The rise of the digital economy has been beyond rapid in the second decade of the 21st century, causing significant disruption across all markets. Modern technological innovations are no longer seen as a matter of additional efficiency but rather as a necessity for business longevity. In the fourth quarter of 2016, there were just under 11 million digital wallets capable of storing and transferring cryptocurrency. As of July 2022, over 80 million have been recorded.^[1] The gap between traditional economic processes and digital economic processes is closing at a faster rate than ever before. Central banks around the globe are seriously considering the implementation of central bank digital currencies (CBDCs),^[2] and are initiating innovative blockchain strategies to boost their economic growth.

The international legal landscape aiming to regulate the use and validity of market interactions through the blockchain has not seen a similar rise. To the contrary, some countries are still attempting to define cryptocurrencies, while others are developing blockchain legislation without critically defining cryptocurrencies or the liability arising in multijurisdictional crypto deals.^[3] This reveals the ‘tip of the iceberg’ – the lack of an international consensus on cryptocurrency, asset tokenisation and smart legal contracts, among others, creates a fundamental challenge for private international law (PIL), as the legal position of such assets and contracts is unclear in some jurisdictions. The resulting failure arises when rules governing cross-border disputes are absent as national law is yet to firmly cement legal classifications associated with the digital world.

In basic terms, blockchain refers to the shared decentralised database on which a range of data is stored in ‘blocks’, where these blocks are connected to one another through unique ‘hashes’ (mathematical functions), which thus forms a chain of blocks. Each block contains its own unique hash as well as that of its predecessor. These blocks are recorded on a distributed ledger that constantly updates and that cannot be modified in any way.

This article aims to shed light on some considerations with regards to the implementation of an international framework for PIL. While the primary focus will be on matters of private law, finance and security as they relate to the use of blockchain technology, the considerations mentioned will inevitably be relevant when considering non-financial interactions and processes. The primary concern requiring resolution is how PIL is to develop to permit further recognition and enforcement of assets in the digital economy without compromising the security of economic activities, financial stability and consumer safety.

Considerations regarding contractual agreements, recognition and enforcement

The private law of contract raises a host of preliminary challenges for the sound functioning of PIL. Preliminary because, in many instances, matters of private law will first have to be resolved before dispute resolution proceedings can even commence, and the lack of legal clarity in this area leaves parties in different jurisdictions with an unacceptable level of unpredictability as to the status of their agreement. For the sake of business efficacy and legal certainty, therefore, any international framework will have to consider contractual obstacles that hinder the application of PIL principles.

Smart contracts provide an example of a highly positive application of blockchain technology. By using lines of embedded code, smart contracts are able to supplement base contracts by performing parts of a base contract automatically without further action from the parties. Moreover, the blockchain accurately records and securely stores the agreement between parties in the event that the base contract is lost or unlawfully altered in some way. It is quite a different matter, however, to have a smart contract on the blockchain act as the base contract that includes all of the main terms and conditions, and where performance is wholly governed through the blockchain.^[4] Among the benefits and unique processes involved within the smart contract, however, it is critical to recognise that the smart contract does not necessarily meet the criteria of a contract under English common law, and indeed does not fit the mould of foreign economic transactions, primarily due to the lack of an international consensus for this legal phenomenon.^[5] Focusing on the former problem, however, let us examine the definition that is adopted in The Law Society’s Guidance for the Smart Legal Contract (SLC): ‘a written and legally enforceable contract where certain obligations may be represented by or written in code’.^[6]

There are a few aspects of this definition that must be unpacked, and that indicate the magnitude of the regulatory challenge that legal experts and legislators will have to overcome. First, we must question what we mean by ‘certain’, which does not indicate a defined range or number of provisions that must be written in conventional language. If all obligations are written in code, is the contract still legally enforceable? In the context of PIL principles, the applicable law would surely become a problem in such a situation where all obligations but one are written in smart contract code, then the principle of closest connection – where the jurisdiction closest to the foreign element and most apt to deal with the cross-border agreement is chosen – ceases to have meaning given that no jurisdiction has built the requisite body of legislation and precedent to deal with such a contract. Second, assuming that the obligations can be adequately understood by lawyers, future research and legal guidance should focus on how a blockchain transaction or agreement between two parties fits into the private law of contract where, prima facie, the agreement does not constitute a contract. To provide a brief example, if party A sends party B cryptocurrency on the basis that B provide consideration in the physical world for A, then under English law, no contract has been created – the decentralised agreement has no consideration and B has no obligation towards A. Case law has not emerged on this particular point, but the nuance of the law of contract should be borne in mind when considering smart contracts, the transfer of digital assets and the jurisdiction of courts globally.

