The widespread use of virtual currencies and other crypto assets may lead to problems that have been well-known for centuries in private law. The media reveal on an almost daily basis numerous cases of transfers that are the result of either fraud or coercion. Less reported, but equally possible is that the transferor commits a mistake or lacks legal capacity when making the transfer. Besides problems with faulty transfers inside the blockchain (which may be called ‘endogenous problems’), there may also be a need to change the blockchain because of events that take place outside of it (to be called ‘exogenous problems’). Examples include the opening of insolvency proceedings or a succession into the estate of the holder of crypto assets.
The Distributed Ledger Technology (DLT) is incapable of dealing with both types of problems: Neither does it provide a mechanism to reverse faulty transfers, nor does it allow for a transfer of title outside the blockchain. DLT was designed to avoid the risk of double spending, yet it does not solve other problems that are standard in private law.
One could of course simply try to impose the ordinary rules of private law on the blockchain, such as those on fraudulent transfer or on the effects on insolvency. Two characteristics of the DLT make this enterprise very tricky. The first is the irreversibility of the blockchain. Once a transaction is recorded, it becomes virtually impossible to correct or delete it from the ledger. How can private law fulfil its corrective function under these circumstances? The second problem is caused by the a-national nature of the DLT. Before one can apply any rule of private law, one needs to clarify the governing law. Private international law is centred on the idea that the legal system with the closest connection applies. Yet given that the DLT is not connected to any particular state, how can such a connection be identified?
I have dealt with these questions in a recent paper forthcoming in the Minnesota Journal of Law, Science & Technology. The gist is as follows: The irreversibility problem can be resolved by the obligation to make a transfer. For instance, a person who has received a certain amount of Bitcoin by error could be obliged to send back the same amount. A transfer obligation may also be the remedy of choice to effectuate the rights of an insolvency administrator or the heir of an estate.
As for the applicable law, the UK Financial Markets Law Committee has made a number of proposals for factors connecting the DLT to a legal system. They range from the choice of the governing law (dubbed ‘elective situs’) to the place of the relevant operating authority (‘PROPA’) to that of the primary residence of the coder. These factors work best for permissioned networks with a governing authority and a number of identified nodes. They do not, however, provide an answer for permissionless networks where the coder is unknown, such as Bitcoin. In the latter case, there seems to be no other solution than to renounce the identification of one particular governing law. Instead, different national laws should be applied that correct blockchain records where necessary. For instance, the law of torts is the appropriate instrument to rectify the consequences of a coerced transfer, and the law of restitution could be used to ordain the retransfer of crypto assets sent by mistake. These laws can be easily identified using the classic connecting factors, such as the place of the tort or the place of enrichment, because they point to facts outside of the blockchain.
In sum, the validity of a blockchain transfer should not be assessed using the ordinary concepts of property law. Instead, the ledger should only be corrected where necessary by a transfer obligation under an applicable national law. This solution seems, in my view, attractive because it (1) stays clear of an overly assertive role of the law that would make the DLT inefficient and ultimately unviable, (2) corrects its results only to the extent necessary, using the forms and procedures of the DLT and (3) dispenses with the need for identifying one national law governing the blockchain by distributing the applicable rules among the various affected legal systems.
The proposal developed in my paper does not entirely exclude any role of property law concepts for the blockchain. Yet it reserves their application to those cases where an applicable law can be clearly identified—eg by a choice of law embodied in the code of the ledger. Moreover, it leaves the precise rules and consequences to the applicable law. In this way, it is open to conceptions of private law for the DLT that may be developed on the national level.
Matthias Lehmann is Professor of Law at the University of Bonn.