Digital Digest – Volume 2

In this second edition of Digital Digest, we summarise the key developments in the digital asset space in the UK from a regulatory and civil litigation perspective over the second half of 2023.

There is a real sense that the authorities are striving to get to grips with these emerging and important new technologies and that the English Courts are continuing to look to demonstrate that they are a sophisticated and forward-looking forum for digital asset disputes. It is clear these trends will continue.

Of particular note is the new guidance on the promotion and marketing of cryptoassets, which is geared towards bringing these new technologies within the scope of the existing regulatory regime. Similarly, the Law Commission and UK Jurisdiction Taskforce continue to stress-test the capability of the existing statutory framework and common law to cope with digital assets.

We hope the summaries in this Digital Digest provide a useful overview and welcome your comments and feedback.

 

REGULATORY DEVELOPMENTS

1. Cryptoasset financial promotions: The latest FCA guidance

The Financial Conduct Authority (FCA) published new guidance on the promotion and marketing of cryptoassets through FG23/3 on 2 November 2023. Building upon the new rules from PS23/6 that came into force on 8 October, the new guidance aims to assist firms in fulfilling the central tenet of financial promotion regulation: being fair, clear, and not misleading pursuant to COBS 4.2.1.

Whilst PS23/6 is the core of FCA policy alongside relevant legislation, FG23/3 is a useful tool for any firms operating in the cryptoasset space by offering practical guidance and quick reference for best practice.

A full summary of the FCA’s latest guidance can be found at the Annex to this Edition.

2. The Economic Crime and Corporate Transparency Act 2023: A precedent for new cryptoasset regulation?

On 26 October 2023, royal assent was granted to the Economic Crime and Corporate Transparency Act 2023 (ECCTA), introducing a new wave of legislative changes to crack down on the disguise of criminal gains and to strengthen enforcement powers.

The key takeaways from the ECCTA affecting cryptoassets used in crime are:

• new powers to apply seizure in certain circumstances before arrest;
• creation of exceptional circumstances where crypto assets may be destroyed;
• provision of powers to magistrates’ courts to order the sale of cryptoassets like other assets;
• a new ability for enforcement officers to treat cryptoassets like tangible assets during recovery;
• a new right to take control and recover cryptoassets during the execution of a search warrant;
• a provision to allow release of detained cryptoassets back to victims;
• a new capacity for law enforcement to convert seized cryptoassets into cash, preventing price fluctuations; and
• new powers to recover crypto assets directly from exchange providers and custodian wallet providers.

A full summary of the ECCTA can be found at the Annex to this Edition.

3. NFTs, the blockchain and fan tokens: Football in the spotlight

The role of NFTs and fan tokens in sport, especially football, has been a topic of significant scrutiny for the Culture, Media and Sport Committee (CMSC) since November 2022, when it launched an enquiry into the topic. A report on this topic was published on 11 October, revealing a series of findings and suggestions that will likely influence the regulation of cryptoassets in British sport.

A full summary of the CMSC report can be found at the Annex to this Edition.

4. HMT publishes its response to the consultation on future financial services regulatory regime for cryptoassets

HM Treasury (HMT) recently published its long awaited response document to the consultation paper on the future financial services regulatory regime for cryptoassets, published in February 2023. In its response, HMT confirmed its final proposals for crypto regulation in the UK, including its intention to bring a number of cryptoasset activities within the financial services regulatory perimeter.

Our recent article analysing the response document can be found here.

5. Digital Securities Sandbox – Treasury Response

HMT has addressed the feedback to a consultation paper it published on the proposed implementation of the Digital Securities Sandbox (DSS) by publishing a response to the paper on 22 November 2023.

The DSS is intended to be the first financial markets infrastructure sandbox produced under new regulatory powers granted to regulators by FSMA 2023. The DSS should allow for firms to access and trial modifications to the UK legislative and regulatory framework. This will help to provide trading and settlement infrastructure for digital securities in cases where there may currently be barriers.

