At what point do rights to digital currency (in the blockchain) arise?

At what point do rights to digital currency (in the blockchain) arise?

In this article, I will briefly touch on the definition of digital currency, individual methods of its “storage” (custodial and non-custodial wallets), individual methods of its transfer/transfer (“in the blockchain”, outside the “blockchain” and within the platform of the custodial wallet operator) and will offer options for determining the moment of the emergence of rights to digital currency for the recipient of the transfer.

I believe that this issue is not so simple, given the peculiarities of the transfer of digital currency. This article reflects the state of affairs known to the author and existing at the time of its writing, the technologies and legal norms set out in it may change over time.

Digital currency and information system nodes

First, you should define what cryptocurrency is and look at how different jurisdictions have resolved this issue.

In Regulation (EU) No. 2023/1114 of 31 March 2023, cryptocurrency is defined in Articles 3(1)(5), 3(1)(6), 3(1)(7) and 3(1)(9) as follows:

By virtue of paragraph 4 of Article 1 of the Law of the Republic of Kazakhstan dated 06.02.2003 No. 193-VII “On Digital Assets in the Republic of Kazakhstan”, a digital asset is propertycreated in electronic digital form with the assignment of a digital code, including with the use of cryptography and computer calculations, registered and provided with immutability of information based on distributed data platform technology.

According to p. 3 art. 1 Federal Law of July 31, 2020 No. 259-FZ “On Digital Financial Assets, Digital Currency and Amendments to Certain Legislative Acts of the Russian Federation” (hereinafter – the federal law from 31.07.2020 No. 259-FZ) digital currency is recognized a set of electronic data (digital code or designation)contained in the information system, which are offered and/or may be accepted as a means of paymentwhich is not a monetary unit of the Russian Federation, a monetary unit of a foreign state and (or) an international monetary or settlement unit, and (or) as investments and in respect of which there is no person obligated to each holder of such electronic data, with the exception of the operator and (or) nodes of the information system*, which are obligated only to ensure that the procedure for issuing these electronic data and implementing actions in relation to them to enter (change) records in such an information system complies with its rules.

* nodes of an information system is a concept that I will frequently refer to below. The legal definition is contained in Federal Law from 31.07.2020 No. 259-FZ, according to which the nodes of an information system are users of an information system based on a distributed registry, ensuring the identity of the information contained in the specified information system, using procedures for confirming the validity of records entered into it (changed in it) (clause 8 of Article 1). For cryptocurrencies such as Bitcoin and Etherium, the nodes of the information system will be miners (since they use computers to calculate the hash of the transaction block, confirming the operations contained in the block). A similar concept is also used in EU regulation, according to Art. 3(1)(2), 3(1)(3), 3(1)(4) of Regulation (EU) of 31.03.2023 No. 2023/1114:

In the Law of the Republic of Kazakhstan dated February 6, 2023 No. 193-VII ЗРК, the activity of the information system node is called “digital mining” and is given the following definition:digital mining is the process of performing computational operations using computer power according to specified encryption and data processing algorithms, ensuring confirmation of the integrity of data blocks through the blockchain“.

Under Russian law, digital currency is recognized as property for the purposes of application Law about bankruptcy (the federal law from 26.10.2002 No. 127-FZ, last paragraph of Art. 2), Federal Law from 02.10.2007 No. 229-FZ “On Enforcement Proceedings” (clause 4, Article 68), Federal Law from 07.08.2001 No. 115-FZ “On combating the legalization (laundering) of proceeds from crime and the financing of terrorism” (last paragraph of Article 3).

In the event that something is “property”, it seems that the possibility of its “storage” is of significant importance (put in quotation marks intentionally, since, according to Russian law, legal relations on storage in the sense as defined in the Civil Code of the Russian Federation arise only in relation to things, whereas digital currency is not a thing; in this case, we are talking, rather, about the recording of rights).

The Supreme Court of the Russian Federation, defining the characteristics of things in the context of the distinction between objects of the material world and property rights, formed the following legal position: “virtual monetary funds, as well as property rights of claim paid for by such virtual funds, cannot act as things defined by generic characteristics, since they are not objects of the material world and do not exist in a physically tangible form» (Determination of the Judicial Collegium for Civil Cases of the Supreme Court of the Russian Federation dated September 21, 2021 No. 29-KG21-5-K1).