The smart contract on the blockchain is fundamentally different from the traditional contract because it is not simply a transcription of what the parties have agreed, or even what they intended to agree. Rather, the technology incorporates additional contractual terms necessary to self-execute and perform the contract. Legal rules involving the interpretation and implication of contract terms will therefore necessarily be affected by the novel operation of contracts.^[7] How, for example, will a court determine whether an onerous term has been ‘fairly and reasonably’ drawn to the attention of another party in a transaction, if that term has been altered or misunderstood in an automated execution?^[8] Though the answer to this question may only apply to English contract law, it is still in the interest of lawyers and market participants in all jurisdictions to consider how courts may interpret SLCs written in code.

Considerations surrounding payment systems and private international law

Contractual interactions, therefore, through blockchain platforms raise a host of jurisdictional issues that must be considered so that parties may safely conclude transactions and legal processes over the blockchain and ensure that legal systems are able to recognise and enforce such transactions. This section will therefore address regulatory issues that may be encountered in transforming payment systems. It must first be noted, however, that the digital economy has been created with the intention of going beyond traditional finance and market interactions governed by legal relationships. Decentralised structures imply and necessitate a lower level of red tape and intermediaries between participating individuals. Legislation must caution against the acceptance of blockchain technology in its current form and should look towards reforming market interactions so that parties may transact safely. The following section considers how the benefit of decentralised payments can be reaped while the danger of increasingly sophisticated cybercrime and fraud can be mitigated for the purposes of effective dispute resolution.

Clearing transactions and replacing central counterparties

Clearing is the process by which financial trades (often derivates) are settled. The process reduces the risk of insolvency and harm to either party, as a central counterparty (CCP) is placed in between the buyer and seller to validate the transaction prior to its settlement. CCPs act as financial intermediaries – a buyer to every seller on the market, and a seller to every buyer. The financial health of these market infrastructures is central to the stability of financial and economic systems. Decentralised financial market infrastructures (dFMIs) have the potential to yield a range of benefits for financial markets, including faster settlement times and a reduction of systemic risk given that defaulting transactions will only effect parties to the transaction, and not the financial health of the network, avoiding more severe effects of contagion, particularly into the economies of other nations.^[9]

Despite the largely tamper-proof and transparent nature of the distributed ledger technology (DLT) mechanism, CCPs increase market transparency significantly given their position as the focal point of transactions. Moreover, CCPs perform a critical function of guaranteeing the terms of a trade and protecting parties from defaulting buyers and sellers. The ability for dFMIs to replace such FMIs has been reviewed extensively,^[10] and the difference between traditional clearing processes and the blockchain lies primarily in the fact that trade and settlement are executed simultaneously on the blockchain. Efficiency through lower levels of intermediation and delay between trading and settlement is traded for security because blockchain finance is governed by blockchain entities – not banks and financial institutions that have significant amounts of information on any given user in the system – and can control the consequences following default, fraud or a range of other situations.

