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The Lay of a Virtual Land: Cryptocur- Rencies As Collateral

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The Lay of a Virtual Land: Cryptocur- Rencies As Collateral SELECTED TOPIC “Cryptocurrencies,” digital assets that use under federal tax law, virtual currency will blockchain technology to provide for secu- henceforth be treated as “personal prop- rity and anonymity of transactions, have er t y.” 14 According to this emerging majority, become an inescapable global reality since cryptocurrencies therefore qualify as the introduction of Bitcoin in 2009.1 Their “intangible personal property.”15 popularity has, in turn, raised numerous questions about how to classify such assets II. EVOLVING ISSUES MAY 2019 and perfect security interests in them under A. Collateral Type the Uniform Commercial Code (“UCC”).2 Yet, whether a cryptocurrency functions THE PUBLICATION FOR CREDIT & FINANCE PROFESSIONALS $9.00 As more lenders have reconsidered their solely as a medium of exchange or as initial reluctance to accept cryptocurrency participation in an issuer of property can as collateral,3 commercial lawyers have (and likely will) have a huge impact on been increasingly focused on how best to its classification under the UCC. Article 9 protect clients that lend money secured by focuses exclusively on security interests in a pledge of such assets. Within this unset- “personal property” pledged as collateral tled area, 2018 brought little certainty, but for repayment of a debt.16 “Collateral” is it confirmed the likelihood that the classi- defined as “property subject to a security The Lay of fication of any cryptocurrency will depend interest”;17 such “property” includes “[g] on its unique function. eneral intangible[s],” which are defined as “any personal property, including things in a Virtual A Crypto-World action, other than accounts, chattel paper, “Bitcoin is a digital payment system,” with commercial tort claims, deposit accounts, Bitcoin its “unit of account.”4 Beginning documents, goods, instruments, investment Land: in 2011, other cryptocurrencies based on property, letter-of-credit rights, letters of Bitcoin’s open-source code emerged.5 By credit, money, and oil, gas, or other minerals 2018, between 5.8 million and 11.5 mil- before extraction,” and as encompassing Cryptocur- lion users had “cryptocurrency wallets.”6 “payment intangibles and software.”18 Under Crucially, not all these virtual currencies Article 9, a “payment intangible” is thus a serve the same purpose; rather, function subcategory of “general intangible[s] under rencies as and origination distinguishes the “coins” and which the account debtor’s principal obliga- “tokens” stored within those virtual holders. tion is a monetary obligation,”19 money spe- Generally used as a medium of exchange, cifically excluded.20 In effect, this “catch-all” Collateral coins are formulated based on their own term brings within Article 9 miscellaneous native blockchain and given as a reward or types of contractual rights and personal payment for a recipient’s services.7 Tokens, property frequently used as commercial however, are created on existing block- collateral, a sufficiently elastic category to chains and often distributed through initial subsume most cryptocurrencies.21 coin offerings (“ICOs”) as a means of raising capital.8 Tokens “are designed for, and have, The UCC contains other potentially relevant, a clear and intended use” apart from simply if problematic, definitions, all of which have serving as a unit of value.9 For example, a elicited some support from commentators token can convey voting or participation or courts. Under Article 1, “‘money’ means rights in an organization or grant the owner a medium of exchange currently autho- access to application features.10 rized or adopted by a domestic or foreign government” and “includes a monetary Cryptocurrencies Under the UCC unit of account established by an intergov- Richard Hagerty, Esq., Of I. AN EMERGING CONSENSUS? ernmental organization or by agreement Counsel, Troutman Sanders 22 LLP has three decades of In recent years, many have concluded that between two or more countries.” Because experience representing secured crypto assets are “personal property” sub- cryptocurrency coins operate as “pecuni- and unsecured creditors. ject to Article 9 of the UCC.11 In a case ary resources” and as both “a medium of involving online money exchangers who exchange” and “a means of payment,”23 clas- Amir Shachmurove, Esq., is an associate in the Financial failed to register with the Financial Crimes sifying cryptocurrency as money appears Services Litigation section of Enforcement Network, a federal court held logical. Apart from the Oglala Lakota Troutman Sanders LLP. Bitcoins to be subject to civil forfeiture as Tribe’s prospective MazaCoin,24 however, “personal property” under 18 U.S.C. § 1960.12 no cryptocurrency enjoys the backing of A bankruptcy tribunal likewise held that a sovereign state,25 a fatal omission under Bitcoin was “personal property” for purposes the UCC.26 Casting further doubt on this of the Bankruptcy Code’s fraudulent-transfer denomination, the U.S. Commodity Futures provisions.13 And the IRS has ruled that, Trading Commission (“CFTC”) has deemed 1 BUSINESS CREDIT MAY 2019 cryptocurrencies to be “commodities,” a rul- that could severely hamper the marketabil- 12 United States v. 50.44 Bitcoins, No. ELH-15-3692, 39 2016 U.S. Dist. LEXIS 70404, at *2–3 (D. Md. May ing subsequently upheld by an influential ity of any cryptocurrency. 