Cryptoassets – The English law position in January 2023
While cryptoasset enthusiasts likely wish to forget 2022, the year marked some significant legal developments in the recognition and treatment of this recalcitrant asset class. The best-known cryptocurrencies, such as Bitcoin, Ether and Cardano, fell more than 60 percent. Major failures in the exchange operating space, such as FTX, captured the attention of the public and regulators alike. A number of other crypto exchanges and trading models also collapsed.
Yet the appetite for more technologically advanced assets and trading practices which enable a wider range of users to trade across markets on a 24-hour basis with maximum transparency, immediacy and on an immutable basis may be as strong as or even stronger than ever.
The goal for participants, regulators and policy makers in January 2023 is to enable safe advancement through improved technology and systems. This requires existing participants and new entrants being able to enter the market with new products and different systems based on a better understanding of the risks and a much better market and regulatory infrastructure capable of enabling these new technologies to operate safely and to their potential.
The market matured in 2022 and this will hopefully result in the implementation of a forward-looking regulatory infrastructure and legal decision-making that builds on understanding the failures that occurred.
Here, we analyze the current status of English law and proposed regulation which reflects a maturing of understanding and the potential for cryptoassets to move into a more accepted mainstream infrastructure.
The Bank of England
Jon Cunliffe, the Deputy Governor of the Bank of England, has described the crypto industry as unstable and risk prone, given that cryptoassets are unbacked by tangible security. Cunliffe believes that regulation is essential to protect consumers and maintain financial stability of mainstream financial markets. He contests that the market cannot continue to grow significantly if it continues unregulated because of its very instability which will deter investors. For innovation to continue, regulation is needed.1
As discussed by Cunliffe, the Financial Services and Markets (FSM) Bill, which as of December 2022 was reviewed by the House of Lords2 for the second reading, contains a provision which will enable the Treasury to regulate payments in relation to digital assets and currency (Section 22: Digital Settlement Assets: Power to make Regulations).3 The Bill will address the use of stablecoin as a means of currency, which would see the Bank of England bearing responsibility for its use and stability. This to some extent is similar to steps being taken in the EU through MiCA.
Whilst the above addresses certain products in traditional financial markets, there is still and open question as to dealing with new forms of financial platforms that operate on a borderless basis. Decentralized finance (DeFi) potentially frustrates the ability of centralized regulators to control decentralized activities. One solution may be embedded supervision, enabling decentralized blockchain transactions to be monitored by regulators whose jurisdictions are touched by the decentralized activity.4 The Financial Policy Committee at the Bank of England suggests it may be possible to create industry-led codes of conduct to create a level of cohesion between different jurisdictions.
The UK government released a policy paper, as updated in November 2022, commenting on how the law should develop to address the holding of cryptoassets. The paper suggests that the law needs to develop to enable the forfeiture of cryptoassets so that they can be recovered by the Magistrates Court.
The proposals set out five elements relating to the treatment of cryptoasset holdings:
- Seizing cryptoassets as part of a search warrant
- Recovering cryptoassets directly from cryptoexchanges
- Enable cryptocurrency which has been frozen in a wallet to be recovered and converted into cash
- Enable destruction of cryptoassets
- Enable cryptoassets or cash equivalents to be released to victims to alleviate consequences of fraud.5
The Government acknowledges that cryptoassets presents risks due to their volatility, in addition to emphasising that regular investors are not protected for example in the way depositors would be protected under the deposit protection scheme. These items can, however, be managed through clear risk warnings and education. There is a particular focus, however, on criminal activities and protecting the public from misleading advertisements which could induce them to purchase cryptoassets.6 The difficulty here however may be in applying responsibility for ensuring standards are met. Whilst fraud and criminal activity are dealt with through law enforcement bodies, responsibility often falls with the FCA to remind investors that their investments are not protected, neither guaranteed.7 The FCA is, however, tasked with addressing financial activities and instruments that fall within the regulatory perimeter, and certain cryptoassets currently fall outside the regulated scope. Non-regulated activities fall within the ambit of the Advertising Standards Board, which has taken action in 2022 over a number of cryptoasset offerings (highlighted by criticism of certain football club schemes). There is a recognition that English law needs to develop clearer standards and responsibility for policing activity in this space.
