Crypto Revolution or Evoluyton?

In the words of Abba: “Money, money, money; it’s so funny” – and it’s getting funnier. For the uninitiated, the world of blockchain and cryptocurrencies can cause befuddlement and head-scratching. Braver souls may have been tempted to have a flutter, investing in the latest virtual currency in a bid to cash in and become the next.com-style millionaire. Those inside the crypto community have developed their own language of digital wallets, crypto jacking, hashes and consensusbased algorithms. They understand the promises of the brave new world and the opportunities the technology presents to be a game-changer for the economy and way we do business. Companies and governments are starting to look seriously at it, with technology startups turning to initial coin offerings to secure investment, instead of traditional venture capital funding. After a spike in value a couple of years ago it was seen by some as a form of digital gold. Some law firms have even started accepting payments for work in bitcoin – the most well-known cryptocurrency.

WHAT’S THE FUSS?

Cryptocurrency is a virtual or digital currency, like an online version of cash with no physical form. In reality, it is a computer file stored in a ‘digital wallet’ on a computer or smartphone. You can acquire bitcoins in three ways: buy it using real or ‘fiat’ money, by selling things for which you are paid in them, or they can be created by a computer – a process known as mining. The digital money is not backed by central banks or governments, but every transaction is recorded on an open digital ledger known as the blockchain. There is now a plethora of oddly-named crytocurrencies, including Ethereum, Ripple, Litecoin, XRP and Bitcoin Cash; and it’s estimated that the top 100 cryptoassets are worth a quarter of a trillion dollars.

MYSTERIOUS ORIGINS

Bitcoin has been around for just over a decade. It’s origins, explains Richard Hay, UK head of fintech at international law firm Linklaters, are “clouded in mystery” (it forms the subject of Netflix documentary Banking on Bitcoin). There is, says Hay, debate in the community about what bitcoin should be used as – cash, a digital commodity or an investing mechanism. On its benefits, he explains: “There is an economic role for a system that stores value independently of any government, especially in unstable regimes.” He adds that it’s an efficient way of transferring money overseas speedily. The growing interest in the new form of money, Hay says, came about in part as a result of the financial crisis, which fuelled distrust in the established financial system. With the passage of time, it has become better known and, as it has become widely used, it has become more trusted. Marc Jones, a partner at Stewarts Law, suggests the rise has been mainly down to financial speculation. “The massive increase in the price of bitcoin over just a few years really got people’s attention around the world. On the back of that more and more cryptos were launched with the aim of making their developers and early adopters rich.” Cryptocurrencies remain much less widely used when compared with regular fiat monies. But, suggests Jones, that has the potential to change with the advent of Libra, the cryptocurrency planned by social media giant Facebook. With plans to launch sometime this year, Libra records transactions through the blockchain, but relies on a more centralised infrastructure that has the support of major businesses. To prevent it suffering from the price volatility associated with bitcoin, it is backed by a range of financial assets held in a variety of currencies. Although the Swiss authorities, where Libra is set to be based, initially gave it the green light, they have since raised concerns about its suitability as a global currency, which looks set to delay the launch.

LEGAL STATUS

In the UK, uncertainty over the legal status of assets created using blockchain technology is said to have blocked wider adoption, investment and development. But last November, a high-profile panel led by the High Court judge Sir Geoffrey Vos (though not in his capacity as a judge) issued a legal statement to the effect that cryptoassets are the same as property – going some way towards addressing that uncertainty. The statement says cryptoassets “have all of the indicia of property” and the “novel or distinctive features possessed by some cryptoassets — intangibility, cryptographic authentication, use of a distributed transaction ledger, decentralisation, rule by consensus — do not disqualify them from being property”. The statement was intended to provide investors with “increased confidence of their rights” and “a dependable foundation for mainstream utilisation of crypto-assets”. Sir Geoffrey said: “In legal terms, cryptoassets and smart contracts undoubtedly represent the future.” Lawyers suggest the greater certainty over their legal status means cryptoassets will be used more frequently by the wider population as well as specialist investors. Chris Bushell, a partner in the disputes practice at Herbert Smith Freehills, says that while the statement did not have legal status, the clarification that cryptoassets were to be treated “in principle” as property does “take us one step further along in the legal analysis”. He suggested that the statement would be used by litigating parties, but says there are more legal questions to be answered. Despite the statement, Jones says the status of cryptoassets under English law remains unclear. He says: “The legal statement is very clear, persuasive and helpful, but it has no legal effect.” He explains: “Fortunately, it does very much look as though English law is prepared to treat cryptoassets as a type of property. But until we get either a Supreme Court decision or legislation, developers, investors and others involved in this part of the economy can’t be sure.” He also stresses that “the devil will be in the detail: no two cryptoassets are the same, and it is quite possible that two apparently similar cryptos could be treated quite differently at law”.

