Crypto-assets: what are they, practical applications and legal implications?

Crypto-assets

What they are, practical applications and legal implications?

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Crypto-assets

What they are, practical applications and legal implications?

It is very likely that you will have heard of such terms as ‘crypto-currency’, ‘blockchain’ and ‘bitcoin’. Despite a growing awareness of the sector, there are many who do not understand what crypto-assets entail or, perhaps more pertinently, its applications and implications. The purpose of this article is to provide an insight into the crypto-assets sector. This article will in general terms use the term ‘crypto-assets’ as being inclusive of ‘crypto-currencies’, which are just one type of asset class.

Ryan D'Souza Solicitor-Advocate ryan-dsouza@laytons.com +44 (0)20 7842 8000

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Crypto-assets | What they are, practical applications and legal implications?

What are crypto-assets?

In its most simplistic form, crypto-assets are merely a modern form of a ledger. A ledger is a method of recording information. Ledgers have been used in varying forms for thousands of years, from ledgers on clay tablets to wooden tally sticks.

Modern society organises its data through trusted third parties. For instance, the Land Registry maintains a database record of who owns property; the DVLA keep a record of car ownership; and in the finance sector we entrust our money to banks who keep records of our data using computer bank account ledgers. Crypto-assets are the next enhancement on how we store data in ledgers.

How? Through ‘decentralised Mutually Distributed Ledgers’ (“MDLs”), which is fundamentally what crypto-assets are. If you break down this phrase it becomes much simpler to understand: • ‘decentralised’: ledgers are decentralised because they are not run by a third-party custodian such as a bank or government. The middle man is cut out of transaction, which usually saves on costs and transaction fees. Ledgers are also decentralised by not needing to be stored in few locations; cryptoassets are portable and permanent;

• ‘mutual’: ledgers are mutual because everyone in the group to which the data is distributed has access to the ledger. Risk of fraud is therefore minimised because everyone can see changes made to the ledger, with transaction records being permanent.

Note that the term ‘crypto’ is just a fancy word for ‘concealed’ or ‘secret’. Data is stored securely using encryption. A ‘blockchain’ is merely a description of an MDL, i.e. the block representing the group of people and the chain representing the distribution of the ledger through a chain of people.

There presently is no one single definition of a cryptoasset, however, perhaps the best suggestion in English law has been from Sir Geoffrey Vos (a judge who has been appointed Master of Rolls as of 11th January 2021): “cryptographically secured digital representation of value or contractual rights that uses some type of

• ‘distributed’: ledgers are digitally distributed amongst a group of people. That could be a very large group

Distributed Ledger Technology and be stored or traded electronically”

of millions of people who all have access to a currency ledger; or a just two people who want to share data for the purposes of a contract between them, perhaps to buy and sell a property;

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Sir Geoffrey Vos is part of a UK Jurisdiction Taskforce, which will be influential in determining the legal status of cryptoassets in the the UK.

Crypto-assets | What they are, practical applications and legal implications?

Is there a need for crypto-assets? The world is becoming

4. Decentralised Finance (De-Fi)

increasingly borderless and the volume of data is growing

Ffinance that is decentralised away from traditional

exponentially. There appears to be a need for a new

institutions using smart contracts. For example, one

method of storing data, in a secure and easily manageable

can now conduct peer to peer borrowing and lending

way. Banking technology is often very outdated and only

of money between individuals using digital assets as

four ‘challenger banks’; Ziglu, Revolut, Starling and Monzo

collateral.

operate in the cloud. It will also be borne in mind that one of the purposes of bitcoin, and MD, technology generally, is to be independent of government and third-party control, its creator becoming concerned after the 2008 financial crisis, caused in large part by those very institutions.

Crypto-assets facilitate the disintermediation of many industries. There does seem to be a need or, at the very least, clear use cases for the benefits that crypto-assets can

5. Interconnecting Blockchain The connecting of different MDLs together so that you can have one network with multiple MDLs. The Polkadot altcoin is an example of this. You can have, say, a police database that seamlessly connects a criminal records ledger, a car registration ledger and a home ownership register.

provide.