With regards to PIL, however, the economic benefits of dFMIs must be weighed against the legal issues that arise when using digital platforms. Unlike parties to a transaction that is settled through a heavily regulated clearing house, decentralised platforms lack jurisdictional boundaries – defining the jurisdiction to be used in a situation of conflict of laws will depend, inter alia, upon the ability of parties to be identified. If the pseudonymity of participants on the network cannot be resolved, then the application of PIL frameworks is not only undesirable, but also practically impossible in relation to the initiation of legal proceedings. It limits the process as the choice of governing law cannot be determined, and the jurisdictional origin of the transaction may be completely unknown to injured parties. Moreover, as Lehman notes, DLT is not connected to any state and thus the resolution of the identification problem does not necessary resolve the dilemma that no particular jurisdiction is closely connected to the technology.^[11] This is compounded by the increasingly fragmented nature of domestic laws and classifications of cryptocurrencies and crypto assets. Japan, for example, has no unified framework while the Financial Conduct Authority in the United Kingdom has banned the sale of cryptocurrency derivatives, suggesting a significant friction between concepts of control through legal control, and automated, unrestricted market activity through decentralisation. PIL frameworks will have to grapple with the reality of unorganised regulation in this area and provide suggestions for unification on the basic rules regarding digital assets as objects of proprietary ownership and contract law.

Transposing physical contracts with a jurisdictional origin to a smart contract written in code would be near impossible for lawyers to draft without prerequisite knowledge of coding, to ensure that the smart contract emulates the conventional contract. Even assuming that lawyers could do this, managing the failure of blockchain technology as a payment system is critical to a legal framework in the digital economy, as computers are not humans and the execution of a contract in a manner that does not correspond to the precise expectations of parties is not a desirable mechanism for future transactions. Instead, the technology will only suit simplistic transactions and contracts if care is not taken to ensure accuracy. Perhaps this is where the technological competence of lawyers needs to become a part of future training and law – the unconventional coded language of decentralised finance may require such a radical shift.

Perhaps what is needed is a logical transition from inefficient cross-border operations to multilateral platforms (MLP) systems, to the final move into a decentralised blockchain platform. The Committee on Payments and Market Infrastructures recently investigated the role of MLPs in cross-border payments.^[12] Such platforms have the potential to yield similar benefits to decentralised structures via reductions in cost, time and the range of differing frameworks that cause uncertainty. As the committee suggests, MLPs raise questions of competition, given that the network effects that characterise payment markets could produce negative concentration effects, excluding participants in certain regions and forcing the use of less efficient mechanisms.^[13] Such systems controlled by private enterprises will also have to be monitored closely to ensure that the social utility of using a new mechanism is not damaged by corporate incentives that may result in the externalisation of risk, a phenomenon that is already closely associated with CCPs owing to their too-big-to-fail nature.^[14] Setting aside this CCP specific risk, the failure of cryptocurrencies pegged to fiat currencies presents a major financial contagion problem of its own, as was demonstrated by the collapse of Terra USD. The Bank for International Settlements has highlighted ‘severe deficiencies’ in relation to the risk management capabilities of crypto intermediaries.^[15]

It is suggested that transactions on blockchain platforms should simply be accepted by the law as fact, and that the validity of blockchain transactions need not be questioned.^[16] This suggestion is not only accurate but is necessary to understand how PIL may proceed without creating an undue level of bureaucracy on decentralised networks, which defeats many of the key purposes of their existence. While lawyers must find a method of understanding the relevant technologies and processes governing payments on dFMIs, they must not conflate the law of finance with the code of blockchain – it is the latter that has authority in the digital economy.

Upon this basis we may make two suggestions that have not received extensive examination from a legal perspective:

1. Mandating the use of collateral contracts that stem from the original decentralised agreement and setting out the intention of parties in relation to governing laws and/or dispute resolution:

(i) Disputes over transactions that have been agreed upon in an automated market infrastructure will mean that contractual agreements between nodes in the network are written in code and are thus foreign to lay market participants. Moreover, transactions in code will simply look to the performance of a contract (execution), and not its resolution once the contract is executed. A legal framework that requires the parties to create and sign a collateral contract settling PIL matters prior to entering into a transaction will have to consider an international consensus on the enforceability of such collateral contracts.

(ii) This is not a suggestion to have traditional contracts interfere in DLT systems – the only inefficiency caused is requiring contracting parties to sign collateral contracts determining the precise intentions should the transaction or contract performance fail for reasons out their control or reasonable contemplation. The contract here is supplementing the blockchain, not hampering its operation. This can also be streamlined or improved via the adoption of internationally accepted standard forms, or on a national basis. The traditional contract here becomes nothing more than a formality to a transaction – not the economic basis for facilitating market activity. This suggestion provides the law with the legitimacy it needs to interfere only in a retrospective manner and ensures parties to think about the allocation of losses and account for force majeure clauses in the event of performance impossibility (eg, where the network fails or is breached).

