With digital assets maturing as a category many more people now hold them in one form or another.
In theory cryptocurrency or other digital assets can be used as a medium of exchange, but, more realistically, most are treated as an asset class or store of value and are unlikely to be transferred regularly. At some point though, anyone who holds a digital asset with value will want to sell or gift their asset.
This note looks at how digital assets can be transferred or sold and some of the legal issues arising.
If I have bought or won in-game currency or a collectible item, can I transfer it?
There is a large category of digital assets which is not blockchain based. There are digital assets which are pure collectibles “Collectibles” i.e not NFTs or cryptocurrency, and not usually blockchain based, but instead a digital item or “currency” which is earned, won or purchased in a game or app and which is (usually) only usable or viewable within that game or app.
- Collectibles may be transferrable but only if permitted by the platform operator.
- Unless expressly granted, there is no ‘right’ to be able to transfer a Collectible and usually the ‘asset’ itself is nothing more than a licence to view or use the item in the game or app.
- Whether a Collectible is transferrable will almost entirely be down to the terms and conditions of the platform provider and the underlying software which operates the platform.
- Some platforms will allow users to transfer Collectibles and some games have had lively secondary markets but the mechanism by which Collectibles are transferred will vary between platforms.
The same principles may apply to many ‘metaverse’ platforms where the market for the Collectibles is operated by, and the rules of that marketplace decided by, the company which runs the platform, essentially as a matter of private contract law.
How do I transfer cryptocurrency directly?
For an explanation of what cryptocurrency is please see here.
If you hold cryptocurrency directly (i.e. not through an exchange or custodian), then you will need to have a wallet. A wallet is a piece of hardware or software which enables cryptocurrency to be held securely.
The key point to note about cryptocurrency (or NFTs) is that while there is usually a person ‘associated’ with the wallet (i.e. the owner), the transactions are anonymous. Each wallet will have two ‘key’s associated with it, a public key and a private key.
The public key is a code which is, as the name suggests, public, can be shared and is available on the blockchain which records all transactions. The private key is confidential and (should be) known only to the owner and ensures that only the person which that key can unlock a given transaction or asset.
Many wallets also have a passphrase which generates the private key (and is easier to remember).
Transferring cryptocurrency between wallets will require inputting the recipient’s public key and your own private key to authorise the transaction.
In order for the transaction to be effective both users have to have a wallet and have to know, but not share, their private key (or their passphrase).
This seems quite risky. Is it?
The process is relatively straightforward but the fact that there is no central governing entity means that mistakes are not rectified. If you include the wrong public key then the assets may be gone for good, with little in the way of legal remedies available.
In the event of fraud traditional legal remedies may apply but extreme caution is warranted.
For this reason many people rely on exchanges to hold and transfer their cryptocurrency.
How does an exchange work?
A cryptocurrency exchange is a platform which does several things.
- Firstly it provides a more user-friendly environment for those who want to hold cryptocurrency but who do not want to deal with wallets, private and public keys etc.
- Secondly an exchange, as the name suggests, provides liquidity by allowing users to trade their cryptocurrency and buy and sell from other users.
- Private transactions can be relatively easily facilitated with a wallet, if the sending party knows the receiving party’s public key. An exchange allows the currency to be sold to or bought from an unknown user at a prevailing price.
- An exchange may also ‘make’ a market by sitting in between the buyer and the seller.
Are exchanges more secure?
Generally exchanges are considered to present risks which do not exist if you hold currency in a private wallet. Exchanges can be hacked and smaller exchanges are at risk of fraud.
There was previously thought to be some uncertainty whether holdings of currency held by an exchange were held on trust for the users, in other words if the exchange went bust, could the users get their currency back or would they have to stand in line with other unsecured creditors.
Fortunately it now seems (following a recent High Court judgment) that exchanges are likely to be treated as holding assets on trust which does offer more security.
There are also risks associated with holding a private wallet principally that if you forget or lose your private key there is no way to recover the assets.
How do I transfer on an exchange?
Each exchange will have their own system for facilitating transfers but all large reputable exchanges facilitate transfers.
These transfers may be on-chain – which is a direct transfer to a public key (this is irreversible) or off-chain – which is a transfer between two users of the exchange, which is reversible and may be less risky.
I own an NFT; what is the process for transferring it?
For an explanation of what NFTs are please see here.
Blockchain NFTs are treated like cryptocurrency. They are ‘associated’ with a wallet and can be transferred between wallets the same way as cryptocurrency.
There are also NFT marketplaces (Opensea being the largest) which operate in a similar way to cryptocurrency exchanges.
What are custody services?
A custodian is usually an institution which holds cryptocurrency for its users/customers or provides an additional security layer for holding digital assets.
An exchange is a type of custodian in that they hold cryptocurrency on behalf of their users (the users individually don’t have a public key for their individual holding).
However there are custodian service providers which do not directly hold the assets but instead provide additional security for institutions which hold large amounts of cryptocurrency. It is risky for an institution to be subject to the discretion, competence and honesty of a single private key holder, and do not want a single private key to permit transactions.
Usually these services allow customers to implement hardware or software security solutions which require multiple trusted users to authorise transactions, and the private key is only ‘unlocked’ to facilitate a transaction when the relevant security protocols are followed.