knowledge 24 February 2023 |

International draft principles to facilitate transactions in digital assets

Introduction

The International Institute for the Unification of Private Law, UNIDROIT, published a consultation on “Draft Principles and Commentary on Digital Assets and Private Law” on 10 January 2023 (the “Principles”). The Principles were prepared by the Working Group on Digital Assets and Private Law over the course of seven sessions between 2020 and 2022.

These draft Principles are the latest move in the effort to bring traditional legal concepts into step with new technology. To take another example, in the EU, the upcoming Markets in Crypto-Assets (MiCA) Regulation will introduce a new regulatory framework for European crypto-assets.

The courts have also been grappling with the application of existing concepts to the digital environment such as disclosure, freezing orders and the location of crypto-currency and considering whether developers of networks relating to digital assets owe a duty of care to investors in digital assets. They have had to recently consider the consequences of a liquidation of a crypto-currency exchange, whether deposits belonged to the exchange (and fell to be distributed pari passu in the liquidation) or were held on trust for the benefit of its account-holders.

What is the aim of the Principles?

The Principles are designed to facilitate transactions in certain digital assets (for example, crypto currency) used in commerce. UNIDROIT believes that clear private law rules must be adopted to govern the key aspects of these transactions. While the Principles use certain core concepts, they do not address all contractual and proprietary issues relating to digital assets. In addition, they do not cut across intellectual property law or consumer protection. Regulatory matters are also outside of scope.

UNIDROIT’s recommendation of these Principles is based on its view that a consistent set of rules will increase the predictability of transactions both domestically and cross-border and decrease associated costs. The method of implementation is left to the individual jurisdictions.

To facilitate their widespread application, the Principles are technology and business model neutral as well as being jurisdiction neutral.

Digital Assets

In order for digital assets to be caught by the Principles, they must be subject to ‘control’. The Principles state that ‘control’ refers to a digital asset where a person can establish that they have:

1. the exclusive ability to change the control of the digital asset to another person;
2. the exclusive ability to prevent others from obtaining substantially all of the benefit from the digital asset; and
3. the ability to obtain substantially all the benefit from the digital asset.

For example, a public block chain operates on a consensus mechanism embedded in the underlying software, which no one individual controls. This means that the block chain itself is not subject to ‘control’ as defined in the Principles and is not a digital asset within its scope. An individual user does however have control over a private key which allows the user to obtain ‘control’ over a digital asset within the software, such as a bitcoin, meaning that these digital assets fall within the scope of the Principles.

Proprietary Rights

The Principles further recommend that, in line with recent cases internationally and authoritative commentary, digital assets should be the subject of proprietary rights. This would mean that in certain jurisdictions, digital assets may be classified as ‘property’ or ‘good’ or similar concept however the Principles leave it to individual States to decide.

The Principles also recommend that where a State’s law includes different categories of assets, which can be subject to proprietary rights, and different consequences attach to these different categories, the State’s law should specifically set out which category digital assets fall within. Alternatively, a State could decide to introduce a new category of asset.

The overarching aim of the Principles in this regard is to increase legal certainty on the classification of digital assets and make it clear that they can be the subject of property rights.

Applicable Law

The Principles set down a ‘waterfall’ of factors for the determination of applicable law in respect of a relevant digital asset. They start from the position that the applicable law is the law of the State specified in the digital asset itself. If that does not apply, the applicable law is that of the State specified in the system or platform in which the digital asset is recorded. These choice-of-law rules are based on party autonomy.

If neither of these apply, then the Principles provide a State with a large amount of freedom to choose the appropriate rules for a forum sitting in that State. A primary consideration is the fact that often the digital asset might have no significant connection with any State. Therefore, the Principles explain that it is not feasible to specify a definitive, “one size fits all” approach to be applied by the forum to proprietary questions in respect of a digital asset.

Innocent Acquisition

The Principles also deal with innocent acquisition of digital assets, conferring rights on innocent acquirers. These mean that digital assets will have attributes similar to those of negotiability under rules applicable to negotiable instruments, negotiable documents of title, and negotiable certificated securities in many common law and civil law jurisdictions.

The Principles explain here that digital assets are intangibles that are often traded on a distributed ledger system or other electronic networks that permit near instantaneous transactions. This fluidity, and the fact that many transferors are pseudonymous and often based in different jurisdictions, makes investigations as to whether there are any conflicting proprietary rights in the asset being acquired highly impractical. The availability of an innocent acquisition rule would facilitate these transactions and contribute to legal certainty.

Other Areas

The Principles are wide-ranging and also deal with issues such as the custody of digital assets, including the duties owed by custodians and the position on the insolvency of a custodian. They deal with the concepts around the use of digital assets as security for creditors, including issues around third parties, priority and enforcement. There is also a discussion on the effect of insolvency on a proprietary right in a digital asset. Finally, the requirement to update court procedures to take account of the practicalities of dealing with digital assets is also addressed.

Conclusion

It remains to be seen how the Principles will be received by the international community.

Also contributed to by Matthew Stenson