2. Regulating the interaction and balance between privileged information:

(i) Once decentralised transactions and contracts can be stabilised and appropriately dealt with in law and through legal systems, we encounter a second problem of privileged information. In legal terms, problems of privilege arise with respect to automated processes, and the potential for no-fault disclosure of sensitive information.^[17] Moreover, privileged information does not only include that which arises in the anticipation of litigation or during dispute resolution, but also includes privileged market data and functions not available to all participants in the peer-to-peer network.
The possibility for data misuse, or interruptions in the finalising of transactions due to miners’ access to market data,^[18] must be addressed through legal mechanisms that can ensure parties have the necessary tools to pursue dispute resolution without jurisdictional ambiguities.

(ii) Details in self-executing smart contracts are often made completely public, with only identities of the parties being concealed in most instances of blockchain transfer. Guidance regarding how privilege or work product doctrines may apply to communications and transactional information that is the subject of proceedings is effectively absent in numerous jurisdictions. Privacy concerns are at the forefront of blockchain debates, and thus this suggestion is about guaranteeing the rights of consumers operating on the market.

Recognising the limits of smart contracts as they proliferate in the financial world suggests that the law ought not to interfere with on-chain operations. Rather, it must find a way to provide security to consumers through liquidity thresholds, regulatory safeguards or general recovery and resolution frameworks that ensure that losses on dFMIs are mitigated. Unlike current FMIs, dFMIs cannot provide a standardised method to market operations in a similar fashion to CCPs or other FMIs. This raises the potential for frustrating automation and causes extreme disruption in financial markets given that the continuation of derivative contracts or securities is not guaranteed, and the volatility of financial markets as a result of such a development could be difficult to reverse through economic policy or otherwise. We may therefore conclude that dFMIs must be separated from PIL in the sense that the latter will govern the legal relationships between market participants, while the former can provide a desirable method of transacting in the future: ‘Because standardization is partial and less immediate than in the CCP case, it can lead to uncertainty in the regulatory realm. Therefore, off-chain and legally enforceable contractual agreements would be better suited to establish the rights, benefits and obligations of participants, rather than solely relying on source code, the underlying blockchain or network attributes.’^[19]

Digital wallets and decentralised autonomous organisations

The Bank of England’s current ‘exploration’ phase in its strategy to find a use case for the introduction of a digital currency warrants a close understanding of the mechanisms involving digital wallets and their organisational uses.

Digital wallets are programs on devices that allow the wallet owner to securely store and access their private key, which in turn provides access to their cryptocurrency. Additionally, the wallet is assigned a public key, which is a cryptographic code linked to the private key. The public key allows transactions to take place from the wallet, as well as receiving cryptocurrencies from other addresses. Only the private key, however, can ‘unlock’ the wallet in order to prove their identity as the owner of the digital money. Technically, therefore, an individual cannot ‘own’ cryptocurrency as it lives permanently on the blockchain but can only be accessed by the owner of the private key who can then utilise the currency.^[20] There are two interrelated issues with the phenomenon of such wallets that must be addressed for the effective operation of private international law, which concerns both the principles of PIL, as well as the promotion of an increasingly unified body of law surrounding the choice of law in international contracts.

First, the lack of security surrounding digital wallets is a critical issue that has led to significant cryptocurrency fraud, theft or other illicit hacking. In the UK, a 15-year-old adolescent accessed wallets through the development of a proof-of-concept code, which provided a backdoor entry to wallets sold in the millions by Ledger.^[21] Unlike the traditional wallet, or even more recent e-wallets, private key information contained in the digital wallet is the root cause of the majority of hacking incidents. The interference of hackers may occur when the wallet is connecting to the transaction network, during which key theft occurs. Numerous innovations have attempted to mitigate this problem,^[22] but for the purposes of this article the concern relates to the multijurisdictional legal consequences following crypto-related theft. Dispute resolution in this area is proving difficult as courts attempt to help aggrieved plaintiffs with permission to trace and recover funds that they are entitled to.^[23] The lack of assistance from financial institutions with strong financial records and resources to extract stolen cryptocurrency exacerbates delays for plaintiffs, and the ease of transferring funds between different crypto wallets or withdrawing funds from a crypto wallet, means that court proceedings currently do not provide individual users with the legal reassurance required in the event of theft or fraud.

