The Virtual is Real: An Argument for Characterizing Bitcoins as Private Property

Petter Hurich. Banking & Finance Law Review. Volume 31, Issue 3. July 2016.

Introduction

Courts should characterize bitcoins as private property.

Bitcoins are commonly described as virtual or digital currency. Unlike a bill of exchange or money deposited with a bank, bitcoins are valuable in-and-of themselves. Bitcoins do not represent claims to an underlying asset or against another person.

Typically, users download software known as a “wallet” which allows them to send and receive bitcoin payments. A growing number of companies, including e-commerce companies like Microsoft, Overstock and Dell, travel booking companies and companies which sell gift cards for websites like Amazon have begun to accept bitcoins as payment. The most common way to obtain bitcoins is through a currency exchange.

From a technical perspective, bitcoins are valuable units that exist as a state of information stored within a database. The database acts as a ledger and private passkeys confer the ability to authorize transactions which alter parts of the ledger. While the passkeys are held individually, the database is “shared” in the sense that there is no single entity with authoritative control over the database. While people tend to assume that they own their bitcoins, the legal status of information based property is somewhat murky.

Clarifying whether bitcoins are property is important because it is a prerequisite of determining basic questions such as: what happens if a vendor, acting in good faith, accepts stolen bitcoins as payment, can bitcoins may be used as collateral to secure a transaction and what are the legal consequences if a user is illegitimately deprived of their bitcoins?

In my view, the law of private property is the appropriate legal framework to apply to goods like bitcoin because it is well suited to defining relationships between persons with respect to a resource where the relationships are necessarily a matter of exclusive control.

The usage of a bitcoin is necessarily a matter of exclusion because bitcoins are inherently highly rivalrous. By inherently highly rivalrous I mean that if one person uses a bitcoin, it is impossible for someone else to use that bitcoin at the same time. In contrast, other information based resources, like ideas, are capable of being used by a multitude of persons at the same time. Basically, a bitcoin is more like a spoon than a song. If I am eating with a spoon it is impossible for you to eat with that spoon at the same time. In contrast, we may both sing the song.

The Technical Perspective: Valuable Units, Passkeys and Shared Public Ledgers

This section elaborates on a number of technical details to the extent that they are relevant to understanding the discussion of property rights. However, in the interest of brevity and simplicity, some of the details are simplified or omitted. The key points are:

  1. Bitcoins are valuable units assigned to accounts by transactions;
  2. Bitcoins are controlled by private passkeys stored by individual users;
  3. Bitcoin transactions are public information recorded in a database which acts as a ledger;
  4. The ledger is shared by a network of computers which operate without a central administrator.

Authorizing Bitcoin Transactions: Valuable Units, Accounts and Passkeys

A bitcoin is a valuable unit assigned to an account. Unlike a balance in a bank account, bitcoins do not refer to an underlying obligation, they are independently valuable. The number of bitcoins in circulation is limited according to a mathematical formula.

A bitcoin account is identified by a digital “address”. Every account also has a passkey associated with it. The passkey is privately stored by the individual who controls the account.

A user spends a bitcoin by broadcasting a transaction to a computer network requesting that the transaction be added to a database which acts as a ledger. The transaction specifies how many bitcoins currently assigned to the user’s account will be assigned to another account. The transaction also includes a digital signature which allows the user to prove that they have access to the account’s passkey without revealing the passkey. This prevents users from impersonating each other. Once the network verifies that the transaction is valid, it is eligible for inclusion in the ledger.

Transactions are Recorded in a Public Ledger

A transaction is complete when it is included in the ledger. The state of the ledger is updated with new transactions every 10 minutes (on average). Further, the current state of the ledger (and all previous states of the ledger) are public information.

Each update, known as a block, contains a set of transactions to be added to the ledger and a “cryptographic link” to the previous update. The cryptographic link creates a chain between each update which guarantees that transactions which have been previously added to the ledger cannot be reversed or altered. This chain of cryptographic links is the reason why the ledger is often referred to as “the blockchain”.

The Ledger is Capable of Operating Without a Central Point of Control

The Bitcoin ledger does not exist on any one particular computer. Rather, it is shared (i.e. distributed) amongst a network of computers. Each computer maintains an iteration of the ledger and follows a set of rules which specify which version of the ledger is valid in the case of temporary discrepancies. There is no central authority that controls, stores or defines the “authoritative” version of the ledger. Updates to the chain are managed through a consensus mechanism known as “proof-of-work” which basically allows users to take turns adding new updates to the ledger.

The Bitcoin protocol allows a diffuse network of users connected through the internet to agree upon whether a particular transaction occurs before or after another transaction without relying on a central “timekeeper”. This is important because it prevents a user from undermining the system by broadcasting a transaction which purports to pay the same bitcoin to multiple payees at the same time.

