Once merely the technological foundation of Bitcoin and known only to virtual currency cognoscenti, the ‘blockchain’ or, more generically, ‘distributed ledger technology’ has emerged from the shadows to become an enthusiastically discussed technology in its own right. The aspirations that some have for it are exemplified by a recent UK Government report on the subject:
‘distributed ledger technology provides the framework for government to reduce fraud, corruption, error and the cost of paper-intensive processes. It has the potential to redefine the relationship between government and the citizen in terms of data sharing, transparency and trust. It has similar possibilities for the private sector.‘[1]
Whilst the most well-known application of blockchains is still Bitcoin, there have already been other applications; it has, for example, been used to record and transfer diamonds.[2] If the technology really does provide ‘the‘ framework to reduce fraud, corruption, error and cost, it is not unreasonable to expect an explosion of uses, including those (such as Bitcoin itself) where the contents of the blockchain amount to valuable assets.
Just like any other valuable assets, blockchain-based assets are susceptible to theft and fraud, as exemplified by the well-publicised instances of alleged ‘theft’ of bitcoins such as the one in January 2015 when the UK bitcoin exchange ‘Bitstamp’ was hacked and $5m bitcoins were stolen. Such phenomena raise an obvious question: if a bitcoin (or any other blockchain-based asset) is stolen or if the owner is defrauded, is there a legal route to recovery? Although in a practical sense a bitcoin is property, what about in the legal sense? Can a bitcoin be ‘owned’? What rights of action does an ‘owner’ have against a third-party recipient of the ‘stolen’ asset? Notwithstanding that in some circumstances there may be potential for a contractual claim against an exchange, these questions seem to us pertinent in the case of Bitcoin and, if distributed ledger technology is set to become more widespread, potentially have far greater ramifications. This article considers (at a relatively high level) how English law might approach some of these questions.[3]
Blockchains
Conceptually, a blockchain is a public, distributed database, whose structure resembles a ledger in which each new data ‘block’ that is added or ‘chained’ to the ledger is inextricably linked to every previous entry. By virtue of the chaining process (which uses public key cryptography), the distributed public nature of the database, and the CPU-heavy block verification process, the authenticity of the blockchain is readily ascertainable and alteration of previous entries is rendered impracticably difficult.
In the context of Bitcoin, the blockchain publically records each transfer of a bitcoin, or parts of a bitcoin to and from unique addresses. Individuals control particular addresses with a private key and transfers are only possible by using that key to sign the transfer. Every transfer of every bitcoin (or part of a bitcoin) is broadcast to participating nodes and becomes part of the blockchain; thus every transfer can be traced back through the blockchain and can thereby be authenticated.[4] Amongst the many qualities that make Bitcoin interesting are (1) that bitcoins do not exist apart from the blockchain and (2) that the transfer of every bitcoin can be perfectly traced from address to address.
Is there property in a bitcoin?
It is intuitive to treat the holder of a private key as ‘owner’ of the bitcoins associated with that key. There are, however, two difficulties from a legal perspective. The first is that ‘ownership’ is a difficult concept to define in the English legal system: whereas in everyday language, ‘owner’ is typically used to label the person who has the absolute and best right to a thing;[5] the English legal system recognises that there can be multiple individuals each entitled to assert ‘ownership’ rights to the same property.[6]
The second, rather more fundamental difficulty is that the subject matter of ownership is property, and it is not at all clear that a block of data in a blockchain would be recognised in English law as property. Some authority for the proposition that such data would be recognised as property can be found in the case of Armstrong DLW GmbH v Winnington Networks Ltd [2013] Ch 156 at [275]–[276], a case concerning a fraud by persons unknown that led to the transfer of carbon credits from (innocent) Armstrong to (also innocent) Winnington. As with Bitcoin, the carbon credits exist only electronically, and have no existence outside the national registers in which ‘ownership’ is tracked.