The second issue of user privacy is closely related, and in terms of choice of law, the digital economy poses a dilemma for legal systems and lawyers alike. It is appropriate to assume that the relationship between this issue and the first is inversely proportional, meaning that improved security and identification processes related to opening and maintaining the digital wallet is likely to correspond to a decreasing level of data security. Before considering how legal approaches may manage this relationship, it is critical to point out that the pseudonymity of digital wallet users (and blockchain users more generally) creates a major jurisdictional issue from a contractual point of view. Parties to a transaction using a crypto wallet are not required to agree on the choice of law governing a transaction (a problem that could be rectified through the solution mentioned in the previous section). In the absence of parties exercising this choice of law, legal systems often have rules or indicators in place for determining the applicable, such as the habitual residence of the party selling the goods,^[24] the origin of the service provider^[25] or (in the case of contracts within multilateral systems) the single governing law.^[26] Such defaulting rules have no use, however, if the identity of the parties and their digital addresses are unknown. Improving wallet security while improving data security is a task that data agencies and regulatory authorities will have to consider in light of existing guidance and definitions offered in legislative texts, such as the General Data Protection Regulation (GDPR).

The High Court’s recent ruling, however, in LMN [2022] EWHC 2954 (Comm) provides hope for the retrieval of information about the individuals behind transactions, which may be a significant step in reducing the interrelated problems of pseudonymity and jurisdiction simultaneously. The plaintiff in LMN was permitted to serve defendants out of jurisdiction for the first time through civil procedure rules under the new ‘Gateway 25’ where permission for service out of the jurisdiction can be given, inter alia, if the purpose of the service is to find the true identity of a potential defendant or understand what has become of the claimant’s property.^[27] The plaintiff LMN (a cryptocurrency exchange) was also permitted to add an eighth defendant called ‘Persons Unknown’ given that the precise legal entity in the corporate structure of the various defendants named could not be ascertained by the plaintiff. As per Mr Justice Butcher, this referred to ‘the individuals or companies or other entities who are identified in the Binance.com platform’s terms and conditions as Binance Operators but not [the named defendant]’.^[28] The willingness to assist victims of cryptocurrency in this manner could circumvent some of the issues surrounding identification without undermining data security, if exchanges reveal information on the basis of narrow requirements for courts to provide the required permissions. Of course, there is an argument to be made that a bankers’ trust order (made to locate and identify misappropriated property) could infringe the sovereignty of a foreign jurisdiction.^[29] To avoid legal divergence in this area, legal authorities, perhaps through established fora, such as the Hague Conference on Private International Law (HCCH), should seek to find an international consensus to reduce the associated time and costs associated with the identification process.

JP Morgan Chase & Co recently executed its first ever trade on a public blockchain as part of Singapore’s Central Bank pilot regime. Additionally, in 2019, Santander issued the first ever end-to-end blockchain bond. The integration of blockchain technology with corporate finance could have major implications on an already strained system of global financial services regulation that must consistently coordinate to ensure prudent financial activity to maintain market confidence and consumer safety. The system of private international law must adapt to this by considering how to bypass the security problems raised by digital wallets and blockchain networks more generally. Limiting the issuance of digital wallets to regulated financial institutions is a possibility that could increase security while maintaining the decentralised integrity of blockchain transactions. It also provides a solution to the applicable law issue as the jurisdiction of the issuing bank can be deemed the most appropriate where parties have not exercised their right to choose the governing law. However, it could still raise concerns as to which entities and individuals become liable at the point of security breaches or consumer fraud and may not resolve the host of identification problems that have been indicated above.

Decentralised autonomous organisations

A third and related issue, perhaps in need of less urgent focus currently, is that of digital autonomous organisations (DAOs), and their legal status.