The key takeaways from the response are:

• a statutory instrument to implement the DSS will soon be published, with enactment before the end of the calendar year excepted;
• amongst respondents the feedback for the DSS was generally positive;
• there were nineteen expressions of interest from numerous regulated financial services firms but also new entrants; and
• where respondents asked for more clarity was in how firms may apply, how activities within the DSS will interact with activities outside the DSS, how limits set in the DSS will be managed, and how to exit the DSS.

A full summary of HMT’s feedback regarding the DSS can be found at the Annex to this Edition.

 

CIVIL LITIGATION UPDATE

1. High Court ordered delivery up of funds in offshore cryptocurrency accounts

In Joseph Keen Shing Law v Persons Unknown and Huobi Global Ltd (unreported), 26 January 2023, (London Circuit Commercial Court), HHJ Pelling KC ordered delivery into the jurisdiction of the equivalent value of cryptoassets held in two offshore cryptocurrency accounts. The order was made notwithstanding the existence of a post-judgment worldwide freezing order (WFO), to assist the claimant in enforcing a default judgment against in relation to assets misappropriated by fraudsters.

The question to be determined was how best to manage the funds, given that a WFO had already been granted, which generally limits the circumstances in which the court will order such a transfer.

HHJ Pelling KC was “entirely satisfied” that he should order delivery up of those funds. The judge found that, since the court had no control over the alleged fraudsters or the exchange holding the funds, which were outside the jurisdiction, exceptionally, it was appropriate to make the order for transfer. In making the orders sought, the High Court, in line with prior jurisprudence, showed flexibility to achieve a practical outcome for a victim of fraud. It is notable that the exchange had already indicated that it would cooperate with any order the English court may make and did not oppose the application.

Under the order, the cryptocurrency was first to be converted into fiat currency and then transferred to the Court Funds Office, either directly or via the claimant’s solicitors. Given the costs involved, including the costs of conversion, the claimant was required to provide a cross-undertaking in damages.

This decision predates the decision in Piroozzadeh v Persons Unknown and others [2023] EWHC 1024 (Ch) (discussed in Edition 1 of Digital Digest), in which the High Court discharged an interim proprietary injunction against an exchange requiring the exchange to preserve cryptocurrency. It is significant that in this case, unlike in Piroozzadeh, the claimant already had the benefit of a judgment against the fraudsters.

2. Crypto and Arbitration Awards

In Payward Inc and Others v Chechetkin [2023] EWHC 1780 (Comm), the English High Court refused to enforce a Californian-seated arbitral award for contravening English public policy.

The claim, brought against a British citizen resident in England, under section 101 of the Arbitration Act 1996 (AA 1996), sought enforcement of a New York Convention arbitral award made in relation to a dispute over cryptocurrency trading losses. The High Court refused enforcement, deciding that the presence of an arbitration clause in the agreement providing for foreign-seated arbitration and for disputes to be governed by foreign law cannot prevent the English court from adjudicating on matters concerning UK consumer protection rights.

Given the popularity of arbitration provisions in the standard terms of crypto exchanges, due to the perceived ease of international enforcement of arbitral awards under the New York Convention (among other matters), the decision is of broad significance for the industry and how it resolves consumer disputes.

Our detailed analysis of this judgment can be accessed here.

3. Wright v BTC Core - copyright in the Bitcoin File Format as a literary work?

The Court of Appeal recently allowed an appeal in copyright infringement proceedings where the claimant asserted copyright in the Bitcoin File Format as a literary work (Wright v BTC Core [2023] EWCA Civ 868).

In Wright, the claimant claims to be the creator of the Bitcoin digital currency system and asserts that he owns the copyright in the Bitcoin File Format as an original literary work. The Claimant asserts that the defendants had infringed his copyright in the format, defined as the work “consisting of the structure of each block of the Bitcoin Blockchain as described in Schedule 2” to the particulars of claim.

The judge at first instance refused permission to serve the claim form on the defendants out of the jurisdiction – it was held that the claimant had no real prospect of establishing that copyright subsisted in the format because it had not been “recorded, in writing or otherwise”, as required by the Copyright, Designs and Patents Act 1988, which gave effect to the requirement of “fixation”.