31, 2016). federal district court.27 13 Elements Capital Grp. v. Carmack (In re Carmack), Perfecting a security interest in a digital 2018 Bankr. LEXIS 3253 (Bankr. D. Mass. Oct. 22, 2018). Meanwhile, Article 8’s definition of “secu- token that is treated as a security presents 14 I.R.S. Notice 2014-21. rity” arguably, but imperfectly, encom- different issues. UCC § 9-313(a) permits 15 E.g., Currier v. PDL Recovery Grp., LLC, No. 14- passes cryptocurrency tokens. After all, perfection of “certificated securities”40 by 12179, 2018 U.S. Dist. LEXIS 145127, at *5 (E.D. 41 Mich. Aug. 27, 2018); SEC v. PlexCorps, No. 17-CV- equity tokens equate to “an obligation of “taking delivery.” Delivery occurs when 7007 (CBA) (RML), 2018 U.S. Dist. LEXIS 102453, an issuer or a share, participation, or other a person (either directly or through a at *1–3 (E.D.N.Y. June 15, 2018). interest in an issuer or in property or an third-party “securities intermediary”42) 16 UCC §§ 9-101, et seq. enterprise of an issuer,”28 constituting a “acquires possession of the security certifi- 17 Id. § 9-102(a)(12). 18 Id. § 9-102(a)(42) (emphasis added). cognizable “financial asset” and thus, a cate.”43 Alternatively, and for uncertificated 19 Id. § 9-102(a)(61). 29 “security.” Indeed, in a recent settlement, securities, perfection is obtained through 20 In re Wright Grp., Inc., 443 B.R. 795, 804 (Bankr. the Securities and Exchange Commission control,44 a process that also depends N.D. Ind. 2011). (“SEC”) maintained that an ICO of digital on whether a securities intermediary is 21 CERx Pharm. Partners, LP v. Provider Meds, LP (In re ProvideRX of Grapevine, LLC), 507 B.R. 132, 162 tokens was a sale of unregistered securi- involved. Since most tokens are not going (Bankr. N.D. Tex. 2014). ties.30 Yet, as others note, this argument to be certificated, and because effective 22 UCC § 1-201(b)(24). ignores an important fact: as Bitcoin (and “control” over a token may require control 23 United States v. Faiella, 39 F. Supp. 3d 544, 545 its progeny) lack an “issuer,” none fall within of the relevant encryption key, a secured (S.D.N.Y. 2014). 31 24 Mandy Williams, Is MazaCoin, The Native Article 8’s definition of “security.” party would need to perpetuate such con- Cryptocurrency, Gaining Popularity Again?, trol to perfect an interest in any token that CRYPTOPOTATO (May 13, 2018). B. Attachment and Perfection is classified as an uncertificated security. 25 United States v. Petix, No. 15-CR-227A, 2016 U.S. Dist. LEXIS 165955, at *18 (W.D.N.Y. Dec. 1, 2016). If cryptocurrencies are “general intangibles” 26 UCC § 1-201(b)(24); United States v. Murgio, 209 or “securities,” different rules regarding Conclusion F. Supp. 3d 698, 709 (S.D.N.Y. 2016). the attachment and perfection of security For now, the debate over how to classify 27 CFTC v. McDonnell, 287 F. Supp. 3d 213, 224–26 (E.D.N.Y. 2018). But see Faiella, supra; United interests apply. cryptocurrencies as collateral under the States v. Ulbricht, 31 F. Supp. 3d 540, 570 (S.D.N.Y. UCC remains volatile, its unpredictability 2014) (treating cryptocurrencies as “money” for federal criminal purposes). To attach an enforceable security interest, undiminished from the perspective of 28 UCC § 8-102(a)(15). Article 9 requires the satisfaction of three commercial lenders and debtors. Whatever 29 Id. § 8-102(a)(9). elements: (1) the secured creditor must the merits of each proposed delineation, 30 In the Matter of Gladius Network LLC, Admin. give value; (2) the debtor must have rights cryptocurrencies today represent a useful, Proc. No. 3-19004, www.sec.gov/litigation/ admin/2019/33-10608.pdf (Feb. 20, 2019). in the collateral or the power to convey if legally fraught, opportunity. 31 Bob Lawless, Is UCC Article 9 the Achilles Heel of such rights; and (3) one of the conditions Bitcoin?, CREDIT SLIPS (Mar. 10, 2014). in UCC § 9-203(b)(3) must be met.32 In 32 UCC § 9-203(b). most cases, a creditor wishing to attach a 1 The term “cryptocurrency” generally refers to digital 33 Tu, supra note 2, at 551. currencies that are not issued by any centralized 34 UCC §§ 9-203(b)(3)(A)–(D). security interest in cryptocurrency could authority, while the term “virtual currency” encom- 35 Id. § 9-203(a). easily satisfy the first two conditions.33 But passes similarly distributed currencies actually 36 Id.
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