Types of Crypto-assets

Practical Applications

The five main classifications

The four main use classes

1. Bitcoin

1. Cash

Bitcoin was the first decentralised crypto-currency,

It is already possible to buy and sell using crypto-

released in 2009. It seems likely that bitcoin will be

currencies. Some crypto-currencies, known as

become a store of value in much the same way that

‘stablecoins’ are pegged to traditional Fiat currencies

gold is a store of value.

(i.e. traditional government issued currency), such as

2. Alternative token (aka Altcoins) Crypto-assets other than bitcoin. There are currently

Tether, which is pegged to the US dollar.

2. Securities

over 5,000 altcoins, many of which have use cases

Tradable financial assets and instruments. Raising

that are not merely to store value. A key example is

capital through shares, bonds and Initial Coin Offering

Ethereum, which is a platform on which to develop

(“ICOs”).

other MDLs such as smart contracts.

3. Blockchain

3. Utilities The storage of data. Let your mind wander as to

The use of ledgers to record information. This could

what data needs to be stored and MDL technology

cover everything from exam results to criminal

– crypto-assets – has a use case: insurance, credit,

records;

loyalty management, identification, medical data, qualifications. Such examples are the tip of the

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Crypto-assets | What they are, practical applications and legal implications?

iceberg and many are already in use. Estonia has famously operated its national identity system on an MDL for years.

4. Property In the UK the Land Registry keeps records (i.e. a ledger) of property ownership. It seems likely that these records will be transferred onto an MDL in due course. Significant sum of money has already been spent to make this a reality.

Legal Implications The regulation of crypto-assets is constantly evolving. The US and UK appear to be leading the way when it comes to plans for regulation. The UK’s position may change after leaving the EU from whom it no longer needs to align. Some of the legal issues facing crypto-assets are as follow: 1. Global Divergence Different countries have thus far adopted different stances to

2. UK Regulatory issues include: a. Anti-money laundering.

crypto-assets and crypto-currencies in particular. They are

Processes, including identity requirements, are the

illegal in some countries (Bolivia, Ecuador), to be regulated

norm on the most reputable platforms that are likely

(Russia) and prohibited by banks and financial institutions

to become mainstream.

only (China). The UK is pro crypto-currencies. The Financial Conduct Authority wants a regulatory framework that supports crypto-assets.

b. Tax evasion This issue goes hand in hand with having acceptable anti-money laundering processes. Crypto-currency data is ultimately on a permanent MDL. However, some altcoins, such as Monero, are designed to facilitate anonymity.

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Crypto-assets | What they are, practical applications and legal implications?

c. Legal status In the UK, it seems increasingly likely that cryptoassets will be defined as a type of ‘property’. The law might then be codified through legislation or developed through case law (i.e. common law), Sir Geoffrey Vos preferring the latter. A predominantly common law approach seems likely given the fastevolving nature of the sector.

d. Contract law The law will almost certainly need to be adapted to allow for such issues as computer code forming the basis of a contract, and private keys replacing traditional signatures. Such issues are certainly not insurmountable but it will take time before there is legal certainty.

In Conclusion It is clear that there are many use cases for crypto-assets throughout society, many of which are already in use or are being developed. Crypto-assets offer numerous advantages over and above societies existing trusted financial and legal architecture. Whether or not crypto-currencies challenge traditional money will likely be determined by the extent to which there is mass-scale adoption. The extent of adoption remains to be seen, but has been growing rapidly, particularly at institutional level. On 8th February 2021, Tesla invest $1.5bn into bitcoin, a likely seismic event for the crypto-asset sector, that could facilitate mass adoption. One things seems certain, it would be unwise to ignore the crypto-asset sector – the underlying technology is likely to permeate through all of our lives. laytons.com | 7

Crypto-assets | What they are, practical applications and legal implications?

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