The Law Commission’s final report on Digital Assets (Report) released in June 2023 has underscored how the private law of England and Wales remains a dynamic, flexible tool to recognise rights in token based digital assets to give a high degree of legal certainty to markets and participants. While the common law has all but confirmed that certain digital assets can be afforded the same treatment as personal property, there remains “highly nuanced and complex” areas of uncertainty that can be addressed through statute, law reform and further development of the common law.

A key recommendation in the Report is to recognise by statute that a thing that is neither a (1) thing in action or (2) thing in possession can be personal property (being “Third Category” personal property). While Third Category personal property is already recognised under common law, this would be a timely update to the traditional personal property dichotomy of things in action and things in possession. Legislative confirmation of Third Category personal property would help also provide greater legal certainty and foster further common law development from a clear conceptual foundation by shifting focus to considering substantive issues regarding the relevant digital assets.

The Report also makes a number of other recommendations, including:

• Creating a panel comprised of crypto token experts, technical experts, lawyers, academics and judges to provide non-binding guidance on the further development of the common law.
• Clarifying whether crypto tokens can satisfy the definition of cash or money under the Financial Collateral Arrangements Regulations.
• Confirming the validity and use of crypto tokens for issuing and transferring equity and other corporate securities.
• Creating a multi-disciplinary project to create framework for regulating the enforcement and operation of certain cryptoasset collateral arrangements.

The ongoing role of the common law

The Report recommends that rather than defining the boundaries of Third Category personal property in statute, the common law is better suited to consider whether a particular digital asset could be Third Category personal property on a case-by-case basis.

There’s much to be said for the recognition of cryptoassets by English courts through incremental development of the common law: certain crypto tokens like Bitcoin are already capable of being personal property;[1] a resident claimant regarding their rights in crypto token has jurisdiction to bring a claim;[2] service via NFT is valid;[3] and the bona fide purchaser defence also applies to purchasers of cryptoassets.[4] The Report concludes that the common law is sufficiently flexible, dynamic and resilient to continue evolving to accommodate digital assets.

Specific areas that the Report concludes are best left for further development by the common law affecting digital assets include:

• Specific and discrete principles of tortious liability to address wrongful interferences with Third Category personal property.
• How crypto-token intermediated holding arrangements can be recognised where underlying entitlements are held on a consolidated unallocated basis and potentially commingled with unallocated entitlements, whether as trusts or as control-based proprietary interests subject to superior title retained by users.
• Recognising the defence of bona fide purchaser for value without notice for Third Category personal property.
• Applying mistake, misrepresentation, duress and undue influence, and the principles applicable to void contracts, to contracts involving Third Category personal property in the same way as they apply to contracts regarding other personal property.
• Applying principles relating to breach of trust, fiduciary duty and equity to arrangements involving Third Category personal property in the same way as they apply to arrangements involving other personal property.
• Developing a specific common law principle in place of proprietary restitution, restitution for unjust enrichment or conversion if a defendant burns a claimant’s crypto token, as a claim for restitution would not succeed due to the crypto token being removed from the system and the tort of conversion only being available for things in possession (which a crypto token as Third Category personal property is not).

See also our previous article exploring the potential for the common law to recognise fiduciary and tortious duties owed by blockchain protocol developers to crypto token owners.[5]

What digital assets are capable of giving rise to personal property rights?

Digital assets encompass a wide array of things, including digital files, records, email accounts, domain names, in-game digital assets, as well as cryptoassets and crypto-tokens. The nature and features of each digital asset, the technology used to create and sustain them, and their purpose or use cases, is just as varied.

The rapid pace of technological developments and the widespread use and adoption of digital assets has seen many cases brought before the courts by claimants seeking to enforce rights and obtain remedies on the basis of personal property rights existing in a particular digital asset. Whether digital assets can be treated as personal property in the traditional sense can be problematic:

• It is not tangible, so cannot be categorised as a thing in possession.
• It may not necessarily just consist of a legal right or claim enforceable against a person by action and can exist or be used regardless of their legal enforceability, so cannot be categorised as a thing in action.

The common law, particularly over the past 10 years, has however explicitly recognised Third Category things to which personal property rights can relate.

Whether a particular digital asset can be considered as Third Category personal property is a complex and dynamic question highly dependent on what the actual digital asset consists of.

