Blockchain-based electronic transferable record’s functional equivalence to endorsement of paper-based transferable documents

A chain of transactions of an electronic record on a blockchain looks like a chain of endorsements on a paper-based transferable document except that the transactions are anonymous. Despite the anonymity, the blockchain technology ensures a far greater security than bearer documents. I think, therefore, that the law should be crafted in such a way as to allow documents made to order (such as order bills of lading) as well as bearer documents (such as bearer bills of lading) to be replaced by blockchain-based electronic records.

From that point of view, this post will examine the draft text of the UNCITRAL Model Law on Electronic Transferable Records. I have noted in my earlier post that the work on the Model Law should be pursued with the blockchain technology in mind so as to facilitate its applications to replace paper-based transferable documents. As of the time of writing, the most recent official documents containing a draft text are A/CN.9/WG.IV/WP.135 and A/CN.9/WG.IV/WP.135/Add.1, both dated August 2015. The draft provisions quoted below are taken from them.

Draft article 19. Endorsement
Where the law requires or permits the endorsement in any form of a paper-based transferable document or instrument, that requirement is met with respect to an electronic transferable record if information [relating to the endorsement] [constituting endorsement] [indicating the intention to endorse] is [logically associated or otherwise linked to] [included in] that electronic
transferable record and that information is compliant with the requirements set forth in articles 8 and 9.

While an electronic record on a registry may include information constituting endorsement, in the case of an electronic record on a blockchain, it is the blockchain (or, to be more precise, a chain of transactions contained therein) rather than the record itself which indicates intentions of endorsement. Accordingly, the expressions “indicating the intention to endorse” and “logically associated with” seem better cater for the blockchain technology. The words “logically associated” was indeed retained “to provide for all possible instances and methods for the incorporation of an endorsement in an electronic transferable record.” (A/CN.9/828, para. 80).

A more difficult question relates to compliance with the requirement set forth in Article 9.

Draft article 9. Signature
Where the law requires a signature of a person, that requirement is met [with respect to] [in relation to] [by] an electronic transferable record if:
(a) A method is used to identify that person and to indicate that person’s intention in respect of the information contained in the electronic record; and
(b) The method used is either …

This provision will not pose problem with respect to a blockchain-based electronic record to the extent it applies to signatures to be included in the record itself, e.g. a “for the master” signature on a bill of lading. 

It is also intended, as indicated by Draft Article 19, to cover signatures for endorsements. It would be natural to impose a signature requirement to ensure functional equivalence to endorsement, especially if we envisage a registry-based electronic transferable record.  But the requirement of identification, if it is read as requiring identification by name, would be incompatible with electronic records on an open, permissionless blockchain since the parties are anonymous. Logistically, it seems possible to build a system whereby the performance of the obligation represented by the electronic record (e.g. the delivery of goods) is effected without the name of the holder of the private key having to be revealed to the obligor (e.g. carrier) by, for example, allowing the record to activate a key in the physical world (e.g. the key to the container). In my earlier post, I have suggested that a blockchain-based bill of lading may, for that reason, be seen as functionally equivalent to a bearer bill of lading. But the present post is considering how to make rules enabling the replacement of order bills of lading (and other documents made to order) with a blockchain-based electronic records. 

The word “identify” also appears in the following provision.

Draft article 17. [Possession] [Control]
1. Where the law requires the possession of a paper-based transferable document or instrument, that requirement is met with respect to an electronic transferable record if:
(a) A method is used to establish exclusive control of that electronic transferable record by a person and to reliably [identify] [establish] that person as the person in control; and
(b) The method used is either …

The Secretariat notes, “identification should not be understood as implying an obligation to name the person in control” (para. 22) (See my earlier post for a comment). It would aid clarity to say so expressly in the provision. The same could be done in draft Article 19 and it would make it friendlier to blockchain-based electronic records. But it might not be satisfactory for register-based electronic records. That is why I call this a “more difficult question.”

Different functions of electronic transferable records: UNCITRAL’s definition

There are no fewer than three different functions which electronic records transferable on a blockchain may perform with the necessary support of applicable laws. The Model Law on Electronic Transferable Records currently drafted by UNCITRAL is only applicable to a type of electronic transferable record which fulfills one of them.
According to the latest draft published in an official document (A/CN.9/WG.IV/WP.135), for the purpose of the Model Law, an “electronic transferable record” [is an electronic record that contains all of the information that would make a paper-based transferable document or instrument effective and … “(Draft Article 3). The same article defines “paper-based transferable document or instrument” as “a transferable document or instrument issued on paper that entitles the holder to claim the performance of the obligation [indicated] in the document or instrument and …”. It will be possible to use a blockchain to transfer an electronic record which contains all of the information that would make a paper-based bill of lading, for example, effective. Such a record would would constitute an “electronic transferable record” within the meaning of the draft Model Law.
Cryptocurrencies, on the other hand, do not represent entitlement to claim the performance of any obligation. Unlike the traditional forms of electronic money, there is nobody who owes obligation to the holder of cryptocurrencies. If right conditions exist, the market will find an inherent value in cryptocurrencies (or some of them) and recognises them as substitutes for money. Cryptocurrencies are electronic records and transferable on a blockchain. But they do not fall within the definition of the Model Law.
A blockchain may also be used to transfer an electronic record indicating proprietary interests (such as security interests) in tangible or intangible properties. My suggestion for substituting a blockchain-based ledger for the registry of the Cape Town Convention (See my earlier post) relates to this type of usage. Such electronic transferable records do not represent entitlement to claim the performance of any obligation. Hence, they do not come within the definition of the Model Law.
The current Model Law project, therefore, leaves a vast area of use cases of the blockchain technology untouched. I think that UNCITRAL can be instrumental in harnessing the technology in all its applications. 