In Winnington, the court considered a number of earlier cases in which the different statutory definitions of property had been analysed and concluded (at [50]):
‘Applying the test enunciated by Lord Wilberforce in National Provincial Bank Ltd v Hastings Car Mart Ltd [1965] AC 1175, in my judgement, an EUA [i.e. a carbon credit] is “property” at common law. It is definable, as being the sum total of rights and entitlements conferred on the holder pursuant to the ETS. It is identifiable by third parties; it has a unique reference number. It is capable of assumption by third parties, as under the ETS, an EUA is transferable. It has permanence and stability, since it continues to exist in a registry account until it is transferred out either for submission or sale and is capable of subsisting from year to year.’
Many of the same points could be made in relation to Bitcoin or any other blockchain-based asset: like carbon credits, bitcoins are (1) definable, (2) identifiable by third parties; and (3) transferable; they also have permanence (indeed, they arguably have greater permanence than carbon credits, as they exist in a widely distributed database as opposed to a mere handful of national registries). However, there is also a potentially important difference: whereas a carbon credit comes with a bundle of rights and entitlements conferred by statute, a Bitcoin does not; consensus of the users may imbue it with value but unlike a carbon credit it does not come with a bundle of rights – it is ‘mere’ information.
There is clear authority, at Court of Appeal level, for the proposition that there can be no ‘property’ in information. In Your Response Limited [2014] EWCA Civ 281 the Court of Appeal rejected the submission that an electronic database was a type of intangible property that was capable of possession and therefore capable of being subject to a lien. Floyd LJ stated (at [42]):
‘When information is created and recorded there are sharp distinctions between the information itself, the physical medium on which the information is recorded and the rights to which the information gives rise. Whilst the physical medium and the rights are treated as property, the information itself has never been.’
This ‘sharp distinction‘ is principled but tends to undermine the case for deploying Winnington as the basis for treating bitcoins as property.[7] And if bitcoins are not property it is not obvious how they can be owned or indeed possessed.[8]
Does it matter?
Whether a bitcoin (or other blockchain-based asset) can be ‘owned’ and whether it is ‘property’ may be interesting academic questions, but labels such as ‘owner’ and ‘property’ are of no practical importance if a bitcoin ‘owner’ whose bitcoins have been misappropriated is denied remedies that would be available to a conventional ‘property owner’ in a similar position. In the remainder of the article we consider whether and the extent to which that is so. Specifically, we consider the extent to which causes of action that English law provides to owners whose property has fallen into the hands of third parties might successfully be relied upon in relation to blockchain-based assets (and, in particular, Bitcoin). We do so by reference to the following scenario:
– a thief (X) fraudulently transfers bitcoins from an address controlled by A to a third party (C)
– X has vanished into the Dark Net and is untraceable
– A wishes to recover his bitcoins (or their value) from C.
Of course, it is not every case where A will need to look to C for his remedy. If X can be traced then there may be claims in the tort of deceit or, if there is a contract between A and X, for breach of contract; if the fraud has occurred in the context of a bitcoin exchange, A may have contractual and negligence claims against the exchange (for example on the basis of an express or implied duty to take certain steps in relation to security and/or to take reasonable care in relation to security); a similar analysis may apply where A has been provided with software (such as an e-wallet) that is later compromised.
Our focus is on the prospects of A claiming against C for two reasons: first, C actually has the bitcoins and so is the obvious target of an action; secondly, the potential claims against C are ‘property-like’ in nature (in that there is no direct relationship between A and C) and are thus the most likely to be affected by the question of whether bitcoins are ‘property’ and whether they have an ‘owner’.
Potential remedies against third-party recipient of a stolen bitcoin
There are several possible causes of action that may give an innocent victim of Bitcoin theft (A) a remedy against a third party recipient of those bitcoins (C).
Conversion
The most obvious ‘proprietary’ remedy is given by the tort of conversion. If A’s bicycle was stolen by X and then later transferred to C then A will be able to claim the bicycle from C.[9] In the tort of conversion, liability is ‘strict’ and there is no general immunity for a third-party purchaser who takes possession in good faith and for value (the so-called ‘bona fide purchaser’ exception).[10]
Curiously, the bona fide purchaser exception does apply to money: Miller v Race (1758) 1 Burr 452. A third party who acquires possession of money in good faith and for value destroys all superior titles to that money. The reason for this exception in the case of money may be the need for certainty in commercial transactions (a reasoning that might equally apply to Bitcoin).