On appeal, it was held that the judge at first instance had erred in holding that the claimant had no real prospect of establishing that the fixation requirement was satisfied. It was determined that the work in which copyright was claimed was a structure. There did not necessarily have to be content defining the structure in order to fix it: all that was required was that the structure was completely and unambiguously recorded.

4. Law Commission publishes its long-awaited recommendations for the development of the law relating to Digital Assets¹

On 28 June 2023, the Law Commission of England and Wales published its Final Report on Digital Assets (the Report). The Report sets out the Law Commission’s recommendations for the reform and development of the law relating to digital assets, with the aim of creating a clear, consistent and transparent legal framework for digital assets that will provide greater clarity and security to users and market participants alike. A copy of the Report can be accessed here.

The Report follows neatly on from several landmark publications from the UK Jurisdiction Taskforce (UKJT), which was established to clarify key questions regarding the legal status of cryptoassets, distributed ledger technology and smart contracts under English law.

Building upon the UK Jurisdiction Taskforce’s: (a) Legal Statement on Cryptoassets and Smart Contracts (see our analysis here); and (b) Legal Statement on the issuance and transfer of digital securities under English private law, the Report represents a further indication of the private law of England being a dynamic and globally competitive tool for market participants in the digital assets space.

The Law Commission’s tripartite approach in the Report to digital assets, and their recommendations with respect to the same, is as follows:

1. First, the Report recognises that the common law system in England is very well placed to provide a coherent legal regime for existing and new types of digital asset and should serve as the primary means (rather than through legislation) by which reform in this area should occur. The Report accepts that the common law allows for the recognition of a distinct, third category of personal property (in addition to the traditional two categories of “things in possession” (i.e., tangible property) and “things in action” (i.e., rights capable of enforcement)) that can better recognise, accommodate and protect the unique features of certain digital assets.
2. Second, the Report recommends only targeted statutory reform to confirm and support the existing common law position or where common law development is not realistically possible. In particular, the Report recommends that the Government set up a multi-disciplinary project to formulate and put in place a bespoke statutory legal framework that better and more clearly facilitates the entering into, operation and enforcement of (certain) crypto-token and (certain) cryptoasset collateral arrangements, as this is an area in which the common law cannot provide sufficient certainty.
3. Third, to ensure that the English courts can respond diligently to the complexity of current and emerging digital technologies, the Report calls upon Government to create a panel of industry technical experts, practitioners, academics and judges to provide non-binding guidance on the complex and evolving factual and legal issues relating to certain digital assets. The rationale for this novel approach is that it should drive consistent and informed decision making going forwards, thereby driving confidence in market users.

Overall, the Report does not propose significant legislation is required, concluding that the common law of England and Wales has proven itself “resilient in the face of new technology and flexible enough to answer legal questions concerning digital assets”. Consistent with the UKJT Legal Statements that have gone before, the Report provides a further welcome vote of confidence in the ability of the laws and courts of England and Wales to deal with an increasingly digital future.

Our full article on the Report can be accessed here.

5. UKJT launches new public consultation – Digital Assets and English Insolvency Law

Following the UKJT’s Legal Statement on the issuance and transfer of digital securities under English private law in February 2023, the UKJT is now focusing its attention on the way in which English insolvency law applies to digital assets. This follows on from several recent high-profile collapses of digital asset exchanges, platforms and funds.

A consultation was open for responses until Monday 4 December 2023, with the Legal Statement on Digital Assets and Insolvency Law expected to be published in early 2024.

6. Speech by HHJ Pelling KC – Issues in Crypto Currency Fraud Claims

HHJ Pelling KC delivered a speech at a crypto disputes conference on 28 June 2023, a copy of which can be found here.

HHJ Pelling KC discussed judicial developments in the English Courts over the past 12 months, many of which were discussed in Edition 1 of Digital Digest. Pelling KC’s concluding thoughts indicate his confidence in the ability of English law and the English courts to deal with disputes relating to crypto:

“The cases referred to […] show the incremental development of English law in response to a novel and developing form of commercial activity. I am confident that most industry players will continue to engage with the English jurisdiction because it provides responses that are fair, proportionate and predictable. What uncertainty remains will be eliminated if the statutory law proposals of the Law Commission concerning what constitutes property are adopted. More generally, the working out of the applicable principles will I hope reduce the cost of litigation in this area, improve access to the legal system for victims of fraud whilst enabling intermediaries to arrange their business affairs in reliance upon that level of predictability.”

