Digital assets and the conflict of laws

In 2023, lawmakers and regulators across the globe have continued to face up to the challenges brought by digital assets, such as cryptocurrencies and non-fungible tokens. One area that perhaps receives less media attention is the challenge of accommodating digital assets within international conflict-of-law rules.

Conflict-of-law rules assist lawyers in determining which jurisdiction’s laws apply to cross-border transactions that have connecting factors to more than one jurisdiction, from commercial deals to succession and inheritances. The body of rules that has developed over time to try to resolve these issues is generally referred to as private international law (PIL).

Why is this so complex for digital assets?

The main issue is the question of where digital assets are located. Although the situs of most asset classes has long been settled under domestic laws, digital assets present some novel questions due to their unique characteristics.

Broadly, crypto-assets exist as intangible computer code on digital ledgers that are distributed across multiple computers (or ‘nodes’) worldwide. These distributed ledgers are also known as the blockchain. Transactions on the blockchain are described as ‘decentralised’, since no one person or group can block or approve a transaction or rewrite the state of the ledger. Instead, the blockchain code determines whether a change to the ledger may be validated. However, practical control of a specific crypto-asset or token is possible with a ‘private key’, i.e., a series of numbers and letters that is often stored on a hard copy device or on a computer.

To date, there have been various approaches put forward by academics, courts and tax authorities in different jurisdictions as to how to determine the situs of such unique assets, but the area is still relatively untested and harmonisation is sorely lacking.

Another issue is that the newness and complexity of the technology can mean that the terminology used to describe the assets or definitions of their core features may vary. This leads to more uncertainty as market participants have to consider whether the token they have fits into the same ‘box’ in each jurisdiction or context in which they operate.

Implications for cross-border succession

In PIL terms, when jurisdictions apply different rules regarding the location of the same asset it can lead to complex outcomes. If more than one jurisdiction (or none at all) considers that it has control, conflicts can arise. In a succession context for individuals with international connections, such a situation may cause uncertainty regarding the laws that govern their estate on death and how it will be administered.

Example

Alice is habitually resident in England and owns some cryptocurrency. The private key is stored on a USB stick that she keeps at her parents’ house in Abu Dhabi. Under English and Welsh law,[1] Dicey and Morris suggests,[2] tentatively, that the state of location of the owner of the cryptocurrency has indirect control of the property and, therefore, has the best claim to being where the property is located under existing lex situs rules. The ‘owner’ would be the party who exercises factual control, such as being able to effect a sale. The situs of Alice’s cryptocurrency would therefore likely be England, from an English law perspective. However, if Abu Dhabi were to consider the cryptocurrency to be located in Abu Dhabi because the private key is physically there or because Alice’s parents could also be said to have control of the private key, there would be a conflict as to the situs.

This could cause difficulties if Alice has executed separate wills covering her English property and her Abu Dhabi property on different terms. It could also call into question which succession law applies. For example, if Alice is UK-domiciled, then English law will govern the succession of her cryptocurrency as a movable asset. However, if Abu Dhabi considers itself to be the competent forum for succession matters relating to assets situated within its territory, it might then apply another succession law to the cryptocurrency under its domestic law.

So, how are legal bodies trying to resolve these issues?

Law Commission of England and Wales

Over the past few years, the Law Commission of England and Wales (the Commission) has brought together legal and technological experts to consider some of the more complex issues relating to digital assets, with the aim of supporting courts to develop consistent, evidence-based principles. In July 2022, the Commission published its digital assets consultation paper (the Paper),[3] a detailed examination of the technological features of a wide range of digital assets, along with an analysis of fundamental questions and challenges posed by digital assets (for example, whether they fit within the traditional types of property at common law). On 28 June 2023, the Commission published the final report (the Report) with its final recommendations.[4]

Although neither directly considered conflict-of-law questions, the Paper started to lay the groundwork for how such questions might be resolved. The Commission suggested that identifying the person with ‘control’ may be a way to ascribe situs for conflict-of-law purposes. The concept of control could be developed through non-binding guidance produced by industry experts to foster innovation and ensure the law is flexible enough to keep pace with technology rather than defining it in legislation. In the Report, the involvement of industry experts was one of the three pillars of the Commission’s key recommendations, alongside common-law development and limited statutory reform.

It should be noted that the concept of ‘control’ will have broader application than conflicts of law. In the Report, the Commission states: ‘We think that the courts will turn to the concept of control as a matter of default.’ According to the Commission, the concept of factual and legal control in a digital asset context is highly nuanced and may provide a way in to understanding and characterising many transactions involving digital assets.

In addition, in October 2022, the Commission announced a related project, ‘Digital Assets: Which law, which court?’ This project will focus primarily on conflict-of-law issues, including how to determine which court has jurisdiction over crypto-assets and situs. Publication of the consultation paper is expected in the second half of 2023. It is hoped that the Commission will apply the same methodical approach to these questions as to the other legal issues considered in its earlier reports and that it will build on its earlier analysis.

UNIDROIT

In parallel, the International Institute for the Unification of Private Law (UNIDROIT) has been working on a set of principles covering a wide range of PIL issues for digital assets that countries could enact in their domestic legislation (the Principles).

The Principles, currently in draft, also look to the concept of control. They define a digital asset as ‘an electronic record which is capable of being subject to control’. Principle 6 defines control as the exclusive ability to obtain (and to prevent others from obtaining) the benefit of the digital asset and the exclusive ability to transfer those abilities to another person. The commentary to Principle 6 indicates that a person may identify themselves as having control by ‘reasonable means’, such as a cryptographic key or account number. It also makes the point that factual control (such as being able to influence a private key holder to follow your wishes) can be as important as the functional control of possessing the private key.

Final thoughts

It is not possible to eradicate conflicts of law in a succession (or any other) context. However, the ongoing work of both the Commission and UNIDROIT, with their focus on control as a key connecting factor, are positive steps.

Both the Commission and UNIDROIT are in favour of jurisdictions developing their own concept of control. This may well be the right approach given the inherent variability and constant innovation of blockchain technology, although, the meaning of control will inevitably be interpreted differently between states. However, the Commission says that it intends its recommendations to be consistent with other reform initiatives, including UNIDROIT’s, and that UNIDROIT’s work could be a source of guidance on the concept of control.

In short, if control of a digital asset were accepted internationally as the touchstone for assigning a location to a digital asset, this would simplify cross-border succession planning, even if what control means remains somewhat subject to interpretation on a jurisdiction-by-jurisdiction basis.