The vision of a truly digitised commodity trading system, where paper documents are relegated to waste paper bin of history, has been tantalisingly held out to the industry since technologies such as blockchain, cryptoassets and smart contracts began to show their true potential. But the law has lagged somewhat behind the technology, with uncertainty as to the legal status of cryptoassets and smart contracts being one of the significant barriers to their mainstream adoption.
Importantly, given the prevalence of English law documents in international commerce, there has just been helpful clarification of the status of cryptoassets and smart contracts under English law by the UK Jurisdiction Taskforce (UKJT), part of the LawTech Delivery Panel of senior solicitors and barristers headed by Chancellor of the High Court, Sir Geoffrey Vos. The UKJT's "Legal Statement", whilst not binding authority, is a persuasive opinion on the novel areas of law thrown up by these new technologies, which will go some way to clarifying uncertainty. But it is clear that further legislative action is required to really take advantage of the opportunities presented by these technological advances.
The Legal Statement provides clarity on whether cryptoassets – assets that are defined by their intangibility, cryptographic authentication, use of a distributed ledger, decentralisation and rule by consensus – can be considered as "property" under English law. This is important because it determines other legal principles: if cryptoassets can be property it means that they can be owned, which gives rise to important proprietary rights that can be recognised against the whole world. It also determines issues such as the rights of liquidators in insolvency.
The Panel's view was that cryptoassets can in principle be property, on the basis that they all have the characteristics of property under the English authorities – including being definable, identifiable by third parties, capable of assumption by third parties and having some degree of permanence or stability. Moreover, none of their unique properties - such as intangibility or the use of decentralised ledgers - disqualify them from being considered property.
Of course, the type of cryptoasset that is of most interest to the commodity industry is one that purports to be an electronic document of title: an intangible representation of a physical asset external to the system. That might be, for example, e-bill of lading on a blockchain. Under English law a document of title is a class of document which confers property ownership rights on the holder, where ownership rights pass with possession of the document. A document may become a document of title as a result of statute (as with a bill of lading) or by established mercantile usage.
In the Panel's view, whilst qualifying as property, cryptoassets are not tangible documents capable of being physically possessed, and so cannot as a matter of law be documents of title.
This is not a radically new conclusion, although it is helpful that the Panel has confirmed their status. However, interestingly, the Panel believes that with the proliferation of electronic documents, the law will come to recognise electronic documents as documents of title as the old categories of documents decline or are fundamentally redefined by the process of "dematerialisation occurs" - the substitution of paper form documents by registers. That would, in the case of e-bills, require statutory changes, perhaps by the adoption of legislation such as the UNCITRAL Model Law on Electronic Transferable Records (MLETR). This provides for the recognition of electronic records where the electronic record contains all of information required in, say, a bill of lading and where a reliable method is used to maintain integrity of the record and subject it to control during its life cycle.
The Legal Statement also examines smart contracts, starting from the position of identifying the legally novel or distinctive features of these contracts. Smart contracts have excited the industry because of their capacity to self-execute upon the occurrence of pre-agreed actions. When combined with truly electronic documents of title, such as e-bills, they could provide for functionality such as the automatic transfer of title upon payment of agreed sums. However, there has been some doubt as to the legal enforceability of smart contracts.
The characteristic feature of a smart contract is automaticity: it is performed automatically and without the need for human intervention. That requires the terms of the contract to be recorded in code. Many smart contracts are embedded in a networked system that uses the same techniques as cryptoassets (i.e. cryptographic authentication, distributed ledgers, decentralisation, consensus) discussed above. In the Panel's view, a smart contract was just as capable of satisfying the formal requirement for agreement, an intention to create a legal relationship and consideration as a traditional or natural language contract was, and that a smart contract was, therefore, capable of having contractual force.
The Panel considered whether automaticity amounted to a good reason for treating smart contracts as different in principle from conventional contracts and concluded that it did not. In doing so, the panel acknowledged that the scope for legal intervention in smart contracts may be reduced, because the automaticity of smart contracts and the manner in which computer code operates should mean that there is strictly no need for a party either to promise performance or to resort to the law to enforce a promise by their counterparty: the code will simply do what it has been programmed to do.
However, the Panel was of the view that the risk that performance of the contract is affected by an event external to the code, such as a system failure, or that the code may behave in an unexpected way still remained, and it was important that any disputes that arise should be capable of adjudication. Although the parties’ contractual obligations in a smart contract may be defined by computer code (in which case the code may not be susceptible to the exercise of contractual interpretation at all), a smart contract can be identified, interpreted and enforced using ordinary and well-established legal principles. For example, just as with any other contract, a Court will intervene in cases of duress, fraud, misrepresentation and so on.
The Legal Statement also highlights that English law provides a suitable framework for dealing with a number of issues that arise in relation to smart contracts. For example, English law does not struggle with the concept of anonymous or pseudonymous parties contracting. There is no requirement at common law for parties to a contract to know each other's real identity (although of course they may be AML requirements to do so in some areas). English law also does not struggle with the notion that a contract can be formed between individuals by virtue of them each having agreed to subscribe to a set of rules.
One of the most welcome parts of the Legal Statement, when it comes to smart contracts, is the analysis around whether a statutory signature requirement can be met by using a private key: The Legal Statement discusses the legal rules which require certain documents to be “signed” or “in writing”. The Panel concludes that, in their view, a statutory “signature” requirement could be met by using a private key which is intended to authenticate a document, and a statutory “in writing” requirement can be met, in principle, in the case of a smart contract whose code element is recorded in source code. This is encouraging and reflects the reality of modern day commerce.
2020 will not see the adoption of large scale truly paperless physical commodity trading. Statutory changes to English law (and other systems of law) would be required before key documents such as e-bills have true functional equivalence, and thus far only Bahrain has enacted the MLETR.
But the very fact that reports such as the Legal Statement are addressing key areas of legal uncertainty thrown up by these new technologies is both welcome and an encouraging sign that the law is playing catch up with recent technological advances. As the Panel itself remarks, it seems inevitable that electronic transferable documents replace paper ones and the benefits of smart contracts and cryptoassets can be realised by the commodity industry. That may not be in the next year – but it will not be long coming.