7. Landmark ruling in Singapore - High Court Recognizes Crypto Assets as Property

In ByBit Fintech Limited vs. Ho Kai Xin and others ([2023] SGHC 199), the Singapore High Court followed the position of the English Courts in declaring that cryptoassets can be legally recognised as property (albeit the Singapore adopted different reasoning, treating crypto as a “thing in action” (i.e., personal rights that can be claimed or enforced by legal action)).

The case concerned a claim brought by Seychelles-based crypto exchange ByBit, against an individual, Ho Kai Xin, who was employed by WeChain and was responsible for the payroll processing of ByBit’s employees. ByBit alleged that Ho Kai Xin had breached her employment contract by transferring a total of 4.2 million in Tether (USDT) to addresses secretly owned by her. The Singapore High Court ruled that USDT qualifies as property and can be held on trust:

“The holder of a crypto asset has in principle an incorporeal right of property recognisable by the common law as a thing in action and so enforceable in court,”

 

News & events

• Past event - 20 June 2023. Cryptoassets: Emerging legal trends in common law and civil law jurisdictions – Thursday: - Video Recording can be accessed here.
• Past event – 28 September 2023. The Global Digital Forum and DLA Piper brought together leaders from government, international business, and regulatory bodies to explore the implications of operating in the evolving digital landscape and its impact on global businesses and capital markets. A summary of the key takeaways from the forum can be found here.

 

ANNEX

Cryptoasset financial promotions: The latest FCA guidance

The Financial Conduct Authority (FCA) published new guidance on the promotion and marketing of cryptoassets through FG23/3 on 2 November 2023. Building upon the new rules from PS23/6 that came into force on 8 October, the new guidance aims to assist firms in fulfilling the central tenet of financial promotion regulation: being fair, clear, and not misleading pursuant to COBS 4.2.1. This article summarises the key elements firms will find useful when considering their own promotions.

Published back in June 2023, PS23/6 detailed the FCA’s new regulatory regime for all firms, domestic or overseas, for the marketing of cryptoassets to consumers. Since 8 October, when the new rules came into force, cryptoassets have been treated as “Restricted Mass Market Investments”, meaning firms are allowed to mass market them but under restriction.

Specifically, “qualifying cryptoassets” are now within legislation under amendments to the Financial Promotion Order 2005 (FPO) and are the focus of FCA regulation. These are defined “as any cryptographically secured digital representation of value or contractual rights that is transferable and fungible.” To engage in the promotion of qualifying cryptoassets a firm can only follow four routes to do so lawfully:

• act as an FCA authorised person;
• have an FCA authorised person authorise an unauthorised person;
• the firm registers with the FCA under the Money Laundering, Terrorist Financing and Transfer of Fund (Information of the Payer) Regulations 2017 (MLRS); or
• the promotion complies with the FPO or its exceptions.

If a firm has satisfied one of the four paths, it will be authorised and thus will be able to legally market qualifying cryptoassets. However, where the guidance in FG23/3 comes in is to ensure all firms still act in a way that is fair, clear, and not misleading.

Prior to making any promotion, firms should first make some key considerations. Firstly, they should engage in a thorough due diligence process to understand the cryptoasset they are promoting, to understand its nature and risks. Secondly, firms should assess whether they can disclose, clearly and prominently, the legal and beneficial ownership of a cryptoasset where this may be subject to change under complex models. Thirdly, all firms must be able to apply the FCA Consumer Duty to ensure that a good outcome is delivered to retail customers alongside the production of rules for products and services, price and value, consumer understanding and customer support.

If a firm believes it can satisfy these elements, the guidance also illustrates a series of other focuses for what promotions should avoid in order to comply with proper practice. Some of the most prominent steps (amongst others) that firms can take from the guidance are:

• ensuring that customers understand the risks involved in the cryptoasset being promoted;
• avoiding exaggerated claims about the returns generated by the cryptoasset;
• presenting marketing in a way clearly comprehensible to consumer;
• disclosing information about past and future performance of the product; and
• providing balanced information on the risks and rewards of the cryptoasset.

