‘Third category thing’ — untangling digital asset property law in England and Wales – Crypto News

Imagine if your car was stolen. Or your watch, a guitar, your pet hamster, or anything else in your possession that you value. You could go to the police to report it missing. You might not get it back, but at least no one would question the validity of your claim to ownership.

The same goes for debt. It may not exist as something solid like that guitar in your hands. But it still exists and there are ways built into law guaranteeing you what you are owed.

So how about a digital asset such as a cryptocurrency or a non-fungible token (NFT)? Without a strong legal and regulatory framework in place guaranteeing possession, is it really yours?

Of course, you might answer. You paid for it. It’s yours. But in truth, digital assets generally do not constitute personal property in the laws of many countries.

In July 2022, the Law Commission for England and Wales — an independent legal advisory body to the U.K. government — began work on a report into digital assets. Its mandate, as defined by the government, was to recommend reforms to existing laws “in a way which allows the possibilities of this type of technology to flourish.”

The Law Commission’s digital asset project team, led by former Oxford University law professor Sarah Green, published its recommendations on June 28 this year. It concluded that digital assets, falling outside the two traditional categories of personal property, should form their own sub-group as a “third category thing.” 

Following the passage through parliament of the Financial Services and Markets Act (FSMA) on June 19 — a comprehensive bill allowing regulators increased oversight over digital assets, among other measures — the report provided the second thrust in a double-pronged breakthrough for the U.K.’s logjammed crypto conversation.

Green spoke to Forkast editor Will Fee about the legal theories behind the Law Commission report, breaking down the reasoning for categorization of digital assets as a separate “third category thing” for personal property. 

The Q&A has been edited for clarity and length.

Will Fee: The Law Commission’s digital assets report focuses on establishing a legal basis for the asset class as personal property. Why is the issue of personal property rights so central to the ongoing digital asset debate?

Sarah Green: What’s really interesting about property rights in this area is that, if you’re not a lawyer or you haven’t had reason to think about the legal implications, then it might be a strange question to ask. And that’s because fundamentally it really isn’t clear that, as a matter of the law of England and Wales, these digital assets can in fact be somebody’s property. Which is a pretty scary thing for somebody to realize if they’ve just invested a huge amount of money — or even any amount of money — in these assets. 

But that is still arguably the case to some extent. If you don’t have a property right in something as a matter of law, then the point is that it isn’t protected in the way that one would assume one’s property rights would be. If you lose it, if it gets taken from you in some way, if you don’t have a property right, you can’t necessarily get the law to help you out when things go wrong.

Fee: The Law Commission report concludes that the current legal framework in England and Wales is flexible enough to cope with any legal challenges posed by digital assets. Why is that?

Green: One of the main legal challenges in this area is that the technology changes a lot — sometimes slightly, sometimes quite dramatically. And that obviously can have knock on effects for how the law should treat it. If you’re going to put something in a statute you’d need an act of parliament — a digital assets act. That provides a huge amount of certainty on the one hand, because it sets out a list of rules and a list of conditions. But it also takes a long time to get through Parliament. That can be a number of years depending on all sorts of other conditions. But once it’s there, it sort of ossifies the setup and the framework and the rules. 

Whereas, if you use the common law — a judge in a court making informed decisions based on established precedent — that of course can change. It can be a lot more nimble and agile. It’s sensitive to really quite subtle differences between different technologies, platforms and protocols. It can just mold to those different requirements in a way that statute law can’t. And actually English law is very used to doing that. It’s one of its great strengths and it’s what it is known for. So that’s a particular sort of appeal of the law of England and Wales for people who are transacting with digital assets.

Fee: The report goes on to say that, despite that flexibility, there remains residual legal uncertainty and complexity. Where do those concerns lie?

Green: Despite what I’ve just said, there are parts of the law of England and Wales which do require and have been bolstered by statutory intervention. There are specific rules that have arisen for protection in specific areas. For example if you want to use your digital assets as collateral. And obviously once you start doing that, there need to be protections in place. 

So it’s not as easy in those situations for the common law just to step in and mold around those protections. The common law actually can’t prevail over a statutory rule. So that’s a particular area where it’s clear that, if we were to adapt to using digital assets in that way, parliament would need to intervene and update those rules. 

