Virtual or cryptocurrencies continue to gain momentum. A number of financial institutions and funds are now recognising them as a viable asset class for new products and services. However, nine years on from the first Bitcoin, the true legal status of virtual currencies is no clearer.
We are often asked about the regulator's views on virtual currencies. But arguably the more important question is: what are its fundamental legal characteristics? The answer to this question is critical when looking to consider virtual currencies as an asset class.
Funny money: what are crypto currencies?
First, a disclaimer: virtual currencies clearly come in many forms, from tokens issued by a centralised issuer that can be redeemed against it for value, to crypto-currencies that have no issuer as such and are transferred via blockchain technology on a distributed ledger. This article does not try to address all of the permutations, but instead focuses on decentralised virtual currencies that are generally used as an exchange in value, but do not represent a claim against any particular issuer.
At their core, such cryptocurrencies are simply a mathematical code representing an amount of that virtual currency which is recognised and verified by a public (or 'distributed') ledger as belonging to a particular key. A holder of a cryptocurrency will typically have a public key (akin to an 'address') and a private key. The private key, itself a mathematical number, is required to control and affect a transfer of cryptocurrency to another public key/address.
Given these characteristics, questions regarding the fundamental legal nature of a cryptocurrency emerge that have important ramifications on how cryptocurrencies can be used, and how rights relating to them will be recognised and protected by English law. A central question is whether the law will recognise and protect property rights in cryptocurrencies.
A familiar face – the benefits of recognition
Recognition of 'property' and 'ownership' is crucial for cryptocurrencies to be a viable asset class. Primarily, such recognition would recognise and then protect the true 'owner' in the event the 'property' has been misappropriated by a third party. It would also enable legal concepts that are central to the functioning of financial markets to apply, such as being able to declare a trust over cryptocurrencies (the method by which client assets are protected on an insolvency) or assigning or granting security interests in respect of them.
However, cryptocurrencies defy easy categorisation within the traditional types of property recognised under English law. These categories generally distinguish between real (eg real estate) and personal property. Personal property is further divided into tangible property (choses in possession – i.e. something that can be possessed) or intangible property (choses in action – i.e. a right of action against someone).
The problem with cryptocurrencies is that they are just a mathematical code, where control over that mathematical code falls to anyone with knowledge of the relevant private key (itself a mathematical code). Knowledge of a code is not something that can typically be "possessed". Furthermore, cryptocurrencies on a distributed ledger do not really represent a right of action against anyone, as there is no centralised issuer. Further doubt is cast by a series of English cases that do not consider mere information to be 'property'.
The true nature of cryptocurrencies has not yet been determined by the courts. However, despite the above difficulties, the English courts are generally flexible. They have been willing to recognise 'property' where rights have an economic value and have shown themselves susceptible to transfer and trade. Indeed, the Financial Markets Law Commission believes that cryptocurrencies display some characteristics of both tangible property and intangible property and could constitute their own type of property: the "virtual chose in possession".
Nonetheless, until the issue is resolved by the courts or legislators, uncertainty as to whether English law will recognise property and ownership interests in cryptocurrencies may hinder chances of virtual currency being considered a mainstream asset class.