Regulating Blockchain
The legal state of play for cryptoassets.
Disclaimer: This article is intended to function as a non-technical overview of the position of cryptoassets within the existing UK legal landscape. I am not a legal expert, and am instead aiming to write this as one curious layman to benefit (hopefully) many others of the same disposition and intrigue regarding Bitcoin SV and cryptocurrency in general.
The 11th anniversary of the first Bitcoin block ever mined — the genesis block — rolled around last week. This marked eleven years since the beginning of a revolution in electronic cash that has gained increasing traction in recent years, despite the chequered history of its development.
In particular, the vision of Satoshi Nakamoto, as laid out in the seminal white paper ‘Bitcoin: a Peer-to-Peer Electronic Cash System’, is beginning to command the attention of legal authorities as it’s continued persistence and proliferation position Bitcoin at the heart of a revolution in micropayments and immutable data.
In the UK, this rise to prominence has attracted particular attention from the Lawtech Delivery Panel (LTDP), which has recently addressed the uncertainties surrounding the maturing cryptocurrency market in a landmark legal statement. The statement, produced by the UK Jurisdiction Taskforce of the LTDP, draws particular, and much needed, attention to the legal status of crypto assets and smart contracts. The Rt Hon Sir Goeffroy Vos, who wrote the foreword for the statement as a key member of the panel, explained the motivations for the statement.
“The objective, of course, is to provide much needed market confidence and a degree of legal certainty as regards English common law in an area that is critical to the successful development and use of cryptoassets and smart contracts in the global financial services industry and beyond.”
— Sir Geoffrey Vos, 18th November 2019
This move to expedite regulatory certainty in the industry is testament to the cementation of cryptocurrency and indeed blockchain technology’s role in the future of global financial services and perhaps more profoundly, signifies a new buttress from which this technology can flourish.
The last decade or so has made clear the Bitcoin, and blockchain technology in general, is certainly here to stay and may rapidly become an integral part of modern society.This is something that the Lawtech Delivery Panel Director, Jenifer Swallow, believes demonstrates the need for common law systems to be adaptable in an era in which technology is fast developing and evolving. Swallow says that:
“The worldwide smart contract market is expected to reach $300m by 2023 and the World Economic Forum predicts 10% of global GDP will be stored on the blockchain by 2027.”
— Jennifer Swallow, 18th November 2019
The long-term success of the technology is predicated on one of the core principles of Bitcoin: the use of a peer to peer network. This means that actors are free to interact with each other without the need for third party assistance and on a system that incentivises honest behaviour across the network.
The peer-to-peer model for financial interactions between people, such as customers and merchants, enabled by blockchain is a significant departure from traditional payment systems such as the Visa network and Paypal. These systems are heavily reliant on trusted intermediaries that can introduce inefficiencies to payments in both time and cost. What the LTDP statement provides is a clarification on the regulatory view of cryptoassets as property in this new peer-to-peer world.
Here’s the legal statement in full:
As the new year has just begun, It’s probably fair to assume that you’ve got better things to do then trawl through a 64-page legal summary.
That’s why I’ve taken the time to comb through the findings of the UK Jurisdiction Taskforce myself and provide you with a summary that (I hope!) will provide at least some clarity.
What is ‘property’ anyway?
When looking at how we attribute the word property to a given asset we should first familiarise ourselves with what is meant by the term property. This is however, a somewhat difficult task given that there is ‘no general or comprehensive definition of property in statute or case law’. That said, it is possible to draw some fundamental characteristics from former high court judge, Lord Wilberforce, who in 1965 stated that:
“Before a right or an interest can be admitted into the category of property, it must be defineable, indentifiable by third parties, capable in its nature of assumption by third parties, and have some degree of permanence or stability”.
— Lord Wilberforce, National Provincial Bank Ltd v Ainsworth, 1965
Fundamentally, at the heart of the ruling above is the characterisation of the relationship between an actor and asset, in the view of the law, as that of ownership. There are, however, a number of other defining qualities that must be considered when determining whether something may be treated as property in a legal sense. These core characteristics of property are delineated in the LTDP statement as the following:
- Definability;
- Certainty (identifiable by third parties);
- Control;
- Exclusivity;
- Assumption by third parties;
- Assignable;
- Permanence; and
- Stability.
