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How can investors trace digital assets?

How can investors trace digital assets?

Following the pandemic-fuelled meteoric growth of digital assets, $2tn (£1.6tn) was wiped off the crypto economy earlier this year.

The churn in the digital assets industry, evidenced by the dramatic change in the fortunes of investors in digital assets such as Filecoin, EOS, DYDX, LooksRare, among others, and recently in FTX following its high-profile bankruptcy, has provided further basis for increased legal and regulatory scrutiny.

Suffice to say, this year has been a challenging one for the crypto industry and has brought key issues regarding digital asset tracing and enforcement to the fore. 

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Globally, laws and regulations have struggled to keep pace with innovation in the digital assets space.

From securities trading to restructuring and insolvency, most legal systems have faced issues in characterising and ascribing rights and obligations to digital assets. This is most acutely felt in the tracing and enforcement of digital assets.

In this article, we explore the key challenges and opportunities in the tracing and enforcement of digital assets, with a focus on English law and practice.

What is a digital asset?

A digital asset is any investment represented digitally or electronically. This includes crypto assets and tokens. For the purposes of this article, we assume that digital assets are capable of attracting personal property rights and are therefore valuable in the context of enforcing a judgment or award in respect of it. 

English law recognises two categories of property: things in action and things in possession. The former relates to rights that can only be enforced by legal action. The latter relates to rights attaching to tangible property that is capable of physical possession.

For example, the car which a person owns is a thing in possession whereas a debt owed to them is a thing in action. However, having regard to the distinguishing features of certainty, exclusivity, control and assignability that apply to the existing categories, digital assets do not fall neatly into them. 

Therefore, the Law Commission is currently reviewing the recognition and protection of digital assets in England and Wales. In a recent consultation paper, the commission recommended the creation of a third category of property: data objects.

To be a data object, a thing will need to: (a) be composed of data represented in an electronic medium, including in the form of computer code, electronic, digital or analogue signals; (b) exist independently of persons and the legal system; and (c) be “rivalrous” (its use by one person inhibits its use by others).

Ultimately, the characterisation of a digital asset in a legal system affects the rights and obligations that attach to it, and this in turn informs the tracing and enforcement options available to investors.