According to case law and as restated in the Report, crypto tokens manifested by distributed, public, permissionless systems clearly meet the indicia of Third Category personal property:

1. It exists independently of persons and the legal system. Crypto tokens like Bitcoin and Ether can be used and enjoyed independent from any rights or claims enforceable by action in relation to them.
2. It is rivalrous. Something is rivalrous if its consumption or use by one prejudices the use or consumption of that thing by anyone else. Whether a thing is rivalrous is binary rather than a question of degree (such that could apply to exclusivity of control or excludability). This is the key indicia that would distinguish a digital asset capable of being Third Category personal property from other digital assets. For example, a crypto token system ensures that any notional quantity unit is rivalrous by ensuring that it cannot be double spent by consensus mechanism regarding state and state transitions. By contrast, a digital file existing on a hard drive would not be rivalrous.

To apply this to digital assets considered at common law and in the Report:

In-game digital assets (for example, a sword that may be used by a character within an RPG) typically exist through a combination of software, enabling infrastructure (e.g. servers, networks, connectivity) and IP licence rights allowing its use and interaction within a game ecosystem, which on this construction would not meet the rivalrous nor independent legal existence indicia. However, it’s possible that some in-game digital assets could, such as NFT-based digital objects that do not exist as mere legal relationships.

Legal status of crypto token transfers

The Report concludes that the legal proprietary interest in a crypto token can be legally transferred:

1. Onchain through a transfer operation and state change; or
2. Offchain by a change of control (with the requisite intention).

On the first limb, the Report provides welcome guidance on defining key foundational concepts regulating the onchain transfer of crypto tokens:

• Crypto systems such as Bitcoin and Ethereum can be described as a “state transition system” where a “state” is the ownership status of all notional units of account across all objects/accounts within the system and a “state transition function” that outputs a new state based on the total of all transactions that occur between objects/accounts within the system.
• “Onchain” transfer of a crypto token occurs when data recorded on the distributed ledger is validly modified by a transfer operation in accordance with the governing protocol, resulting in the crypto token being associated with a receiving public key address.
• A transfer operation typically involves: (a) replacing, modifying, destroying or eliminating (often called “burning”) a “pre-transfer crypto token”; (b) the creation of a new, modified or causally-related crypto token (“post-transfer crypto token”) subject to technical encumbrances that amount to a change of control between the pre-transfer crypto token and the post-transfer crypto token; and (c) resulting in a state change to the distributed ledger.

When applying this to the Third Party personal property and analysing the legal consequences of an onchain transfer, two views emerge:

1. Extinction/creation: A transfer operation and resulting state change extinguishes the pre-transfer crypto token and creates a new post-transfer crypto token. The rules of the crypto token system ensure that the pre-transfer crypto token is extinguished then recreated in the post-transfer crypto token. This is a core principle at blockchain level to avoid double spend.
2. Persistent thing: The crypto token the object of personal property rights persists through the transfer operation and state change. This is a core principle at system level that tracks and records notional quantity units as they flow through the system.

The Report concludes a number of arguments in favour of the persistent thing approach, including that users tend to treat transfers of their crypto tokens this way.

We’ll be further exploring the recommendations of the Report and implications for additional reforms for the recognition of arrangements involving crypto tokens in upcoming articles.

We frequently advise clients on potential legal, regulatory and commercial issues at the forefront of converging technologies in the technology sector, including blockchain involving arrangements, Web3 and AI-driven services. Get in touch if you’d like to have a further discussion about your project and we’d be delighted to assist.

[1] AA v Persons Unknown [2019] EWHC 3556 (Comm), which has been cited by over a dozen cases since including the Court of Appeal to support the conclusion that a particular digital asset is capable of being personal property

[2] Tulip Trading v Van Der Laan [2023] EWCA Civ 83.

[3] D’Aloia v Persons Unknown [2022] EWHC 1723 (Ch).

[4] Piroozzadeh v Persons Unknown [2023] EWHC 1024 (Ch).

[5] Tulip Trading v Van Der Laan [2023] EWCA Civ 83.

[6] Swift v Dairywise (No 1) [2000] 1 WLR 1177.

[7] Armstrong DLW GmbH v Winnington Networks Ltd [2012] EWHC 10 (Ch).

[8] A-G of Hong Kong v Chan Nai-Keung [1987] 1 WLR 1339.

[9] Re Celtic Extraction Ltd [2001] Ch 475.

[10] AA v Persons Unknown [2019] EWHC 3556 (Comm), which has been cited by over a dozen cases since including the Court of Appeal to support the conclusion that a particular digital asset is capable of being personal property