New UCC Amendments to Establish Ground Rules for Blockchain Transactions and Crypto-Backed Secured Financing | Ulmer & Berne LLP

At its annual meeting in July, the ULC approved a final draft of the joint ULC-ALI Emerging Technologies Committee’s (ETC) amendments to the UCC, which includes a brand new Article 12 devoted to defining different digital asset classes and setting ground rules. for crypto-backed secured financing. New Article 12 will be consistent with a number of changes to existing Article 9 (secured transactions) and Article 3 (negotiable instruments).

The ETC was formed in 2019 to address a growing list of legal issues arising from the unique and intangible properties of cryptocurrencies, NFTs and other emerging digital assets, including, significantly, how security interests in digital assets can be perfected.

The new Article 12 deals with transfers of interests in a forward-looking, aggregate class of digital assets labeled “verifiable electronic records” (CERs), a term intentionally created to go beyond current distributed ledger and blockchain concepts to capture future intangible digital assets not yet invented. Under new 12-102(a), a CER is vaguely defined as “a record stored in an electronic medium,” but specifically excludes, among other things, “electronic money,” electronic records of promissory notes (“controllable payments intangibles”) . , and electronic records of accounts receivable (“controllable accounts”). But according to ETC guidanceCERs include NFTs because NFTs do not specifically fall under any of these excluded categories of digital assets.

The proposed amendments to Article 9 are largely focused on clarifying the procedures for attachment and perfection of security interests in CER and “electronic money”, including what constitutes “control” of intangible digital assets that cannot be physically “controlled”. Interestingly, the revised definition of “money” defines “electronic money” to mean digital fiat currencies (central bank-issued digital currencies or CBDCs), while non-fiat cryptocurrencies – such as Bitcoin and Ether – are excluded (although later adopted by a government as legal tender, virtual currencies that existed prior to official government adoption do not qualify as “money” under the revised definition, but are instead considered CERs). What this means in practical application is that perfection of a security interest in CBDC can only be achieved via the lender’s “control” of the CBDC (ie, a UCC financing statement will not suffice).

Under new 9-105A, a lender will be deemed to have “control” over electronic money if “a record relating to or logically associated with the electronic money or a system in which the electronic money is recorded” gives the lender “exclusive power.” ” to control the transfer and the underlying blockchain – or “the system in which the electronic money is recorded” – enables the lender to “easily identify itself” as the one in control (ie via “name, identification number, cryptographic key, office , or account number”). New 9-107A and 12-105(a) create identical rules for establishing control over CERs, controllable accounts, and controllable intangible payments.

In practical application, the “control” rules in new 9-107A and 12-105 mean that in order to be first-priority perfected in (non-fiat) cryptocurrency security, a lender must acquire the borrower’s private key and transfer crypto to a wallet as the lender (or a third party trustee or custodian) solely controls. Alternatively, and more simply, control can be achieved under new 12-105(b) via a self-executing smart contract on the applicable blockchain (ie, where the pledged crypto is either automatically returned to the borrower upon maturity or transferred to the lender’s wallet upon default).

Essentially, new Article 12 (12-104(e)) clarifies that the “take free” rule in Article 8 (8-303) will protect “qualified purchasers” of CERs – i.e., a purchaser who acquires control of a CER without notice of any adverse claims to or security interests in the CER will take the CER (and any verifiable claims or promissory notes evidenced by it) free and clear of any prior security interests.

These UCC amendments are issued following the passage of non-uniform statutes by a handful of states (Wyoming, Kentucky, Idaho, and Tennessee) that attempt to define and regulate interests in digital assets. While timetables will vary from state to state, most state legislatures are likely to adopt the changes proposed by the ETC.

The need for the changes is readily apparent: significant and painful disputes over the relative rights of cryptolenders, borrowers and depositors in the recent Chapter 11 bankruptcy filings of trading and lending platforms Voyager Digital and Three Arrows Capital is gone with little or no statutory guidelines in place. And the business models of existing crypto/NFT secured lending platforms such as Arcade and BlockFi continue to depend entirely on the belief that self-executing smart contracts actually provide lenders with first-priority security interests in crypto-security.

As with all important new legislation, the actual interpretation and application of these UCC changes by the courts will take some time to develop—time that will be carried over to the TBA timeline for state-by-state adoption of the proposed changes. In the meantime, lenders and borrowers secured by digital assets will have to buckle down and continue to take stock of the risks inherent in this rapidly evolving and technically intricate area.