At the same time, property may be not only a thing, see, for example, the legal position of the Supreme Arbitration Court of the Russian Federation: “Articles 301 – 303 The Code provides for the recovery of property from someone else's illegal possession, without narrowing this concept to things as physically existing objects of the material world.» (Definition Supreme Arbitration Court of the Russian Federation dated 02.12.2009 No. VAS-13944/09 in case No. A56-31225/2008).

At the same time, it should be noted that judicial practice on this issue does not have the quality of stability due to its scarcity.

Thus, “storage” in this article is used to simplify the understanding of its content and is not storage in the sense given to it by the Civil Code of the Russian Federation. It should be understood for the purposes of this article as a way of ensuring the accounting of rights to digital currency, which is property, but is not an object of the material world and does not exist in a physically tangible form.

Individual methods of “storing” digital currency

As a rule, in specialized literature (see, for example: Global Digital Finance Taxonomy for Cryptographic Assets2018) there are two ways to store digital currency:

1. in non-custodial wallets; and

2. in custodial wallets.

“Storage” in non-custodial wallets — is the “storage” of digital currency without recourse to intermediaries. The private encryption key required to transmit a message to the information system, on the basis of which the movement of digital currency “in the blockchain” will be made, is held directly by the owner of the digital currency. The owner directly transmits the corresponding messages using the private encryption key and, thus, disposes of the digital currency.

“Storage” in custodial wallets — is the “storage” of digital currency with third parties, for example, on a cryptocurrency exchange. With this method of storage, the owner of the cryptocurrency cannot dispose of it directly, but only by contacting a third party who is the operator of the corresponding custodial wallet. Here, some analogies can be drawn with a bank account, when funds in a bank account, from the point of view of their legal nature, according to one approach, are only obligatory rights to the bank.

In this case, for example, if there are insufficient funds in the bank’s correspondent accounts, the corresponding funds lose their accounting value and become accounting entries (see, for example, the legal positions “If the above arguments are true and the funds in the correspondent account were insufficient to make the payment, then it is necessary to proceed from the fact that in the event of the bank’s insolvency, the clients’ non-cash funds in its accounts lose their purpose as a means of payment and are effectively transformed into claims against this bank.” (Resolution Presidium of the Supreme Arbitration Court of the Russian Federation dated 03.06.2014 No. 2953/14, Determinations of the Judicial Collegium for Economic Disputes of the Supreme Court of the Russian Federation dated 19.03.2018 No. 306-ES17–17 686, dated 20.05.2019 No. 305-ES18–5703(6)).

At the same time, custodial wallets can provide a convenient interface for managing digital currency, as well as the ability to make transfers to other users, including within the platform of the corresponding custodial wallet (for example, p2p transfers between users of various cryptocurrency exchanges).

Separate methods of transferring/transferring digital currency

Scenario 1: Transfer by giving an order and its processing by communication nodes

This is the most standard scenario, in which the Sender transmits a message to the information system, signed using a private encryption key, as a result of which the nodes of the information system process the corresponding transfer in a new transaction block, and the Recipient, accordingly, receives the sent digital currency.

Scenario 2: Transferring a private key to a wallet (off-chain)

In this scenario, the Sender gives the Recipient a private encryption key, which is necessary to manage the cryptocurrency in a non-custodial wallet. At the same time, this operation is invisible to the blockchain, it is not registered in it in any way. The Recipient can subsequently manage the digital currency at his own discretion using the received private encryption key.

Among the analogies known to Russian law, one can cite the presumption of transfer of ownership rights when transferring a thing under a contract (see p. 1 art. 223 Civil Code of the Russian Federation, according to which “the right of ownership of the purchaser of the thing under the contract arises from the moment of its transfer, unless otherwise provided by law or the contract.».

Let me make it clear that I do not consider digital currency to be a thing, as I have already noted above.

In doing so, I take into account the skepticism expressed by Russian legal doctrine regarding the right of ownership, the object of which is not things.

From the point of view of judicial practice, the question of whether digital currency can be an object of property rights is an insufficiently developed issue; judicial practice has been found that confirms the possibility of such an approach, for example:

1. By the decision of the Cheryomushkinsky District Court of Moscow dated September 21, 2021 in case No. 2-5148/21, the division of jointly acquired property was carried out […] And […]. Behind […] The right of ownership to 50% of bitcoins, which is 5.939749925 BTC, was recognized, […] The ownership of 50% of bitcoins has been recognized, which amounts to 5.939749925 BTC.

