In his foreword to the consultation paper that preceded the Legal Statement,1 the Chancellor of the High Court, Sir Geoffrey Vos, stated that in his view, “[s]mart contracts will only finally take off when market participants and investors have confidence in them” and that “the LawTech Delivery Panel believes that perceived legal uncertainty is the reason for some lack of confidence.” Although the Legal Statement is not binding on English courts, it is intended to offer some clarity to the market in the absence of any judicial decisions on these matters to date.
The conclusions set out in the Legal Statement are of general application and will have relevance in a broad range of legal contexts. By way of a summary, the Legal Statement’s conclusions include the following:
- Cryptoassets can be treated as property in certain circumstances (and are not mere information).
- Cryptoassets cannot be physically possessed, so they cannot be the object of a bailment, and only some types of security can be granted over them.
- Cryptoassets are not documents of title, documentary intangibles or negotiable instruments, nor are they instruments under the UK Bills of Exchange Act nor goods under the UK Sale of Goods Act.
- In the absence of a statute giving binding legal effect to a distributed ledger as a register, in assessing competing claims to a cryptoasset, a court will not be bound by the position in the ledger and would take account of all relevant facts.
- New legislation will likely be required to deal with conflicts of laws issues in the context of a truly decentralized system.
- A smart contract is capable of satisfying the requirements of a legal contract under English law and can therefore have contractual force, including enforcement thereof through the courts.
- In principle, a statutory “signature” requirement can be met by using a private key intended to authenticate a document, and a statutory “in writing” requirement can be met in the case of a smart contract whose code element is recorded in source code.
Distributed ledger and blockchain-based projects are being launched in a wide range of different industries, from retail consumer goods to pharmaceuticals and electricity and power networks to global shipping. However, because of the potential to facilitate near-instant messaging, clearing and settlement, blockchain and cryptoassets have a particularly promising potential in a financial services context.
The conclusions in the Legal Statement are useful to financial services firms and to those developing new applications for financial services. As a form of property, cryptoassets could be subject to a legally enforceable2 trust arrangement or form the basis of a legally enforceable security interest (albeit only by way of mortgage or equitable charge).3 In addition, the Legal Statement recognizes that legal transfers of a cryptoasset can be effected through on-chain transfers, without having to have a separate off-chain agreement.4
The Legal Statement also equates control of a private key with effective ownership of a cryptoasset; however, it notes that the rules of a particular system may qualify this. For firms investing, holding or managing clients’ funds in cryptoassets, this emphasizes the importance of having effective arrangements in place to safeguard private keys. A number of providers have already received regulatory authorizations to offer custody services to institutional clients, including Fidelity and Coinbase Custody.
That the Legal Statement recognizes that smart contracts can have legal force is perhaps not that surprising when one considers that English law does not typically require contracts to be in any particular legal form.5 The consequences of this are important, however. The Legal Statement notes that, notwithstanding the characteristic “automaticity” of a smart contract, “there will always be the risk that performance is affected by an event external to the code, for example a system failure, or that the code operates in an unexpected or unintended way, and in such cases any dispute must be capable of adjudication.”6 In such cases, the ordinary rules of English contract law would apply. Disputes regarding smart contracts consisting solely of code (as opposed to a smart contract incorporating natural language and the use of so-called legal markup language)7 will therefore generally need to have regard to extrinsic evidence when applying contract law principles.8 This may provide some reassurance to institutions that are considering the deployment of smart contracts to automate some of their processes, including automation of payouts of cash or collateral represented by (or constituted solely by) on-chain cryptoassets; if something should go wrong, contractual remediation may be possible.
Notwithstanding the helpful clarity offered by the Legal Statement, for financial services firms to “have confidence” in their use of smart contracts and cryptoassets, firms also need to consider the application of financial services rules and the boundaries of the regulatory perimeter. In this respect, 2019 was a productive year for regulators when it came to cryptoassets and blockchain/distributed ledger technology. In July, the UK Financial Conduct Authority (FCA) published a policy statement setting out its “Guidance on Cryptoassets” (PS19/22). The FCA set out a taxonomy for cryptoassets that distinguishes between (i) security tokens (regulated), (ii) electronic-money tokens (regulated) and (iii) unregulated tokens (including utility tokens and exchange tokens, such as bitcoin). 2019 also saw publications by the European Securities and Markets Authority,9 the European Banking Authority,10 the Council of the European Union and the European Commission,11 the International Organization of Securities Commissions12 and the Bank for International Settlements.13
Look out for Sidley’s year-end review of blockchain and cryptoassets regulation, which will be published in the coming weeks.
1 Available at https://www.lawsociety.org.uk/news/stories/cryptoassets-dlt-and-smart-contracts-ukjt-consultation/.
2 The Legal Statement notes that there are technical means by which a cryptoasset could be made subject to a trust-like or security-like arrangement; however “it does not follow that the law will recognise that the security has been created.” See paragraph 105.
3 Legal Statement at paragraph 103.
4 Legal Statement at paragraphs 44-48.
5 Legal Statement at paragraph 137.
6 Legal Statement at paragraph 136.
7 For example, of the type hypothesized by Ian Grigg (i.e., “Ricardian Contracts”). See https://iang.org/papers/ricardian_contract.html.
8 See the discussion at paragraphs 145-148 of the Legal Statement.
9 “ESMA Advice: Initial Coin Offerings and Crypto-Assets,” January 9, 2019. Available to download from https://www.esma.europa.eu/press-news/esma-news/crypto-assets-need-common-eu-wide-approach-ensure-investor-protection.
10 “EBA reports on crypto-assets,” January 9, 2019. Available to download from https://eba.europa.eu/eba-reports-on-crypto-assets.
11 Note from the Presidency to the Council – “Any other business: Stablecoins,” November 6, 2019. Available at https://data.consilium.europa.eu/doc/document/ST-13571-2019-INIT/en/pdf.
12 “Statement on IOSCO study of emerging global stablecoin proposals,” November 4, 2019. Available at https://www.iosco.org/news/pdf/IOSCONEWS550.pdf.
13 BIS – “Statement on crypto-assets,” March 13, 2019. Available at https://www.bis.org/publ/bcbs_nl21.htm.
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