Before we dive into the peculiarities of the legal status of owner registered on a decentralized register, we should define what ownership is from a conventional point of view. In order to do that, could take a look at old legal paradigms of ‘ownership’ and possession’. In fact, the two are closely related to one another. Some scholars define possession as ‘the objective realization of ownership’. This leads one to assume that the owner of a good can’t help but also be the possessor of this good. In other words, ownership stands for the material legal relationship between an object of law and a subject of law; while possession stands for the factual relationship between the two. For instance, civil law systems proclaim acquisition of ownership through possession. Possession is actual control over a good, so-called right in rem.
Does this approach apply correctly to blockchain? First of all, we need to define whether the notes registered on blockchain embody real rights. Secondly, is the fact the register itself is decentralized and shared among all participants sufficient to act against the traditional approach of identification of ownership and possession? Speaking of the first issue, it is far-fetched to say that the rights registered on the blockchain are real (jus in re), since the elements of the code of the network are not physical assets but rather random, hashed sequences of digits and letters. At the same time, access to those elements is allowed with the help of the private key - this key has features of a physical asset. The quasi-multified right of ownership is a matter with the registration of ownership on the blockchain as those rights do not lie exclusively with the owner, but with all other nodes of the blockchain.
Thus, even though the note on the blockchain technically serves as an evidence of the ownership right, it is not similar to the notes in traditional, centralized, offline registers because all the participant of a decentralized register exercises the same rights of so-called ‘probative value’. All blockchains, in their essence, seek to constitute the ownership in the private keys themselves, through the recordings in the blockchain. This poses a challenge to the matter of relationships between ownership and possession. Especially with the case of tokenized securities, the goods are divided into several registers given the functionality and the idea of the ‘public key’.
Some experts argue though that the possession of a token in a blockchain presumes the owner to have both public and private keys, and this is why the ownership paradigm exists in the blockchain. But the mere presence of the public key and its feature suffices for the conflict in the legal realm.
As an argument against the point of view of the private-distinct-from-public doctrine, one might argue that given the fact that the possessor of the private key is the sole owner of the asset, then if that private key is stolen, then the property is lost forever. It’s not even like in the real world, the property does not move to the thief, but is rather lost due to the thief’s inability to obtain the public key after the theft. We can thus conclude that the possession of the private key almost equals the possession of the good (token) itself. The private key is stored on a physical unit, rather in the blockchain itself, therefore we can state that it is a real-world asset. The private key does not get distributed but is stored in one place. Moreover, it is generated only once in its lifetime - to the person generating it in front of the screen.
All in all, we can say that the ownership right on the blockchain is divided into the private and public expression of this right. The first part is the public key which is stored in the network and does not even fully belong to the holder of the private key, and the other part is the private key which may be called a physical object in possession of the token holder.
Now we’ve arrived at the issue of the conflict of laws in relation to securities tokenized on the blockchain. The main trigger of this issue is, again, just like in the case of acceptance of legally binding force of a blockchain transaction, is the difficulty of determination of the location of the security. Keeping in mind that the register is international in nature and completely decentralized, which law should be applied in relation to security tokenized by its owner in the real world? Should it be the law of the issuer’s domicile? Or the law of any of the tokenholder with relation to those precise tokens he or she holds? Or, if it is a private, centralized blockchain, it should be the law of the country of the organization that technically supports this blockchain? Getting back to the way the Hague Convention deals with blockchain transactions, we could state that the same approach seems logical for tokenized securities.
When speaking about registration of securities on blockchain and respective applicable law to them, we can’t omit the first-mover Dispositif d'Enregistrement Electronique Partagé (DEEP) provision implemented in France on December 24, 2018. In applying this reform, French law now provides that DLT registration of certain financial securities equates registration in a securities account. This DLT registration goes for both establishing the property of said securities and their disposal. The choice of using DLT rather than account registration falls to the issuer.