In general, it is considered essential for all of the above traits to be observable in something for a legally-meaningful definition of property to be applied to it. We won’t go into detail here about the specific meanings of these properties here, as these are covered at length in the LTDP statement, but what can be said succinctly is that these terms are the effective ‘indicia’ of property, and should be used as such when assessing the interpretation of an asset as property.
However, that’s not where the requirements end! We also need to take into account whether the asset in question falls into one of the two traditionally-recognised categories of possession: things in possession and things in action. To add further complexity, there is precedent for the disqualification of something being considered property as pure information.
So, how do these factors affect the view of Bitcoin and cryptoassets as legally-meaningful property?
What does this mean for crypto assets?
Well, to cut a long story short, the statement concludes that crypto assets “have all the legal indicia of property and are, as a matter of English legal principle to be treated as property”. This should come as no surprise given that crypto assets are often intended to represent or are linked to conventional assets, often termed off-chain or tethered assets, which we would of course consider to be property. The trouble has been deciphering whether there is a difference significant enough to warrant a legal distinction between the two manifestations of assets.
The report goes into copious detail as to specifically why it is appropriate for cryptoassets to be treated as property in UK law, but it is perhaps most interesting to highlight that the features of blockchain technology so often touted as its most ‘novel’ aspects, should pose no issue to the law in treating cryptoassets as property. In other words, such properties as “intangibility, cryptographic authentication, use of a distributed transaction ledger, decentralisation, rule by consensus”, while key to blockchain systems themselves, do not put these systems above or at odds with the law.
“Strictly, the term property does not describe a thing itself but a legal relationship with a thing: it is a way of describing a power recognised in law as permissibly exercised over the thing.”
As such, and in conjunction with the view that crypto assets do indeed exhibit all of the key characteristics of property, it follows that crypto assets, be treated in much the same manner. This does not mean to say that in every case crypto assets will be treated as conventional/physical assets, but it does however provide some form of initial guidance in navigating the legalities of blockchain Thus, we can view crypto assets as intangible property that carry value in much the same way a conventional asset might, differing principally in how that value manifests, yet importantly, maintains the same axiological characteristics.
But what of the other considerations? Well, the classification of cryptoassets as either ‘things in possession’ or ‘things in action’ is not so straightforward. The idea of cryptoassets qualifying as things in possession if trivially dismissed given the fact that “[they are] not tangible and so cannot be possessed”. However, the statement is clear to point out that the concept that cryptoassets can be considered things in action is “more debatable” and a little muddier.
When broaching this aspect, the statement leans on a long-held sentiment regarding the UK legal system, which was expressed in the paper’s introduction:
“endlessly creative … a living law, built on what has gone before, but open to constant renewal”
— Sir John Laws, The Common Law Constitution, Hamlyn Lectures
In other words, the statement posits that a “cryptoasset might not be a thing in action on the narrower definition”, but that in the context of multiple preceding cases and within the framework of a continuously adaptable legal system, this should not disqualify cryptoassets from treatment as property.
Finally, we must consider whether the argument that Bitcoin, and other crypto assets, may be exempted from treatment as property due to only constituting ‘information’. It is pleasing to see that the LTDP does not take such a view. In fact, the statement uses an interesting definition of a cryptoasset that sees them as a “conglomeration of public data, private key and system rules”, rather than merely the ‘private key’ that underpins the control of a cryptoasset.
The statement makes it clear that, in the panel’s view, cryptoassets are not precluded from consideration as property “on the ground that they constitute information”. Thus, we have reached a powerful conclusion that we may reasonably treat them as such.
Not your keys, not your Bitcoin?
The last few paragraphs touched on an interesting theme that is starkly at odds with one of the most popular memes in the cryptocurrency space.
“Not your keys, not your Bitcoin!”
— 99% of crypto commentators
This oft-parroted concept has become one of the central tenets of most discussion on Bitcoin and other cryptoassets, leaning heavily on a widely-held disposition in some circles that the system invented by Satoshi Nakamoto was purely about individual financial self-sovereignty and freedom.