2. «The courts established that at the time of making the payments, the seller owned the BIP cryptocurrency, and the counter-performance is confirmed by the fact of transferring the agreed amount to the debtor (buyer). The fact of the transaction was confirmed by the dates and times of transactions in banking organizations and the information reflected in @[…]The fact that the financial manager does not have the debtor's documents on the disputed property, as well as access to the cryptocurrency acquired by the debtor, does not in itself indicate that the transaction for its purchase is fictitious.» (Determination of the Supreme Court of the Russian Federation dated 11.10.2023 No. 306-ES23-10386(3) in case No. A65-18296/2021)

3. «In order to conclude that R. is the buyer of the cryptocurrency, the court had to reliably establish that R. received cryptocurrency in the amount of 950,000 rubles into her ownership and can dispose of it.» (Determination of the Second Cassation Court of General Jurisdiction dated 05/26/2022 in case No. 88-11775/2022, 2-1291/2020)

In my opinion, this is not yet sufficient to draw a conclusion about the stability of judicial practice and to make an unambiguous conclusion and categorical judgment on this issue.

Scenario 3: Transfer within the platform loop of the cryptocurrency wallet operator

This operation will also be invisible to the blockchain, since it occurs within the platform of the custodial wallet operator. As I have already noted, the simplest example of such an operation is a p2p transfer on a crypto exchange, since the transfer, as a general rule, does not go into the transaction block, but is carried out “inside” the crypto exchange.

The above methods of transferring/transferring digital currency are not exhaustive, but, in my opinion, are the main ones. It should be noted that I only considered digital currencies based on the blockchain. However, this is not the only distributed registry technology; other technologies may have their own features that affect the possible moment of transfer of rights to digital currencies based on them.

conclusions

In my opinion, this coincides with one of the positions set out in Legal statement on cryptoassets and smart contracts by UK Jurisdiction Taskforce, 2018 The Law Tech Delivery Panelthe owner of the digital currency is the person who holds the private encryption key to a specific non-custodial wallet, since with its help the relevant person can transmit a message to the information system, after which the communication nodes process it and establish consensus, the corresponding transfer of digital currency within the blockchain will actually be carried out.

In scenario #1: after the nodes of the information system reach consensus and add the corresponding transaction block to the blockchain, the Recipient becomes the owner of the corresponding digital currency. To ensure the security of settlements, settlement participants usually wait for several transaction blocks to be added to the blockchain after the transaction block in which the corresponding “transfer” was made.

I believe that until the moment of transfer of rights is explicitly regulated by law or law enforcement practice, the moment of termination of the obligation to transfer digital currency by execution and the moment of transfer of rights should be stipulated in the agreement concluded between the parties, including in the relevant agreement it is possible to determine the number of transaction blocks that must be confirmed by the nodes of the information system after the transaction block with the considered operation to transfer digital currency.

In scenario #2: I believe that the Recipient becomes the owner of the digital currency at the moment of receiving the private encryption key, since it is from this moment that he has the actual opportunity to transmit to the information system a message aimed at transferring the corresponding digital currency, that is, from this moment he gets the actual opportunity to dispose of it at his own discretion. It should be noted that there is a risk that there is only one private encryption key for a certain crypto wallet and the previous owner will also know it, which is a risk for the new owner of the corresponding digital currency, since the previous owner can also transmit to the information system the corresponding messages about transactions.

In scenario #3: I would suggest resolving the issue in the same way as non-cash funds in a bank account. I believe that the digital currency in the custodial wallet for the owner is only the right to demand from the operator of the corresponding custodial wallet to issue (transfer) the corresponding digital currency to him. That is, I propose not to consider the recipient of the digital currency in the custodial wallet as its owner in this case, but to consider the recipient of the digital currency in the custodial wallet as a creditor of the operator of the corresponding custodial wallet, authorized to demand the issuance of the corresponding digital currency. At the same time, in order to determine the moment of fulfillment of the Sender's obligation to transfer the digital currency in the custodial wallet, I would consider it possible to consider this obligation fulfilled at the moment of crediting the corresponding digital currency to the Recipient's account in the custodial wallet, unless otherwise provided by the agreement, since from this moment the Recipient gets the opportunity to demand the withdrawal of digital currency from the custodial wallet to a non-custodial one.

Disclaimer: Please note that this post does not constitute legal advice, but is an expression of my opinion. The accuracy and reliability of the information presented is not guaranteed. You should not make any decisions based on the information in this post.