This is a truly innovative step towards the creation of the appropriate and adequate legal regime for the flow of securities within the blockchains both as whole security registered in the distributed ledger and parts of this securities in the form of tokens. The fact is, this was not the first regulation implemented in France on the path to becoming blockchain-friendly jurisdiction. One year prior to the introduction of the Order, the Ministry of Finances made amendments to the Monetary and Financial Code in relation to ‘minibons’ - a type of debt securities, short-term notes that are offered through the investment services providers - issued and paid off on the blockchain.
The French approach introduced the framework under which registration of financial security in blockchain equals the process of book entry with the traditional securities registrator. The Order goes: ‘Registration in a shared electronic recording device shall be considered a book-entry’. Here, the issue of the ownership with the comparison to a physical object becomes invalid since securities in all developed economies have become dematerialized in the late 20th century, all respective rights and claims to a security are incorporated in the fact of the recording of this security with the registrator. Domicile of the registrator usually determines the law applicable to the security. The French approach proposes the logic according to which the law applicable to a security remains that of the non-blockchain register this security was registered with before it was tokenized, even if the subsequent token holders are spread around the world.
With the advent of blockchain, the significant issue has arisen as to the legal nature of securities tokenized and registered on the blockchain. Was the legal relationship between the shareholder and the tokenholders changed completely or partially modified by the decentralized nature of the register of the securities? The resolving of this issue and coming up with the right legal regime and tackling of the conflict of law challenge is so uncertain that it was a hot topic in the process of composition of the [UNIDROIT Convention](https://www.unidroit.org/fr/instruments/marches-fi nanciers/geneva-convention) on Substantive Rules for Intermediated Securities of October 9, 2009.
Contrary to traditional registers where there is one known, licensed intermediary holder, in the blockchain, there are multiple holders of note of registration of the security with the specific owner. How can a person own a security that is a part of many registers and each of them exercises equal legal power? How can a person exercise possession of a security which exists only in digital realm? Does a person holding a security token exercise the right of ownership of the right of claim? Is it a real right for the holder or a personal right? These questions need to be answered by the international community in order for the blockchain to continue developing as a useful and convenient tool for registration of securities.
Speaking of the conflict of law issue with regard to tokenized securities, we must find some ways to tackle it in the international legal realm, not only national. Although, in my personal opinion, the French approach fits best to be accepted and used in private international law with respect to the transfer of tokenized securities.
The European Union shows the best examples of unification and harmonization of law in all fields, and securities law is not an exception.
There are three main Directives establishing a legal regime for the securities flowing within the Union:
- Directive 2001/24/EC ensures the enforcement of proprietary rights of security owners in book-entries in framework of the actions undertaken in solvency case of credit and investment organizations;
- Directive 2002/47/EC deals with financial arrangements related to book-entry securities;
- Directive 98/26/EC relates to collateral securities book-entries as part of dispute resolution systems where the European Central Bank or the Union States’ Central Banks are involved.
These legislative acts of international law ashare the same principle as is proposed in the Hague Convention - the Place of the Relevant Intermediary Approach. Instead of centering the location of the security or the holder, it takes into account the law of the register. Thus, the applicable law to the securities is that of the register regardless of whether the securities are of foreign or domestic origin. Much like with secondary markets where the law of an exchange a share is traded on is applicable to all shares and other types of securities traded thereon.
Tokenizing securities and finding the right approach to recording of the respective rights poses a new challenge for the international legal community. One might say that all principles and paradigms proposed on the brink of millennia are old and do not even serve as the framework for thinking about the right regulation of tokenized securities. Thus, we must consider this issue completely from scratch, not giving consideration to the old narratives.
Decentralization of the register of securities introduces some new usabilities and eases the process of their transfer, yet it renders the question of the legal protection of tokenholders’ rights untackled. Speaking of the conflict of law with respect to tokenized securities, it is obvious that traditional approaches do not fit the realities of our times and the goals and the fundamental ideas of the blockchain itself.
With regard to the law applicable to blockchain transactions and registration of tokenized securities on blockchain, there is no clear and satisfying solution. Amidst the growing popularity and adoption of blockchain, the world’s legislators need to establish the proper framework of protection of investors’ rights.
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