Firms should also be aware that all rules extend to social media marketing in an identical manner.

Whilst PS23/6 is the core of FCA policy alongside relevant legislation, FG23/3 is a useful tool for any firms operating in the cryptoasset space by offering practical guidance and quick reference for best practice. This article is mainly a snapshot of core considerations, for a fuller picture we recommend firms should read the guidance.

The Economic Crime and Corporate Transparency Act 2023: A precedent for new cryptoasset regulation?

On 26 October 2023, royal assent was granted to the Economic Crime and Corporate Transparency Act 2023 (ECCTA), introducing a new wave of legislative changes to crack down on the disguise of criminal gains and to strengthen enforcement powers. This comes in the wake of the sanctions regime following the 2022 Invasion of Ukraine, a continued focus on countering terrorist financing, and increased awareness of the sinister purposes to which digital assets like cryptocurrencies can be applied.

Whilst the Act has created sweeping reforms in key areas such as Companies House, sanctions, and information gathering, a more novel area of focus was cryptocurrency enforcement. Accordingly, this may be the sign of the UK government cracking down on a thus far minimally regulated space.

The key takeaways from the ECCTA affecting cryptoassets used in crime are:

• new powers to apply seizure in certain circumstances before arrest;
• creation of exceptional circumstances where crypto assets may be destroyed;
• provision of powers to magistrates’ courts to order the sale of cryptoassets like other assets;
• a new ability for enforcement officers to treat cryptoassets like tangible assets during recovery;
• a new right to take control and recover cryptoassets during the execution of a search warrant;
• a provision to allow release of detained cryptoassets back to victims;
• a new capacity for law enforcement to convert seized cryptoassets into cash, preventing price fluctuations; and
• new powers to recover crypto assets directly from exchange providers and custodian wallet providers.

The core element affecting cryptoassets is the new powers the Act grants for seizure and recovery in cases of economic crime. Building upon Parts 2 to 5 of the Proceeds of Crime Act 2022 (POCA), UK law enforcement agencies will now be allowed to confiscate and seize cryptoassets where they have been attained through criminal acts, or are being used to finance them.

Utilizing the criminal regime of POCA, cryptoassets can now be confiscated before an arrest is made. This will particularly benefit law enforcement due to the often international nature of crimes where criminals may be using digital assets in the UK but are themselves outside the jurisdiction. The new ability to confiscate these assets somewhat counters this issue by ultimately preventing further use of the cryptoassets where arrest is not possible. In certain special cases, the Act also allows for the destruction of cryptoassets, bringing home the point that these intangible assets are very much now being treated like their more traditional counterparts.

The civil regime under Part 5 of POCA has also been amended to enable faster and more efficient forfeiture powers in the recovery of cryptoassets. It also expands the scope of enforcement powers to allow seizure straight from custodian wallet providers.

Whilst confiscation capabilities have improved, ECCTA does not ignore the fact that victims also need to be considered. As part of broader reforms, when cryptoassets are frozen or detained they may now be released back to victims without delay, even potentially prior to the end of an investigation.

Additionally, in line with the government’s increased awareness of cryptoassets are now appearing in terrorist investigations, ECCTA reforms both the Anti-Terrorism, Crime and Security Act 2001 and the Terrorism Act 2000. The changes follow a similar ilk to those in POCA, namely increasing forfeiture powers for cryptoassets but in the context of terrorist offences.

Whilst these changes mainly affect criminal activities, the programme of change introduced by ECCTA signifies that cryptoassets are no longer on the fringe of legislative reform but are increasingly become a common consideration. Moreover, the new tangibility with which ECCTA now recognises cryptoassets signals a new philosophy over how to treat them for enforcement purposes in all aspects of the law in the UK.

NFTs, the blockchain and fan tokens: Football in the spotlight

The role of NFTs and fan tokens in sport, especially football, has been a topic of significant scrutiny for the Culture, Media and Sport Committee (the CMSC) since November 2022, when it launched an enquiry into the topic. Now, after just shy of a year, a report on the topic was published on 11 October, revealing a series of findings and suggestions that will likely influence the regulation of cryptoassets in British sport.

