By Timothy Chan
While cryptoassets have generally been accepted as a form of property in Commonwealth jurisdictions, it remains unclear how specific property rules apply. What is required for title to a cryptoasset to be legally transferred? Is a blockchain transaction necessary or sufficient for that purpose? If a transaction is unauthorised or procured by fraud, when (if ever) do subsequent purchasers take free of the original owner’s title? These questions are relevant, for example, to proprietary disputes in crypto litigation and the structuring of secured crypto-finance arrangements.
To get to the bottom of these questions, two foundational issues must be considered. First, what is the subject-matter of the property right? And second, what is the effect at law of a blockchain transaction? Despite their apparent simplicity, no clear answers have emerged. In a recent paper ‘The Nature of Property in Cryptoassets’ published in Legal Studies, Iexamine some existing views, propose a potential approach, and consider its implications for title transfer rules relating to cryptoassets.
It is common to encounter descriptions of blockchains as ‘publicly available ledgers’ maintained by a system of ‘nodes’ (see, for example, CLM v CLN [2022] 5 SLR 273 at [10]). How this actually works is that if A wants to send 1 Bitcoin (BTC) to B, A must first send an instruction to the network. The first node to receive the instruction verifies that (i) A’s balance is sufficient; and (ii) A’s signature is valid. The transaction then enters a pool of pending transactions where it awaits inclusion within a new ‘block’ (which requires a miner to solve a complex mathematical problem). Once done, the answer forms part of the blockchain and the transaction is ‘confirmed’. Note that nodes do not undertake an obligation to validate any particular transactions – mining is a self-interested process designed to earn Bitcoin rewards and the process is fundamentally extra-contractual.
When A transfers that BTC to B, what is the subject-matter of the transaction (the ‘res’)? This apparently straightforward question is complicated by the fact that neither a physical ‘thing’ nor a contractual counterparty can be identified. One option, proposed by Professor David Fox and the UK Law Commission, is to conceive of the res as a ‘data string’ or ‘data structure’, insofar as it has the particular functionality of allowing the user to effect transactions on a blockchain network. But it is not clear how such ‘data’ can be identified in account-based systems, such as Ethereum; more importantly, framing data as the res seems inconsistent with the idea of proprietary exclusion, since the data has to be publicly available on the blockchain.
On another view, championed chiefly by Professor Kelvin Low, the res is a legal right of cryptoasset holders to have their cryptoassets ‘locked to their chosen public bitcoin address on the blockchain’. The difficulty is in identifying a legal basis for this right. Moreover, the corresponding duty must be a duty of non-interference, which seems better analysed as an incident of property rather than an item of property itself.
A further alternative, which I propose, invites a return to first principles. Most Commonwealth authorities treat property as some combination of exclusionary control and a power of alienation. What is the ‘thing’ that cryptoasset users seek to exclude others from by protecting their private keys, and ‘transfer’ through blockchain transactions? I suggest that it is a factual ‘transactional ability’ – an ability to effect a blockchain transaction that will be recognised as valid under the relevant consensus algorithm. This conception coheres with the actual expectations of the parties. It also accommodates various types of cryptoassets, both first- and second-layer, and explains various practical aspects of property in cryptoassets, such as what happens when a private key is irretrievably lost.
Suppose we can agree on how to define a cryptoasset. A further question arises: are blockchain transactions true legal ‘transfers’, or are they events by which the original asset is extinguished, and a new asset created (analogous to a novation)? Factually, at least, whether an event is ‘res-transferring’ or ‘res-creating’ depends on the ‘thing’ being transferred. On Professor Fox’s ‘data centric’ view and my view that the res is a transactional ability, the relevant ‘function’ or ‘ability’ is rendered ‘spent’ and extinguished upon each blockchain transaction. On Professor Low’s view that the res is a ‘right to a registry entry’, no such issues arise. But perhaps the question whether a ‘transfer’ has occurred should be treated as a legal rather than a factual question. The best analogy is with chattels which go through a process of manufacture, where the suggested test is whether the raw materials and the product are economically identical. I suggest that this ‘economic identity’ test is suitable for the context of intangibles because they cannot be physically enjoyed, and provides a strong basis to regard blockchain transactions as true ‘transfers’, rather than ‘res-creating’ events.
The foregoing analysis, if accepted, provides principled grounds for extending to cryptoassets existing rules of title transfer which presently apply to chattels. There are two important similarities between the two. First, and most importantly, blockchain transactions as true ‘transfers’ are different from bank transfers, where nemo dat does not apply. Second, control of cryptoassets via a private key is programmed to be both rivalrous and transferable. As Professor Fox has pointed out, this makes such control functionally similar to the possession of tangible assets. A transfer of legal title to cryptoassets therefore probably requires both an intention to transfer and some proxy to delivery (a transfer of the private key itself or, more commonly, a blockchain transaction). Further, where a party purports to transfer a cryptoasset to which he does not have legal title, nemo dat (which is a rule of general application to all legal transfers) should apply.
I believe these considerations provide a robust starting point for an argument that traditional rules of title ought to be applied to cryptoassets by analogy. What is clear is that, if one seeks to properly resolve proprietary disputes over cryptoassets on a principled basis, serious thought needs to be given to the nature of property in cryptoassets.
A version of this blog post was earlier published by the NUS Centre for Banking and Finance Law.
Keywords: Property Law; Law and Technology; Digital Assets; Cryptoassets
AUTHOR INFORMATION
Timothy Chan is a Sheridan Fellow at NUS Law.
Email: chanwxt@nus.edu.sg