However, the tort of conversion is unlikely to assist in the context of bitcoins, as intangible rights are not protected by the tort of conversion: OBG Ltd v Allan [2007] UKHL 21. Physical things such as a bicycle or cash can be converted but there can be no ‘conversion’ of a thing that is not capable of physical interference. Although it is common to think of bank accounts as relating to physical vaults of cash, as a matter of law, a positive balance in a bank account is no more than a contractual right against the bank to be paid the balance on demand. Accordingly, the fraudulently transferred proceeds of a bank account cannot be the subject of the tort of conversion either – so Bitcoin is no worse off from that perspective.
Where the innocent party can point to a ‘thing’ that has been taken the tort of conversion can offer assistance. For example, if a physical cheque or a share certificate is stolen then the person in possession of the piece of paper can be sued and the damages will reflect the ‘face-value’ of the paper (ie the value of the shares): International Factors Ltd v Rodriguez [1979] 1 QB 351. By analogy, were the private key to be written down on a piece of paper or electronically recorded on a portable storage device then the tort of conversion would lie against the person who had physically interfered with the paper or storage device. However, that is unlikely to be the position in relation to most cases of misappropriated bitcoins and, absent a physical ‘thing’ that can be identified as having been converted, the tort of conversion will be of no assistance.
The problem here is not so much whether Bitcoins are or are not ‘property’ but that they are not tangible property.
Knowing receipt
A claim in ‘knowing receipt’ may in many cases be a more promising avenue for the victim of Bitcoin theft. The requirements for such a claim were outlined by Hoffman LJ (as he then was) in El Ajou v Dollar Land Holdings [1994] 2 All ER 685 (at p 700):
‘For this purpose the plaintiff must show, first, a disposal of his assets in breach of fiduciary duty; secondly, the beneficial receipt by the defendant of assets which are traceable as representing the assets of the plaintiff; and thirdly, knowledge on the part of the defendant that the assets he received are traceable to a breach of fiduciary duty.‘
If a claim for knowing receipt is made out then the claimant is entitled to the assets, or their value, from the third party. Accordingly, if available, the remedy is ‘property-like’ in that it is capable of protecting assets that are in the hands of third parties.
In the context of Bitcoin theft, these requirements would arguably be made out. A thief is a constructive trustee of that which he takes for the rightful owner: Westdeutsche Landesbank Girozentrale v Islington London Borough Council [1996] AC 669 at p. 716. In the Winnington case, the High Court concluded that the theft of carbon credits gave rise to a constructive trust that was capable of founding a claim for knowing receipt. The conclusion that a constructive trust arises on theft (at [125]–[129] and [275]–[276]) suggests that carbon credits are capable of being ‘trust property’, but this is not particularly illuminating as many intangible rights (such as the benefits of a contract) are capable of being trust property. Accordingly, the categorisation of Bitcoin in this regard may well be unimportant.
The second requirement (that of ‘tracing’ the assets into the hands of a third party) should be trivial in the case of any blockchain-based asset, given that the transactional history will be publically recorded in the blockchain (albeit the address may be private). The third requirement is that the third-party recipient has knowledge such as to make it unconscionable for him to retain the benefit of the receipt: BCCI v Akindele [2001] Ch 437. Although at first blush succeeding on this third requirement may seem to pose a significant hurdle, that may not always prove to be the case in practice, as the transaction history embedded in the blockchain may make knowledge difficult to disclaim, at least in circumstances where the theft has been well publicised.
Proprietary restitutionary claims and unjust enrichment
The court in Winnington considered two further claims that could be made in respect of the stolen carbon credits (1) a proprietary restitutionary claim and (2) a claim in unjust enrichment (which was distinguished by the court from a proprietary restitutionary claim).