CRYPTO IS PROPERTY

A judgment from the High Court in December took another step forward in clarifying the situation. In AA v Persons Unknown & Ors, Re Bitcoin [2019] EWHC 3556, Mr Justice Bryan concluded that under English law “a crypto asset such as Bitcoin are property”. He said: “I am satisfied for the purpose of granting an interim injunction in the form of an interim proprietary injunction that crypto currencies are a form of property capable of being the subject of a proprietary injunction.” On the face of the law, he said there was a “difficulty” in treating bitcoins and other cryptocurrencies as a form of property because they were “neither chose in possession nor are they chose in action”. He commented: “They are not choses in possession because they are virtual, they are not tangible, they cannot be possessed. They are not choses in action because they do not embody any right capable of being enforced by action.” While Bryan J said the legal statement was not a “statement of the law” he commented that its analysis as to the proprietary status of cryptocurrencies was “compelling” and “should be adopted by this court”. Explaining his decision, he said that cryptoassets meet the four criteria set out in Lord Wilberforce’s classic definition of property in National Provincial Bank v Ainsworth [1965] 1 AC 1175 as being “definable, identifiable by third parties, capable in their nature of assumption by third parties, and having some degree of permanence”. He also cited other English authorities in which cryptocurrencies had been treated as property, including Liam David Robertson v Persons Unknown (unreported; 15 July 2019) where an asset preservation order over crypto currencies was granted.

ACCEPTING BITCOIN

Perhaps indicating that digital currencies are becoming more mainstream, some firms – naturally risk adverse creatures – have started to accept them as a method of settling bills. Most UK firms remain wedded to hard cash, but Selachii, a bitcoin and fintech specialist firm based in Kensington is, according to its website, prepared to open its virtual wallet and accept payment by bitcoin. Richard Howlett, the firm’s senior partner, says: “We are open to any kind of payment but before accepting we would undertake due diligence and [‘know your client’].

So for example, if someone wished to pay in crypto and could prove that their source of crypto was legitimate… then we would accept payment of an invoice in crypto.” He added that the firm would also adhere to the directions under the Fifth Money Laundering Directive (5AMLD) in terms of source of funds. Last November Quinn Emanuel Urquhart & Sullivan, the US-headquartered litigation firm (it also has a London office) announced it had started accepting Bitcoin and other cryptocurrencies, joining other US law firms, including Perkins Coie, Steptoe & Johnson and Frost Brown Todd that reportedly accept the new money. In a statement, the firm’s founding partner John Quinn said: “As a global law firm with multiple fintech clients we are very comfortable in adapting to — and adopting — new currencies and forms of payment.” He added that the firm wanted “to be flexible for our clients. Bitcoin is an easy and secure way to transfer funds, and we embrace it.” However, last year John Reed Stark, former head of the internet enforcement office at the US Securities and Exchange Commission, wrote a blog advising lawyers against accepting payment in cryptocurrencies. He said if they did they “must have reasonable policies, practices and procedures in place to ensure fee arrangements are not somehow facilitating criminal activity”. Many businesses have eschewed this type of payment, associating it with criminals dealing drugs and arms on the so-called dark web.