So obviously, to some extent what we’ve done here is said to the judges and the common law courts: ‘Right, over to you. You need to develop these rules.’ And of course not every judge in that situation is going to have a strong grasp of what this technology is and how, in fact, those legal principles can be developed to accommodate them. So what we suggest in the report is to set up a panel of legal and technological experts who can provide ongoing factual guidance to say to a court ‘this is what control looks like’ in relation to a particular digital asset. 

So to use NFTs as a very commonly known digital asset in the current environment, the panel would show a judge: ‘This is how you control an NFT. This is what the technology allows you to do. This is how you can acquire it, maintain it, transfer it, destroy it — whatever it is that someone might want to do.’ And it’s that sort of factual information that courts need in order to adapt the legal principles appropriately.

Fee: The report says that certain digital assets, including crypto tokens, are a category of personal property distinct from other things that can be owned. Why don’t digital assets fit into existing categories of common law? 

Green: This to me is one of the most interesting questions of the whole thing. Why are we even given this project when actually the common law of England and Wales has developed over centuries to deal with lots of new things? Why are we now intervening? 

Well, the amazing thing about digital assets is that until now, personal property has been divided into two categories: things in action or things in possession. The difference being that if something is a thing in possession, you can hold it. That applies to obvious things like a pen or a watch or a bag of gold or even something like a horse — although maybe you can’t hold a horse, but you know what I mean. 

And so there are things in possession and there are what’s referred to as things in action. Now, those things in action only exist because they can be enforced at law. So the obvious example is a debt. It’s intangible. You can’t see it, hold it, touch it, but you nonetheless want a property right in it because you want it to be protected. So you’ve got that dichotomy. But digital assets don’t really fit in either of those two categories. And until relatively recently, the idea always was that if you didn’t get a thing within those two categories, it couldn’t be property. 

Fee: Given that lack of fit, the report recommends creating a ‘third category thing’ for digital assets in personal property law. What would that look like?

Green: The first thing you have to ask yourself is, why do digital assets not quite fit in either of the existing categories? Well, I suppose the easiest thing to start with is you. You can’t perceive a digital asset with the unaided senses. You can’t hold them and touch them in the way that you can with a pen or a laptop. But actually they’re not things in action either because they do have an existence in the world. So what we use in the report is an idea known as independence of persons in the legal system. That states that without a legal system and without anyone to lay claim to a debt, it doesn’t exist. 

Of course, you can’t say that about a horse. But a digital asset is the same in that sense. You might not be able to perceive it with the unaided senses, but it does have an existence in the world. If we didn’t have people, if we didn’t have a legal system, that digital asset would remain. And so it has that independence and it has that total transferability. 

In all these questions of tangibility — is it tangible? Is it not tangible? — digital assets sit somewhere in the middle. What we could have done in the report is say these things are more like things in possession, so let’s just treat them in the same way as we treat pens and laptops. But actually that’s probably not the cleanest way of doing it, particularly given all the historical baggage involved in establishing private property law. 

So we actually just came to the conclusion that it would be cleaner to say that digital assets are quite distinct, or what lawyers would call sui generis — as in they have their own rules. And, you know, why not? We’re definitely at a point now where we can consider DLT (distributed ledger technology) a real technological seachange. So why not have a legal seachange to match it? That’s really where we ended up.

Fee: Finally, now that the report is out there, what kind of timeframe are you looking at for your recommendations to be put into practice? 

Green: Our consultation paper, which preceded the report, has already been mentioned in several cases and referred to by judges. So in that sense, it’s already happening and hopefully that will continue to happen. As I mentioned,  common law can be very agile and can get to work on our proposals and recommendations straight away. 

I’m fairly optimistic that within 12 months we could have an expert panel that could produce the recommended guidance. But the statutory reform that we refer to would take a bit longer given the convoluted nature of the parliamentary process and how supreme something is once it’s on the statute books. 

Of course the government also has a lot of work to do in parliament and there’s a lot of congestion. So I think we’re looking at something like a five year plan. But, ultimately, we need to capitalize on this soon because now is a very auspicious time.