The court held a proprietary restitutionary claim to be available in respect of intangible property that has been received by a third party. It further held that in order to make good such a claim the claimant needs to be able to assert a legal title to the intangible property and demonstrate that the legal title remains with the claimant, and that the bona fide purchaser defence would apply to such a claim. The conclusion that such a proprietary restitutionary claim exists is not without its difficulties[11] and the court was not able to identify a clear cause of action for such a claim (at [90]). In any event, the question of whether a holder of a Bitcoin private key could avail itself of such a claim would plainly turn on the question of whether a bitcoin is intangible property in respect of which an ‘owner’ could be said to have legal title. Thus a proprietary restitutionary claim cannot be advanced without resolving the labelling issue and distinguishing the Court of Appeal judgment in Your Response.
More promising for the owner of a misappropriated blockchain-based asset was the court’s recognition in Winnington of the possibility of a claim based on unjust enrichment to recover the carbon credits (at [95]-[98]). The elements of such a claim are (1) enrichment (2) at the expense of the claimant that (3) is unjust. In the context of unjust enrichment the relevant defence is not that of a bona fide purchaser for value but instead that of change of position. We consider that an unjust enrichment claim is the most promising approach in English law to the recovery of a misappropriated bitcoin from a third party. In part that is because such a claim does not turn on the labelling of a bitcoin as ‘property’ or its holder as ‘owner’. Mainly, however, it is because the constituents of a claim in unjust enrichment seem to us to reflect the reality of the situation in which the parties we have referred to as ‘A’ and ‘C’ will usually find themselves – C will have been enriched (because the blockchain treats it as holder of an asset to which the market ascribes a value), such enrichment will be at the expense of A (who is no longer holder), and in most circumstances the enrichment is likely to be unjust. Assessment of the effectiveness of the remedy in practice will of course have to await a judgment in the context of a blockchain-related case.
Closing remark
The blockchain has already brought innovation to the payment services market and its application to other sectors has already begun. It is clear that lawyers and courts will likewise need to display innovation when analysing the legal status of the blockchain and its transactions. This article is not the first word in Computers & Law on this topic, and we can state with confidence that it will not be the last.
Matthew Lavy is a barrister at 4 Pump Court and a Trustee of the Society for Computers and Law
Daniel Khoo is a barrister at 4 Pump Court.
[1] Distributed Ledger Technology: beyond block chain, report by the UK Government Chief Scientific Advisor, published 19 January 2016.
[2] ibid, pp. 56 – 57.
[3] Due to the international nature of distributed ledgers, questions of which law and jurisdiction apply could clearly arise in many disputes: those are not the focus of this article.
[4] Bitcoins can also be ‘mined’ or earned through processing transfers of bitcoins.
[5] This usage broadly correlates to the Roman law concept of ‘dominium’.
[6] See, for example, the successful claim in conversion by a thief of a car against the police force that subsequently removed the car from the thief in Costello v Derbyshire Constabulary [2001] EWCA Civ 381.
[7] It is not wholly obvious how Winnington and Your Response are to be reconciled even in the context of carbon credits, but that is a discussion for a different article!
[8] We mean no disrespect to the court in Winnington that the question of how carbon credits may have been possessed also appeared to give rise to difficulty.
[9] Winfield & Jolowicz on Tort, 19th ed at 18-041 – 18-042, see also the Sale of Goods Act 1979, s 21.
[10] Although there are a number of limited circumstances in which A’s initial rights are destroyed, eg, the Sale of Goods Act 1979, ss 23, 24 and 25, the Factors Act 1889, s 2(1) and dispositions under the Hire Purchase Act 1964, part III.
[11] Strictly speaking the conclusions were dicta not ratio. The reasoning is problematic for a number of reasons. A distinction was drawn (at [65]-[69]) between ‘tracing’ cases, in which the claimant identifies the property’s substitute, and ‘following’ cases in which the claimant follows the original asset into the hands of a third party. However, the court appeared to then apply cases involving the equitable ‘tracing’ of assets in a ‘following’ context and held (at [83]) that there was no reason why, in cases where the claimant asserted a legal title, the same remedy should not be available. Further, although the court recognised that conversion protected tangible property, it gave no explanation for why intangibles should be protected by a ‘proprietary restitutionary claim’ (see [86]–[87]) when intangibles were not protected by conversion. Nor was any reason given for treating the bona fide purchaser defence as an answer to the proprietary restitutionary claim when such a defence did not exist in the context of the tort of conversion.