More broadly, the Bitcoin protocol adds the ability to make payments to an alternative architecture of the internet. Traditionally, users (clients) of the internet are often forced to surrender absolute control to central administrators (servers). Technologies like Bitcoin facilitate cooperation amongst users of the internet where reliance on a central administrator is impractical or otherwise undesirable.

Beyond Bitcoin: Multi-purpose and Permissioned Ledgers

While the purpose of this paper is to address property rights in the context of the Bitcoin ledger, it is worth noting that similar issues may soon be raised by a variety of related protocols.

The Ethereum project recently released a protocol for a proof-of-work blockchain that is able to act as a database for a wide range of applications. Alternatively, Eris Industries offers a application platform which, amongst other things, allows users to deploy a more tightly controlled “permissioned blockchain” which predefines who is able to access, alter or update the database.

The Legal Perspective: Bitcoins As Private Property

Defining the Scope of Bitcoin Ownership: Exclusive Control over Valuable Units

We have seen that bitcoins are units assigned to accounts that exist within a shared transaction ledger and are controlled by a privately stored passkey. The ledger does not exist anywhere in particular, it is the product of consensus between a network of computers which each maintain an iteration of the ledger. In short, bitcoins are a consensus over a state of information.

To be clear, as far as this paper is concerned, I am interested in bitcoins as valuable units. The Bitcoin software protocol that defines the rules of the shared ledger is a separate question.

So what exactly would a particular user own? It would be too wide to assert that they are a joint owner of the entire state of the ledger, no particular individual controls the entire ledger. More importantly, it would be too narrow to assert that they simply own the passkey to their account. This would reduce ownership of a bitcoin to a question of confidential information.

In my view, what would be owned are simply the particular valuable unit(s). Said otherwise, the user owns the specific values within the ledger over which they are able to exercise exclusive control. It is true that, in a de facto sense, exclusive control over a bitcoin is reducible to the question of whether you have access to the passkey associated with the account to which a bitcoin is assigned. However, from the legal perspective, property is about relationships between persons with respect to use of resources. As far as private property rights are concerned, we should be focused on the owner’s exclusive ability and right to use a valuable resource. The passkey is simply a means to that end.

Ownership of Information

In Canada (and many other jurisdictions) ownership of information is often governed by a set of statutes which are loosely united by the concept of intellectual property. The Copyright Act affords authors of literary, dramatic, musical or artistic works an exclusive right to produce, reproduce, perform and publish those works, although the right is typically limited to 50 years after the author’s death. The Patent Act provides the inventor of a ??novel? invention an exclusive right of making, constructing, using and selling their invention for 20 years after the patent is filed. The Trademarks Act confers the exclusive right to use a trade-mark in respect of goods or services to the owner of the trademark for 15 years (subject to renewal).

Outside the domain of intellectual property, common law courts have been mixed in their approach to ownership of information. In R. v. Stewart, the Supreme Court of Canada held that copying the contents of a list was not theft because information is not property for the purposes of the criminal law. In Re Gauntlet Energy a lower court decided that seismic data was securable personal property, holding that R. v. Stewart was limited to the criminal context and the particular facts of the case.

A useful comparison can be found in the legal treatment of internet domain names. While many interactions on the internet are characterized by a user interacting with a central authority, for instance the server that the user connects to when they access google.ca, no one controls the internet as a whole.

In 2007, a majority of the UK House of Lords commented that while they had ??no difficulty? with the proposition that an internet domain name may be intangible property the law of conversion (compensation for serious interference with use of property) did not apply. In contrast, in Kremen v. Cohen (2003), the US Ninth Circuit Court of Appeal held that a domain name registered within a distributed electronic database was personal property capable of being converted. In Tucows.Com Co. v. Lojas Renner S.A. (2011), the Ontario Court of Appeal agreed that a domain name was intangible personal property.

Bitcoins are not Intellectual Property

Speaking simplistically, bitcoins are not intellectual property because they don’t meet the criteria defined by the intellectual property statutes. More importantly, bitcoins do not resemble intellectual property or invoke the same policy concerns.

Intellectual property covers a fairly broad and somewhat discordant domain. However, the basic notion starts with the premise that ideas and other products of the creative activity of the mind, once made public, should be free to use. Unlike other types of property, an infinite number of people can use an idea at the same time. The problem is that creative work often involves a significant investment of resources. While an infinite number of persons may simultaneously use an idea, they will not all be able to derive profit from that use. The concern is that people will not have an incentive to invest in and disclose their creative work to the public if they are unable to profit from their efforts. The solution is to grant “creators” a limited sets of rights that exclude other persons from making specified uses of the ideas.