Work of UNCITRAL on electronic transferable records

Since 2011, the UNCITRAL has been working on legal issues relating to the use of electronic transferable records. From the beginning, it envisages two approaches to establishing the identity of the person to whom an electronic transferable record is issued or transferred, namely the token model which identifies the person in the record itself and the registry model which identifies the person in a separate registry (A/CN.9/WG.IV/WP.115 (hereafter “the 2011 document”) at para. 48). Like its previous works on electronic commerce, the UNCITRAL is adhering to the principle of technology neutrality (Id. at para. 35) and nowhere in the official documents published to date could I find any mention of blockchain, cryptocurrency or bitcoin. But I think the work should be pursued with the blockchain technology in mind so as to facilitate its applications to replace paper-based transferable documents such as bills of lading.
In the current draft of a model law (A/CN.9/WG.IV/WP.135/Add.1, August 2015), the exclusive control of an electronic transferable record is treated as functionally equivalent to the possession of a paper-based transferable document. Thus Draft Article 17(1) provides:

Where the law requires the possession of a paper-based transferable document or instrument, that requirement is met with respect to an electronic transferable record if:
(a) A method is used to establish exclusive control of that electronic transferable record by a person and to reliably [identify] [establish] that person as the person in control; and
(b) The method used is either:
(i) As reliable as appropriate for the purpose for which the electronic transferable record was generated, in light of all the relevant circumstances, including any relevant agreement; or
(ii) Proven in fact to have fulfilled the functions described in subparagraph (a) above, by itself or together with further evidence.

In the Remarks which accompany this provision, the Secretariat makes some noteworthy comments. It says, “the electronic transferable record in itself does not necessarily identify the person in control, but rather the method or system employed to establish control as a whole performs that function” (Id. at para. 22.). This understanding may simply be intended to cater for the registry model as described in the 2011 document. But it may also open the door to blockchain-based electronic records which may be seen as ill-fitted with the description in the 2011 document of the token model. 

The Secretariat goes on to say, “identification should not be understood as implying an obligation to name the person in control, as the draft Model Law allows for the issuance of electronic transferable records to bearer, which implies anonymity” (Ibid.). This view will also ease the way for the blockchain technology as the latter permits the holders of electronic records to remain anonymous. 

The Secretariat also notes, “reference to the person in control of the electronic transferable record does not imply that that person is also the rightful person in control of that record as this is for substantive law to determine” (Id. at para. 21). In other words, the exclusive control of an electronic transferable record is only equivalent to the possession of a paper-based transferable document. Put in the context of the blockchain technology, this view seems consistent with my opinion that the ownership of a blockchain-based electronic record cannot be determined simply by reference to who has the exclusive control of it (See my earlier post).

The Secretariat proceeds to say, “reference to the person in control does not exclude the possibility of having more than one person in control.” It is not easy to see what this observation means for a blockchain-based electronic record. The latter is under the exclusive control of the person holding the private key for the address in which the record is kept. It is, on the other hand, possible for one private key to be known by a number of persons.

Applicability of CISG

The CISG (UN Convention on Contracts for the International Sale of Goods) does not expressly define what constitutes a “contract of sale.” 

There can be little doubt, however, that the Convention will have no application to contracts to buy cryptocurrencies with traditional currencies since the Convention is only applicable to sales of “goods” which are generally understood to mean tangible objects (e.g. Schlechtriem, Commentary on the UN Convention on the International Sale of Goods (1998) p. 23 [Herber]).
A separate question is whether the CISG is applicable to contracts to buy goods with cryptocurrencies. In the language of the Convention, the question is whether payment of cryptocurrencies should be interpreted as constituting “payment of the price.” If not, such contracts would be barter contracts and accordingly fall outside the scope of the Convention (For barter contracts, see e.g. Schlechtriem.)
In this connection, it is worth recalling that the CJEU observed in its VAT judgment that bitcoins had no purpose other than to be a means of payment (para. 24). In other legal contexts, other purposes such as speculative investment purposes may be relevant. But in the context of CISG, a better interpretation seems to be that payment of bitcoins or other cryptocurrencies constitutes “payment of the price,” since they have no intrinsic value of their own.