Football was unsurprisingly found to the be the key sport in the UK representing an uptake in the adoption of NFTs, and more specifically, distinct fan tokens. As a reminder, fan tokens are primarily a novelty to sporting franchises. Users are in effect offered a “digital certificate of ownership”, granting them rights or privileges to some element of the club. For example, in 2022 a football league club used fan NFTs to vote on which position the club should prioritise for its next signing, resulting in the choice of a midfielder dictated by that vote.

These cryptoassets are marketed as a way to increase fan input, with clubs taking a fee with the promise of rights, such as voting as in the above case, or other exclusive perks. A good way to up fan engagement, right? The CMSC appears to think not.

Whilst fan engagement platforms have created partnerships with major football clubs to create NFTs and fan token products, the report emphasises its suggestions to reel in the spread of such operations. Cryptoassets may offer a relatively cheap way for clubs to find an additional revenue stream, but they can pose fundamental problems if used to exploit fan’s loyalty to sell what are ultimately unbacked, and potentially financially volatile, products.

Issuing cryptoassets such as tokens to fans is low risk to clubs, and can generate high profit. The key issue is the products themselves offer little value, as the clubs do not back them in any form other than the promise of exclusive rights. The overarching sentiment from the CMSC is that fans are being monetised but are not receiving real value in return.

As part of broader recommendations, the CMSC have suggested to the government that there needs to be a new code of conduct to apply to online marketplaces and fan engagement platforms in relation to cryptoassets. To affirm its belief that fan tokens should see little further uptake without regulation, the CMSC has stressed that fan tokens are not, and should not be treated as, valuable indicators of fan engagement. It should not come as a surprise then if we see new measures to protect the sports fan as a consumer of cryptoassets coming into effect in due course.

Digital Securities Sandbox – Treasury Response

HM Treasury has addressed the feedback to a consultation paper it published on the proposed implementation of the Digital Securities Sandbox (DSS) by publishing a response to the paper on 22 November 2023.

The DSS is intended to be the first financial markets infrastructure (FMI) sandbox produced under new regulatory powers granted to regulators by FSMA 2023. The DSS should allow for firms to access and trial modifications to the UK legislative and regulatory framework. This will help to provide trading and settlement infrastructure for digital securities in cases where there may be barriers to digital assets currently.

The key takeaways from the response are:

• a statutory instrument to implement the DSS will soon be published, with enactment before the end of the calendar year excepted;
• amongst respondents the feedback for the DSS was generally positive;
• there were nineteen expressions of interest from numerous regulated financial services firms but also new entrants; and
• where respondents asked for more clarity was in how firms may apply, how activities within the DSS will interact with activities outside the DSS, how limits set in the DSS will be managed, and how to exit the DSS.

The range of assets that the DSS will cover includes “all relevant assets currently in scope of the regulatory perimeter” save for derivatives and unbacked crypto assets. Moreover, any transferrable securities that are in Undertakings for the Collective Investment in Transferable Securities form will likely be eligible.

The DSS will not prevent firms outside its scope from dealing in digital securities, provided they are compliant with all other existing legislative and regulatory frameworks. In terms of placing limits within the DSS, a flexible approach will be taken. As use of the DSS progresses limits will adapt accordingly, avoiding rigid parameters in legislation. The financial activities covered, however, will be limited mainly to the operation of trading venues and notary, settlement, and maintenance functions.

Expected to run for an initial term of around five years, the response highlights that the DSS will allow certain legislative modification, such as adapting CSDR requirements and will allow the Bank of England to offer exemptions from the rules for designation under the Settlement Finality Regulations.

Further legislation may come into the purview of the DSS, but for the time being future developments will primarily revolve around gaining Parliament’s approval and establishing close initial supervision by UK regulators.

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¹The Law Commission’s view is that an asset will fall within its proposed third category of thing to which personal property rights can relate if: (i) it is composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals; (ii) it exists independently of persons and exists independently of the legal system; and (iii) it is rivalrous (i.e., the use or consumption by one person / group necessarily prejudices the use or consumption of that thing by one or more other persons).