However, this narrative has been increasingly challenged in recent years as the space has begun to mature and professionalise, and as the legal realities of the Bitcoin system have started to materialise. In particular, Dr. Craig Wright, an influential figure in Bitcoin, has been outspoken in his views about what constitutes legal possession and ownership of cryptoassets.
Private keys make access to funds difficult. They don’t prove ownership of property rights, which never was the intention of Bitcoin.
— Dr. Craig Wright, 20/08/2019
This interpretation of the nature of blockchain and cryptoassets recognises the same distinction made by the LTDP between the amalgam of public data, private key and system rules that constitute a cryptoasset, rather than a private key in its own right. Moreover, the simple analogy of home ownership can be used to demonstrate that this perspective is quite logical and indeed intuitive to the average user. If one loses their house key, they have not lost legal ownership of their home, and so too is the case for cryptoassets and their constituent private keys.
This perspective is well-aligned with the LTDP statement, which reiterates the point that a private key only “confers practical control over the asset” and moreover that “a person who has obtained a private key unlawfully, e.g. through hacking, could not be treated as the lawful owner”.
In essence, the LTDP display a rather progressive view of cryptoassets and their private keys, treating the former as having legal status as articles of property and the latter as mere information that can be used to enact practical control of ownership of those assets.
How does the law apply to smart contracts?
Well, in the case of smart contracts, distributed ledger technology (DLT) is widely considered to be significant for two principal reasons:
- Immutability; and
- Distributed network.
Firstly, it is pretty clear why immutability might be of importance when addressing the terms of a contract. Here, immutability prevents the ability for anyone, third party or otherwise, from interfering and changing the terms of the contract. Secondly, the fact that these smart contracts are stored on a distributed network means that the output of a given contract is validated by everyone that secures the network (i.e. the ‘miners’) and consequently the ability to doctor a contract becomes as good as impossible.
The significance of these two principles means that the outputs of any contract can be carried out automatically when the terms of the contract have been met. This, then, mitigates the need of third party intervention in the authorisation of transactions and, perhaps more importantly, removes the dependance of both actors trusting that a third party will act honestly.
These core principles are also notable in that they create a layer of accountability that forms as a result of the automatic mechanism that smart contracts employ. Given that smart contracts can allocate funds following the satisfaction of contract requisites, it follows that funds can thus be reversed, or taken back, under the condition that any actor falters on the agreed terms, which can be encoded as part of smart contract code in Bitcoin.
Clearly, this added layer of accountability incentivises a more profound degree of honesty in contractual agreements, mitigating the opportunities to exploit the market. Thus, we can view smart contracts in much the same way we do physical contracts: legally binding, yet notably, equipped with a modern armoury to keep up with the challenges that come with technological advancement.
This sentiment forms a core part of the UKJT legal statement on the status of cryptoassets and smart contracts under English and Welsh law which aims to provide a foundation for their responsible future utilisation.
Code is law…?
A final point to consider with respect to the legal view on smart contracts is, sadly once more, a highly popularised view that seems to contradict the viewpoints of established legal institutions: that ‘code is law’.
In a nutshell, this mantra of many in the blockchain space is used to naively imply that an electronic ‘smart’ contract, expressed in executable contract code, should be treated as tantamount to law in a blockchain system.
This, of course, is a flawed view.
The idea of “blockchain law” is a radically interdisciplinary legal area, and the question of whether tokens are securities is only the beginning.
The realm of contracts — jurisdictio ex contractu — is a messy place that runs conceptually counter to many of the principles and ideals of the smart contract.
—
, Blockchain Law: A Pedagogical Vantage Point,02/05/2020This article is well worth a read, and it highlights the need for modern tech companies, cryptocurrency-related startups in particular, to hire legal experts to ensure that their products act within the law.
The take home message here is that the blockchain industry, and cryptoassets utilising smart contracts in general, are naturally no more immune to the law than any industry, and rightly so. As is made clear in the LTDP statement,
“In no circumstances therefore are there simply no legal rules which apply.”
Is this the whole story?
The statement from the LTDP views blockchain and native crypto assets largely through the lens of simple payments and the use case of exchange.
To approach the topic with this perspective is quite natural, and betrays the many of the popular narratives that have surrounded Bitcoin since its inception in 2008. However, the views laid out by the panel may in fact be only the first step of a longer journey toward a full regulatory understanding of the blockchain.