In December 2022, The Chancellor of the Exchequer presented the Edinburgh Reforms to Parliament. The reforms describe how the government intends to amend financial regulation, in order to make the UK an attractive hub for finance. In addition to introducing regulation for stablecoins as contained in the FSM Bill, the Government is consulting on UK retail central bank digital currency with the Bank of England, as well as working with regulators to trial a platform to enable trading of such digital assets. The aim of such reforms is to bring investment in cryptoassets further into the remit of UK regulation.8
The Law Commission analysis of the nature of digital assets as property interests
Perhaps one of the most significant aspects of legal analysis in 2022 was The Law Commission Consultation on Digital Assets9 to determine the nature of digital assets as matter of English jurisprudence. The paper comments that “the law is still in the process of developing a sophisticated legal regime that recognizes and protects the nuanced features,”10 but recognizes that the laws of England and Wales are well placed to address digital assets and develop further regulation. The Commission acknowledges that the United Kingdom is already a competitive market for digital assets and is regarded as a “global hub” for ownership of such assets.11
On the question of the nature of cryptoassets, the Law Commission acknowledges that the current law recognizes two types of property asset, that which has a physical nature and is often characterized by possession and that which exists by virtue of legal rights characterized as a chose in action. The paper recognizes that digital assets are something different to these. This makes legal principles difficult to apply, because by their nature; they are not tangible items, and they are not only enforceable by legal action, but carry their own personal property rights. In the opinion of the Law Commission, English law should develop to create a category of ownership separate from possession and chose in action. Instead, it proposes “data objects,” which covers ownership of digital assets. Data objects are defined by the Law Commission as:
- composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals
- existing independently of persons and exists independently of the legal system and
- being rivalrous.12
By way of example, the Commission states that crypto tokens could be defined as data objects,13 as they are more than bundles of data, carrying functionality and ownership rights to the user.14 The law has recognized certain cryptoassets as rights of property, but it might be better to categorize all digital assets as data objects, being the subject of property rights, which will provide greater clarity and protection to investors.
Developments in law through the courts
Issues relating to the cross-border nature of crypto enforcement were addressed in the 2022 Queen’s Bench Division case of Jones v Person Unknown  9 WLUK 412.1 The claimant was subject to a fraud involving the transfer by the claimant of significant amounts of Bitcoin to accounts established by the fraudsters. The claimant brought an international freezing injunction against perpetrators of fraud located overseas. The fraudsters had convinced the claimant to transfer Bitcoin to accounts on their fake investment platform. Due to the decentralized nature of the crypto industry, the claimant did not know the identity or location of the fraudsters. An investigation by the claimant traced the funds to a wallet with an offshore exchange based in the Seychelles.
The claimant issued a claim against persons unknown for deceit and unjust enrichment. The claim also alleged the exchange held the assets as constructive trustee. The court was convinced to allow service of proceedings via email, Whatsapp or an NFT, demonstrating how English law is evolving to reflect the unprecedented nature of crypto.
The claimant obtained a worldwide freezing injunction against persons unknown and a proprietary injunction against the perpetrator of the fraud and the exchange in order to avoid dissipation of the assets. The court awarded summary judgment holding that the exchange held the assets on constructive trust for the claimant. The claimant was also able to serve the order for summary judgement by NFT airdrop into the exchange’s wallet.
The judge confirmed that the Bitcoin could be treated as property, enabling the claimant to apply proprietary remedies in respect of the fraudulently acquired assets.
