terms are recorded in a computer-readable form, i.e. in code. Its notable feature is that it is performed, at least in part, automatically and without the need, and in some cases without the possibility, of human intervention.
Smart contracts are coded as embedded in a networked system such that when the required consents are in place, these contracts are automatically executed and executed using the coded techniques (such as cryptographic authentication, distributed ledgers, decentralization , the consensus) as we have seen above under tokenization. This means that there is absolutely no need for one counterparty to promise performance or resort to law to enforce a specific promise on another: the computer code will do as programmed.
It is likely that over time, the legal mechanisms for forming smart contracts will gradually become more uniform as crypto token markets mature. In fact, the Law Commission has already made a start on this, suggesting a relaxation of the transfer of ownership rules to allow the transfer of crypto-tokens.
The Law Commission has taken a more open-minded approach by focusing on solutions for digital assets, recognizing that innovation may be required if the full range of digital assets and crypto assets are to be considered in the UK legal framework.
Eventually, law reform will be needed to satisfactorily integrate digital assets into a well-established legal position. Although at this time the Law Commission has concluded that no particular legislation should be introduced, it has taken into account the evolution of cryptographic technologies and made significant suggestions to facilitate the natural adoption of digital assets. in common market practice.
Elliot Cowan is a Partner and Mumuksha Singh a Senior Partner in the CMS Enterprise Team