Proposed legal reform regarding digital assets

The recognition and protection of digital assets could be subject to reform. The Law Commission of England and Wales has proposed a number of changes and has asked legal experts, technologists and digital assets users to contribute to a consultation paper.

The Commission’s action is a reflection of the constantly evolving and developing digital asset environment, which includes the likes of cryptocurrency and NFTs.

The Law Commission acknowledges the increasingly important role of digital assets in the modern world. As a result, it believes certain changes to legislation are required to ensure the protection and recognition of such assets, maximise their potential and protect the rights of those who use them.

Data Objects

The Law Commission’s main recommendation is the creation of a category of personal property that would be in addition to the traditional concepts of things in possession (any object that the law considers capable of possession) and things in action (rights asserted by taking legal action or proceedings, such as shares in a company). The Law Commission has stated that digital assets do not fit neatly into either of the existing common law categories – so it is proposing the new category of data objects.

In order to be classed as a data object, the Law Commission proposes that something must:

1. Be composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals.
2. Exist independently of persons and of the legal system.
3. Be "rivalrous" - meaning that the use of the resource by one person necessarily prejudices the ability of others to make equivalent use of it at the same time.

Transfer

Another notable aspect of the Law Commission’s paper is its view on the issue of transfer of data objects. The Law Commission is of the view that the distributed ledger does not necessarily constitute a record of legal title to a crypto token. It believes it is a factual record.

The Commission has provisionally concluded that the current provisions on transfers of a title can also apply to on-chain transactions, even in cases where it results in creation of a new, modified or related crypto token. The Commission’s paper recommends that there should be an explicit clarification that the common law defence of ‘equity’s darling’ should apply to crypto transactions.

Another important issue the Law Commission has considered is collateral agreements in respect of crypto tokens. In recent years we have seen crypto tokens increasingly used as collateral. The Law Commission acknowledges that the use of Financial Collateral Arrangements Regulations - even with respect to established financial markets - can be rather problematic. In its view, two new frameworks could address the issue of collateral agreements in respect of crypto tokens:

1. To cover 'off-chain' crypto token collateral arrangements where the crypto token entitlements are represented by traditional book entries in a register.
2. To cover 'on-chain' collateral arrangements that rely on technical features of the network in which the collateral is created.
3. The consultation closes on 4th November 2022.