Toward the end of 2022, the Upper Tribunal of the Tax and Chancery heard a case relating to the regulation of a cryptoexchange trading platform, Moneybrain.15 Moneybrain had created a token called BiPS and subsequently applied to the Financial Conduct Authority (FCA) for registration as a cryptoasset exchange provider under Regulation 57 Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017. The FCA refused to do so, on the basis that Moneybrain had recklessly and misleadingly published information relating to the tokens, which suggested they were asset-backed. The FCA under Regulation 58A of the same legislation, determined that Moneybrain was not a “fit and proper person,” thereby issuing a Decision Notice meaning Moneybrain was not permitted to continue trading.
In response to the FCA’s decision, Moneybrain appealed the Decision Notice and subsequently submitted a Privacy Application to the court, seeking to keep the Upper Tribunal judgment private. In determining whether the judgment should be kept private, Judge Anne Redston balanced the arguments of allowing the Privacy Application, weighing whether Moneybrain’s actions as a crypto provider would prejudice the public if it were to continue trading against the judgment as an interlocutory decision.
On balance, the court held that the Privacy Application should not be granted, and the decision should be published accordingly.
In the case Nicholls v Little,16 the claimants provided the defendant with access to their cryptocurrency holdings, under the guise that the defendant would invest the currency and provide them with a financial return. The claimants had not been returned their original investment or any additional investment, and so sought relief through the courts via a freezing injunction.
Charles Bagot QC acknowledged the issue in his judgment:
This is obviously complicated because it is a virtual world. It does not exist as a tangible asset in what might be called the analogue world. There is no regulator or bank which controls interactions involving the assets or holds the assets in an account. It is not in a particular jurisdiction. So it is a complicated matter to follow up.
The claimants proposed that traditional methods of enforcement had failed, and sought access to the defendant’s private key, which would enable access to the defendant’s crypto holdings, allowing the requisite enforcement. As acknowledged by the court through previous cases of Vorotyntseva v Money-4 Ltd (T/A Nebus.com) and Others  and AA v Person Unknown & Ors , cryptocurrencies are a form of property which can be subject to a freezing injunction. However, as the court acknowledges:
It is undesirable for the court’s orders to be nugatory and to have no teeth and for a default judgment, effectively, to be not worth the paper it is written on, so to speak. Enforcement needs to evolve and adapt to new forms of assets.
The court enforced the freezing order demonstrating a willingness to translate traditional legal principles (in this instance, the American Cyanide test, used to establish whether an injunction should be made) to nuanced and developing areas of law.
In spite of a difficult year for cryptoasset investors in 2022, the year marked a significant maturing of the market. When dealing with people’s property, significant penalties and potential imprisonment will be the likely outcome for those who ignored the protections they should have implemented.
At the same time, policy makers, regulators and courts are learning to deal with the challenges of a fast-moving environment, working with the complex and sophisticated technologies that modern society demands. Progress highlighted in the report above reflects however that relevant bodies are making significant moves in understanding and building an infrastructure for advancement. It will be interesting to see in 2023 and onwards how quickly things may develop.
Learn more about the implications of these developments and trends by contacting any of the authors.
1Reflections on DeFi, digital currencies and regulation - speech by Jon Cunliffe | Bank of England
2Financial Services and Markets Bill - Parliamentary Bills - UK Parliament
3newbook.book (parliament.uk) Page 43
4Ibid Page 21
5Factsheet: cryptoassets - legislation - GOV.UK (www.gov.uk)
6Government to strengthen rules on misleading cryptocurrency adverts - GOV.UK (www.gov.uk)
7FCA reminds consumers of the risks of investing in cryptoassets | FCA
8Financial Services: The Edinburgh Reforms - GOV.UK (www.gov.uk)
9Law Commission consultation on digital assets - Ministry of Justice - Citizen Space
10Ibid Page 3.
12Law Commission consultation on digital assets - Ministry of Justice - Citizen Space Page 79
13Ibid Page 156
14Ibid Page 159
15Moneybrain Ltd v Financial Conduct Authority  11 WLUK 478
16Nicholls v Little  7 WLUK 380