HMRC does not consider cryptoassets to be currency or money.
— Cryptoassets: tax for individuals, 20/12/2019
In the governmental policy paper on the taxation of cryptoassets, most recently updated in December, it is made abundantly clear that, as far as HMRC is currently concerned, Bitcoin does not qualify as a ‘money’ of any kind. Instead, the UK classification of Bitcoin is that of an exchange token.
To contextualise this, the paper broadly defines three classes of token:
- Exchange tokens — these are to be used as a means of payment but do not provide access to or rights over goods and services.
- Utility tokens — these provide access to goods and services on a particular platform, whereby the utility tokens can be accepted as payment for those goods and services.
- Security tokens — these provide the holder with interests in a business, such as shares or profits.
At first glance one would be forgiven for thinking that the current HMRC classification of Bitcoin as an exchange token is entirely appropriate. In general, Bitcoin tokens are typically used as a means of payment and peer-to-peer exchange between willing participants, but do not ostensibly grant access or rights to goods and services on their own, to the untrained eye at least.
However, as Deryk Makgill writes, this classification seems to fly in the face of the original vision for Bitcoin, and the purposes for which its inventor created the system.
Satoshi wrote he believed Bitcoin would bootstrap because it had utility and defined its earliest uses in an email on the Cryptography Mailing List as a utility token, not a collectible.
—
, 02/01/2020The emphasis of Bitcoin, and its raison d’etre, was always in its utility as an electronic cash system. This is probably evidenced most convincingly in the Nakamoto white paper that birthed the technology, and we need only take a cursory glance at its title — Bitcoin: a peer-to-peer electronic cash system — to remind ourselves of that fact. Bitcoin was always designed to be a sound monetary system that would enable micropayments and replace the trust in intermediaries that is required in contemporary payment systems.
A subtle caveat to this is that ‘Bitcoin’ is a system, rather than just a crypto asset. That system does of course include a cryptoasset, the Bitcoin tokens themselves, but it also comprises something else — a ledger. The fact that Bitcoin is more than just the native token is where the present regulatory view of Bitcoin, as expressed by HMRC and in part by the LTDP, is limited.
The interplay between these components of the system, the tokens and the ledger that keeps an unalterable record of them, is where there is a strong argument to reframe the regulatory perspective on Bitcoin. The ledger is the component of the system commonly termed the ‘blockchain’, simply because it is itself made up of many discrete blocks of data that are cryptographically linked in a sequence (or ‘chain’), with a new block being appended to the chain every 10 minutes on average.
However we stated above that each of these blocks is discrete, meaning that each will be distinct from one another and each of a particular variable size. The size of a block is effectively a proxy measure of how many people can use Bitcoin at once, and the size of a given block is largely dependent on two factors, measured at the time at which the block is created:
- The demand for block space i.e. how many people want to use Bitcoin at that time; and
- The processing capacity of the mining network.
Both of these factors are clearly economic in nature. The former is subject to, in a simplified sense, basic supply and demand economics, while the latter is subject to mining costs as well as the total fees paid by users of Bitcoin to the miners. The graphic below demonstrates the variation in block size between the three major competing forks of Bitcoin:
For the purposes of this discussion, however, it suffices to say that the block space is an economic commodity, and the Bitcoin tokens can be treated as a utility token that can grant the holder access to the commodity that is economically scarce block space, and the computation required in the Bitcoin mining network to access that block space.
This is perhaps best put by Dr. Wright, where he highlights this profoundly:
[Bitcoin] is money. It is a ledger, and it is commodity money based on use … The commodity that defines Bitcoin is the transaction ledger space and computation.
— Dr. Craig Wright, 12/12/2018
So, with this reformulated perspective on Bitcoin as a monetary system that uses utility tokens to pay for access to goods and services that are part and parcel of the Bitcoin network and ledger, then we come to a slightly different conclusion. The realisation that Bitcoin is not actually a ‘new’ type of money, but is indeed just an example of a ‘commodity money’, for which there is historical and legal precedent.
That is the purpose of Bitcoin, a utility token without the middlemen.
— Dr. Craig Wright, 28/10/2018
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