UNIDROIT adopts Principles On Digital Assets And Private Law

The International Institute for the Unification of Private Law (UNIDROIT) has adopted draft Principles on Digital Assets and Private Law (the “Principles”)¹. These Principles comprise legislative guidance and best practices in relation to transactions involving digital assets such as cryptocurrencies and non-fungible tokens. UNIDROIT suggests that all states adopt legislation which is consistent with these Principles, to provide clear rules and reduce legal uncertainty, in relation to both domestic and multi-jurisdictional digital asset transactions.

Scope of the Principles on Digital Assets

UNIDROIT is an independent intergovernmental organisation with 65 member states, which includes all countries in the G20. Its purpose is to harmonise and modernise private international law among its member states, which are drawn from a wide variety of legal systems and cultural backgrounds. UNIDROIT has recently published 19 Principles relating to digital assets. The Principles serve a twofold purpose: first, to provide clear rules and guidance relating to digital transactions and second, to encourage states to adopt legislation consistent with the Principles. The overall objective is to increase predictability in transactions relating to digital assets, which UNIDROIT hopes will lead to reduced costs and increased efficiency.

The Principles are drafted widely with the intention that they will be technology-neutral, jurisdiction-neutral and organisationally neutral. However, they only address private law issues (primarily issues relating to ownership and rights in digital assets) and do not cover regulatory law, intellectual property or consumer protection issues. Principle 2.2 defines a “digital asset” broadly as any “electronic record which is capable of being subject to control”. Principle 2(1) defines an “electronic record” as “information which is (i) stored in an electronic medium and (ii) capable of being retrieved”. Principle 6 addresses the issue of “control” by reference to the ability in practice to benefit from the digital asset and change control of it (as discussed further below). The broad nature of the definitions in the Principles mean that they include, amongst other digital assets, cryptocurrencies, tokens and distributed ledgers such as blockchain. Pursuant to Principle 4, “linked assets” are also included (whether tangible or intangible), for instance, securities linked to a digital asset.

Key Aspects of the Principles

A digital asset can be the subject of proprietary rights - The Principles establish that digital assets can be the subject of proprietary rights. This may mean that, in certain jurisdictions, digital assets could be classified as “property” (or the law reformed to include a new class of property which can accommodate digital assets), but this is left open for each state to decide. The consequences of this are significant, as it means that digital assets can be transferred and so the Principles accordingly provide guidance for the protection of innocent acquirers and for security rights in digital assets.

Determining applicable law - Digital assets are intangible in nature and often transactions involving them occur without a physical location. As a result, it can be difficult to determine what the applicable law is. The Principles therefore give effect to party autonomy here and allow for the digital asset itself (or the system on which it is recorded) to expressly identify the applicable law. Creators of digital assets and platforms should consider which law would likely be most advantageous at an early stage, bearing in mind that some jurisdictions are further down the road than others in terms of recognising ownership of digital assets and regulating digital assets. The Principles provide for a “waterfall” of factors for the determination of the applicable law: in the first instance, the applicable law is that of the state specified in the asset itself but, if this does not apply, then it is that of the state specified in the system in which the digital asset is recorded. If neither apply then the waterfall continues, looking at the issuer (if any) of the digital asset and then, finally, giving the state freedom to choose the appropriate law and rules for a forum sitting in that state. Although many digital assets and systems will not currently specify an applicable law, the Principles aim to incentivise them to include such a specification going forwards.

Definition of “control” over a digital asset - As mentioned above, the Principles only apply to digital assets which can be subject to control and the concept of control is critical throughout the Principles. The Principles define control as a factual matter, existing where a person can establish that it has (i) the exclusive ability to prevent others from obtaining substantially all of the benefit from the digital asset, (ii) the ability to obtain substantially all the benefit from the digital asset and (iii) the exclusive ability to change the control of the digital asset to another person.

Custody of a digital asset - Chapter 4 of the Principles examines the concept of custody i.e. where a digital asset is maintained (often by a regulated entity) on behalf of, and for the benefit of, another person. This includes looking at how to ascertain when a custodial relationship can be deemed to exist and looking at the duties owed by a custodian to its client, which include the obligation to comply with instructions and to safeguard the digital asset.

Transfers of proprietary rights and the creation of security rights - UNIDROIT takes the position that the most important transactions in commerce relating to digital assets are transfers of proprietary rights and the creation of security rights. The Principles address these two types of transactions in particular. For example, the Principles propose (a) an ‘innocent acquirer’ rule, whereby an innocent transferee who (amongst other requirements) has control of the asset will take it free of third party proprietary claims, and (b) a right for a secured creditor to make a security right in a digital asset effective against third parties by obtaining control of the digital asset.

Procedural law - Principle 18 notes that, unless otherwise provided for in the Principles, the ordinary procedural law of a state will apply in respect of procedural matters relating to digital assets, such as court proceedings and enforcement.

Effect of insolvency - Principle 19 looks at the effect of insolvency on a proprietary right in a digital asset and confirms that, if such a right is effective against third parties pre-insolvency, then it is also effective in relation to relevant parties in insolvency-related proceedings (such as insolvency practitioners and creditors). A liquidator would be entitled to take control over a digital asset if the owner went into liquidation and a secured creditor would, in principle, be able to enforce security over a digital asset in an insolvency scenario.

What next?

It is expected that the instrument will be finalised in the coming months, following which it will be published by UNIDROIT. How influential the Principles will be, and whether states implement and incorporate them into their national law, remains to be seen. It is clear that this is an area of significant concern to governments and legislators.

In the United Kingdom, the Law Commission (who were an observer on the UNIDROIT working group responsible for the Principles) recently carried out its own consultation. Whilst the English courts have indicated that cryptocurrency² and NFTs³ are to be treated as ‘property’ under English law, the Law Commission suggests that the law is reformed so as to explicitly recognise a new category of personal property that can accommodate digital assets in order for them to benefit from consistent legal recognition and protection. This is part of the UK Government’s stated goal to make Britain a global hub for cryptoassets technology and investment. The Law Commission published its final report, setting out its law reform recommendations to the UK Government, at the end of June.

In the United States, President Biden issued an Executive Order, titled ‘Ensuring Responsible Development of Digital Assets’, in March 2022⁴ which calls for a comprehensive digital asset regulatory framework⁵. Currently, the Securities Exchange Commission and the Commodity Futures Trading Commission (“CFTC”) have overlapping authority over the treatment of digital assets but there have been recent calls (including by the chairman of the CFTC) for a single federal regulator. As well as the introduction of a number of bills dealing with the regulation of digital assets (including the Responsible Financial Innovation Act⁶ and the Digital Commodities Consumer Protection Act⁷), the United States have been introducing “regulation by enforcement” in the digital asset space: with over 80 enforcement actions brought by the CFTC in 2022.

UNIDROIT have also announced a joint project with the Hague Conference on Private International Law to build on the Principles and focusing on law applicable to cross-border holdings and transfers of digital assets and tokens⁸.