But, insists Jon Wedge, an adviser and auditor for Financial Conduct Authority (FCA)- regulated entities and blockchain businesses at chartered accountants and tax specialists BKL, it’s a misconception that Bitcoin is a great way for criminals to carry out their activities or to launder money, because you can trace every transaction back to where it came from. In August 2019, BKL announced it had become one of the first UK professional service firms to accept crypto payments. A move, says Wedge, driven by demand from clients, a growing number of whom are people and businesses that work with cryptocurrencies and blockchain. “Paying our fees via bitcoin is a convenient way for many of them, particularly those in the fintech and technology sectors, to buy our services”, he says. “We also recognise the importance of professional services firms being forward-thinking in a rapidly changing, increasingly paperless world.” Crypto, he explains, allows for instant, borderless payments which can be an advantage for businesses that trade globally and particularly those with an e-commerce platform. They are not bound by a single country’s exchange rate or location and, in addition, avoid banking transaction charges. “And there is the marketing edge”, Wedge adds. “The very fact of accepting crypto communicates something dynamic and engaged about a business; and being able to offer several payment options, including this one, helps secure trade as well as to stand apart from rivals.” Accepting crypto payments, he says, requires technical knowhow, something he suggests few businesses will have the time or willingness for. There is, he says, “an infrastructure associated with holding the coins, plus the matter of working out what they are worth at the crucial moment an invoice is raised”. To help out, he says, there are a number of large, well-regarded exchanges that absorb the risk of accepting digital payments and make the necessary transfers, including translating the crypto into the fiat amount billed. Like Quinn Emanuel, BKL works with the payment processing provider BitPay which, he says, has developed a strong compliance and anti-money laundering function. “These essentially absorb the risk of accepting digital payments and make the necessary transfers, including translating the crypto into the fiat amount billed,” he says, removing the risk of loss due to the volatility of the market and price fluctuations. He continues: “That bitcoin price is then fixed for 15 minutes before being automatically renewed using the same process. The invoicing firm then receives its payment electronically through BitPay, but as fiat money.” Firms that accept payment in cryptocurrency, warns Hay, must have appropriate practical and governance structures in place around how they hold it, including consideration of how the password key is stored and who has access to it.

CRYPTO QUEEN

Cryptocurrency recently hit the headlines for the wrong reasons, with the OneCoin scam and disappearance of the so-called ‘crypto queen’. Spotting an opportunity in the cryptocurrency goldrush, as the price of bitcoin started to rise, Ruja Ignatova, an Oxford-educated Bulgarian-German businesswoman thought she could go one better and invented rival coin OneCoin. It is alleged she persuaded investors around the world to invest more than £4m in the new currency before disappearing two years ago. She is now sought by the FBI. Her brother Konstantin Ignatov, who was arrested with other OneCoin bosses in the US, admitted it was all a scam. Pleading guilty to charges including money laundering and fraud, he told prosecutors there was no underlying blockchain for OneCoin and it had all been an elaborate Ponzi scheme. While the scandal has not helped the industry, Wedge insists that “by its design blockchain is designed to be law-abiding”, providing a permanent record of transactions that are private but not anonymous.

REGULATION

As with any growing activity, cryptocurrency has naturally caught the eye of regulators. In the UK there is no regulatory regime, but the European Commission has issued consultation papers on how the space should be regulated. In January 2020, 5AMLD came into effect subjecting cryptocurrency exchanges to the same stringent rules as other financial institutions. And it is anticipated wider regulation will be introduced, which will most likely lead to greater use of the digital money by banks and the public in general. “The idea that it is only anarchists who want to take back control from government and financial institutions, that are interested in bitcoin and other cryptocurrencies, is nonsense,” says Wedge. One of the biggest attractions of cryptocurrencies, says Jones, is the dramatically reduced cost of making payments and international transfers when compared to regular bank payments. “If there was a cryptocurrency that had widespread trust, it’s easy to see why it could become widely adopted,” he says. And when there is more regulation, Wedge predicts that larger financial institutions will be more comfortable getting involved. He expects that a central bank will create a stable coin offering linked to regular currencies like the pound, euro or dollar which he says would make things safer for everyone and help governments with their fiscal planning. Even if this happens, crypto will not replace banks or fiat but, say the lawyers, could provide a viable alternative. “At root, money is all about trust. People have lost trust in some national currencies before, and who’s to say that won’t happen again – and that next time round the replacement could be a crypto or digital currency,” says Jones.