Cryptocurrency (Photo illustration: Jason Doiy/ALM)

 

Our lives are becoming digitalized, and so are our assets. Many people are migrating away from tangible assets in favor of dealing in cryptocurrencies. With this shift to digitalizing assets, it is necessary to determine whether cryptocurrencies can be used as collateral for loans, and whether it is wise for lenders to accept such an asset as collateral.

Understanding How the Cryptocurrency is Used

When it comes to cryptocurrency as collateral, we cannot neatly fit it into any of the existing categories under Article 9 of the Uniform Commercial Code, which regulates secured transactions. This difficulty in categorizing cryptocurrency is furthered by the fact that various courts and government agencies have categorized cryptocurrencies differently. Therefore, because categorization of all collateral under Article 9 depends on how the borrower is using the collateral, and this categorization is essential to taking steps to secure an interest, we must look carefully at the cryptocurrency’s character to determine the best fit.

The way in which a borrower is using the cryptocurrency will influence whether it is categorized as a currency, a commodity or a security, which in turn will determine which Article 9 classification we use. A commodity is a raw material that can be bought and sold. Some cryptocurrencies are commodities because they are needed for a purpose, like providing fuel for smart contracts. Cryptocurrencies are considered currencies or money when they are used to purchase materials. Finally, a security is any debt that has been assigned value and sold. Some cryptocurrencies are securities because they are utilized as investments.

Fitting the Crypto-Currency into an Article 9 Category

Once you have determined how your borrower is using the cryptocurrency, you are armed with the information needed to determine which Article 9 classification the cryptocurrency falls into and, consequently, how to perfect your interest in this collateral.

All cryptocurrencies, may be considered general intangibles because they are items of personal property that do not fall into any other clearly defined category of collateral. Cryptocurrencies may also be classified as currency or money. The UCC defines money as a “medium of exchange currently authorized or adopted by a domestic or foreign government.” Although the United States government has not adopted cryptocurrency as a recognized medium of exchange, other countries have, such as Japan. In addition, cryptocurrencies may be considered investment property if used as a security.

Perfecting the Secured Interest of Crypto-Collateral

If the cryptocurrency is categorized as a general intangible, perfection will occur through filing a UCC-1 financing statement. A financing statement will be sufficient if it provides the name of the debtor, the name of the secured party or representative thereof, and indicates the collateral. Collateral will be considered sufficiently indicated if it complies with UCC § 9-108 or indicates that the financing statement covers all assets or personal property. Filing a financing statement that covers all personal property generally would encompass cryptocurrencies; however, the description required when filing a UCC-1 financing statement only pertaining to cryptocurrencies is not as clear.

When filing a financing statement only covering cryptocurrencies, the description will have to reasonably identify the cryptocurrency in a manner by which the identity of the collateral will be objectively determinable. A possible description for a financing statement will be the address and access key of a cryptocurrency wallet, which is required to deal in cryptocurrencies. As such, the following description could be used: “All cryptocurrency contained within the wallet with the following address and access key.” This is a risky description though because once the wallet address and access key are known, anyone could steal the collateralized cryptocurrency. Another potential UCC-1 description would be “all cryptocurrencies owned by name.” This description, however, could be too broad depending on the amount of cryptocurrency owned by the borrower in comparison to the amount used as collateral. Another concern with perfecting a security interest in cryptocurrency through a UCC-1 financing statement is the potential that the collateralized cryptocurrency will go missing. This would pose a significant problem for the lender because cryptocurrency transactions are anonymous. As such, the concept of securing an interest in cryptocurrency through a UCC-1 is premised on the idea that the borrower is well-behaved.

If the collateral is classified as money, perfection of a security interest would occur through possession. Cryptocurrency is digital; thus, possession could occur in two ways. First, if the cryptocurrency is stored within a tangible “wallet,” such as a paper wallet or in a wallet stored on a flash drive, then the lender could physically possess the wallet. Second, the lender could require the borrower to transfer the cryptocurrency collateral into the lender’s own wallet. As a practical matter though, borrowers dealing in cryptocurrency will likely be unwilling to physically hand over their digital assets.

If the cryptocurrency is defined as investment property because it is used as a security, then the lender must look to Article 8. There are two types of securities, those with certificates and those without. Perfection of an interest in a security can occur through delivering the security certificate to the lender or by filing a UCC-1 financing statement. As discussed above, the lender would have to ensure that the financing statement is sufficient and also ensure that the borrower is trustworthy.

Conclusion

Cryptocurrencies are volatile as there are currently no regulations and few court opinions guiding the classification, sale, purchase, and investing of cryptocurrencies. Although it is possible to use cryptocurrencies as collateral, I leave it to you as to whether it is wise. If you are a lender seeking to use cryptocurrencies as collateral, be vigilant and think hard about whether you want your loan secured by a digital token that cannot be seen or touched and can be easily hidden.



Ashlyn L. Robinson is an attorney at Trenam Law in Tampa, Fla. She practices in the firm’s Commercial litigation and Bankruptcy & Creditors’ Rights practice areas, and can be reached at arobinson@trenam.com.