Bitcoins are different. Bitcoins are inherently highly rivalrous: two people cannot use the same bitcoin at the same time. The question of the right to exclude other persons from usage is grounded in a bitcoin’s inherent nature, not the policy of maintaining an incentive to engage in creative work by conferring exclusive rights to make specified uses of a non-rivalrous resource.

Bitcoins are Private Property

Private property is a flexible concept. However, if there is any default characteristic that usually defines the existence of a private property right in an object, it is the right and ability to exclude other persons from using that object. Because exclusive control over the use of a bitcoin is a necessary dimension of its rivalrous quality, rather than the product of legislation designed to balance economic incentive with the social value of the free flow of ideas, it is appropriate for courts to recognize property rights in bitcoins without legislative intervention.

Courts should not be deterred by the fact that bitcoins are intangible (i.e. bitcoins primarily exist as a state of information rather than a state of physical material). The important point is that users of bitcoins necessarily exercise exclusive control over their bitcoins, not the fact that the ability to exclude arises through control of a private passkey rather than physical possession.

Courts should take a similar approach to the cases that characterize internet domain names as property. The test for the existence of a property right applied by the US Ninth Circuit Court of Appeal in Kremen v. Cohen referred to an interest capable of precise definition which must be capable of “exclusive possession or control”. Rather than focus on the distinction between tangible and intangible, the court focused on the real issue, exclusive control over use of an object.

Further, I agree with the view that compensation for interference with an owner’s right to use should not be limited to tangible property. The English position that such compensation is only available for property capable of physical possession seems out-of-touch with the modern world.

Consequences of Characterizing Bitcoin as Property

It is arguable that protecting property rights promotes economic development. At the very least, characterizing bitcoins as property would make them available for to use as collateral in secured transactions.

If bitcoins are property, this would have consequences for the way in which they circulate. As a general rule, a person who obtains stolen property does not obtain legal title over the property, even if they are unaware that the property is stolen. If persons who accept bitcoins as payment lose confidence that they will actually be entitled to the bitcoins, this could put a damper on the circulation of bitcoins. Given that bitcoins are designed to circulate as a medium of exchange, this would likely be a problematic result.

On the other hand, the law already recognizes this problem and has established an exception to the general rule that allows a person who acts in good faith to obtain legal title to money and money-substitutes like bills of exchange, even if they are stolen. If the exception already applies to paper money substitutes, it would not be much of a stretch to extend the law to virtual units of value which function like currency.

Characterizing bitcoins as property would also affect what happens when an owner is unlawfully deprived of their bitcoins. Unlike the information in question in R. v. Stewart, which was non-rivalrous, (the victim was not deprived of the ability to use the information) bitcoins would be property and the person who intentionally deprived an owner of their bitcoins could be charged with criminal theft. It would also make it possible for the owner to sue the taker for the conversion of their property (at least in parts the United States and probably Canada). It might also be possible to sue for trespass to goods in circumstances where a person is temporarily deprived of their ability to use their bitcoins.

On Balance, Property Rights are the Appropriate Tool

One might question the need to “propertize” virtual space. It has been persuasively argued that as matter of policy property law may not be the preferable tool to address the use of bitcoins. In particular, if bitcoins cannot be owned they would be free to circulate without legal impediment. The exclusive quality of a bitcoin is protected by cryptographic measures, regardless of its legal status. Tort law, such as breach of confidence and perhaps unjust enrichment would still be available to address disputes. In Canada, the offense of unauthorized use of a computer would still be applicable.

My main objection to the argument that the law should not recognize bitcoin as property is that, overall, it is contrary to common sense. People tend to believe they own their bitcoins and this is a very reasonable belief. Bitcoins feel like property. They are digital objects designed to function as currency which, by design, users exercise exclusive control over.

While I appreciate the elegance of excluding bitcoin from the law of property as a means to ensure that they circulate freely, my position is that, on balance, this is not sufficient to justify establishing a legal fiction that would frustrate common practice. While my position potentially adds some friction to the system, if Bitcoin is to achieve wider adoption amongst a non-technical community, who will inevitably turn to courts to resolve disputes, it is preferable that the law reflect common sense. My position also enables commercial activity (such as using bitcoins as collateral to secure a transaction) that would otherwise be impossible.

Conclusion

I have argued that bitcoins should be characterized as private property. Because bitcoins are inherently rivalrous, a person who uses a bitcoin necessarily excludes anyone else from using the bitcoin at the same time. Private property is the legal framework that is best suited to defining relationships between persons with respect to a resource where the relationships are necessarily a matter of exclusive control.

Courts should not be distracted by the intangible nature of bitcoins. The developing jurisprudence characterizing internet domain names as private property is instructive in this respect.