DAO is a general term used to define ‘a group that uses blockchains and related technologies to coordinate its activities’.^[30] DAOs represent the decentralisation of company operations, in contrast to the modern centralised organisation and management methods. This hierarchy is diminished significantly in a DAO, which enables collaboration between large communities to achieve a particular goal. DAOs run on blockchain technology and are run by the members who have invested, with an immutable record of transactions providing transparency to members. The concept is highly attractive given that the modern corporate form is often extremely complex, with an array of subsidiaries, holding companies and director duties imposed by company law in different jurisdictions and is an expensive and unfamiliar operation to lay individuals. Moreover, membership of companies does not always constitute a say in the management and operation of business affairs, particularly in the purchase of non-voting shares. Ultimately, DAOs can gain efficiency and trust more effectively than centralised structures with a board of directors, managers, employees and so forth.^[31]

Of course, the limitations of DAOs cause major problems for enforcement authorities and private individuals attempting to enforce their rights. First, despite decentralisation, DAO communities are often managed through communication platforms, such as Discord, where DAO founders may have access to certain decision-making tools and information that others do not, as well as an ability to manipulate voting outcomes. Further to this, the potential fraud risks for investors can be significant given that the reputability of DAOs is not easy to ascertain – unlike a smaller private limited company on the rise, the legal formalities and investment difficulty that DAOs bypass in their formation casts a shadow as to the true incentive of the founders and associated objectives.

With regard to private international law and the choice of applicable law, the primary issue lies between jurisdictions that have recognised the DAO structure as a company form and those that have not. In the UK, legal guidance suggests that the DAO cannot be a company in the traditional sense, given that it is not a legal construct.^[32] The very same guidance, however, suggests that the label of a general partnership may fit the DAO mould, given that token holders on the DAO can be characterised as investors ‘carrying on business in common with a view to profit’. But this characterisation cannot fit in with the English law conception of a partnership, since the self-executing nature of the decentralised organisation lacks the organisational capacity to perform the necessary registration and tax reporting requirements with His Majesty's Revenue and Customs (HMRC), given the necessary involvement of a human.^[33] Similar concerns have been noted in the US, where reporting requirements to comply with securities law – which require the disclosure of the names of directors – are contradictory to the very nature of DAOs, which don’t have a board or an established universal corporate structure with members that can be held legally responsible for reporting requirements.^[34]

The recent decision of the US District Court for the Northern District of California in Commodity Futures Trading Commission v Ooki DAO may be of significance regarding DAO and the liability of members. It was held that, under California law, a DAO qualified as an unincorporated association and could thus be served by the CFTC (although note the unique definition of unincorporated association under California state law).^[35] Important in the judgment is also the judicial recognition that the CFTC sued the DAO as an entity, and not the individual token holders, given the lack of control of individual users over the DAO’s treasury funds. This significantly limits the liability of token holders, but the question is whether a claim brought by the Financial Conduct Authority in the UK would succeed given that obtaining limited liability is a matter for strict statutory requirements of registration under the Companies Act 2006 regime.^[36] The primary recommendation here, based on existing research and guidance, is to utilise substantive conferences and legal material of the International Bar Association, the HCCH, the UNIDROIT and diverse institutions, such as the Centre for European Company Law and the Institute of World Business Law to consider the development of soft law provisions on the legal personality of DAOs. Legal systems may have recourse in the process of dispute resolution to a globally accepted concept where the applicable law cannot be easily determined by the application of private international law principles.

Conclusion

Traditional conflict of laws may seem outdated in relation to DLT systems as the principles of PIL, such as lex rei sitae, have been created for transactions in goods and services where the parties to the transactions are identifiable. Furthermore, the fact that digital currencies are accessed through keys, and are not actually in the possession of an individual or entity per se, means that the location of property on the blockchain is effectively impossible. This does not, however, warrant the abandonment of an international PIL framework. Rather, authorities should look to understand non-legal research that explains the technical difficulties related to the digital economy and then use existing legal mechanisms (through the law of tort, contract, restitution, etc) to unify the disjointed set of regimes that are in place at the national level.