The growth of virtual currency continues to be held back by the lack of uniform regulations. While regulators at the federal and state level are increasing their oversight over Bitcoin and Ether blockchain-based currencies, there are still very few clear rules for businesses to follow. Given the lack of clear standards, there are significant risks associated with taking and perfecting a security interest in assets that include virtual currency.
Uniform Regulation of Virtual-Currency Businesses Act
As detailed in a prior article, the Uniform Law Commission drafted a uniform model state law, known as the virtual currency laws for businesses, users, and investors. The law was finalized late last year and is currently under consideration in several states, including Connecticut, Hawaii, and Nebraska.(URVCBA), to address the patchwork of overlapping and varying
The URVCBA aims to provide a statutory framework for the regulation of companies engaging in “virtual-currency business activity” and contains a three-tier regulatory scheme that determines whether an individual or company engaging in virtual currency business activity is (1) exempt from the law; (2) must register; or (3) must obtain a license. The URVCBA also contains numerous consumer protections.
While the URVCBA is a great start, it does not contain commercial law rules for covered transactions. To fill that void, the Uniform Law Commission is currently working on a companion model law. It addresses the commercial law rights of virtual-currency businesses that have control over their customers’ virtual currency and, in particular, providing to those businesses and customers duties and rights comparable to those enjoyed by customers of securities intermediaries under Article 8 of the Uniform Commercial Code (UCC).
Commercial Rules for Virtual Currency
Article 9 of the UCC generally governs security interests in both tangible and intangible assets. Because it does not fit neatly into any of the UCC’s existing definitions, the application of Article 9 to virtual currencies is ripe with legal uncertainties.
The(Companion Act) aims to provide some guideposts for businesses and investors. One of its major goals is to provide a roadmap for Article 9 secured parties to the attachment and perfection of security interests in virtual currencies held by intermediaries in a manner comparable to traditional securities held in “securities accounts” subject to UCC Article 8.
“The use of provisions based on Article 8 is intended to provide certainty for using virtual currency as collateral under Article 9 of the Uniform Commercial Code: it allows secured parties taking virtual currency as collateral to proceed under the ‘control’ model for attachment and perfection of their security interests that Article 9 allows,” the Uniform Law Commission states in its draft law. “We also believe that this act will enhance the ‘negotiability’ of virtual currency when transferred or exchanged, as well as making clear that generally recognized commercial law rules are available to supplement the provisions of this act.”
For a licensee or registrant governed by the URVCBA to be subject to UCC Article 8’s rules, the licensee or registrant must assume “securities intermediary” status and maintain a “securities account” to which a “financial asset” is or may be credited. Under UCC Section 8-102, a “securities intermediary” is not confined to a person who is regulated under banking or securities, but includes “a person...that in the ordinary course of its business maintains securities accounts for others and is acting in that capacity.”
Similarly, the definition of “securities account” is not confined to an account at a bank or broker or to an account maintained by a person regulated under banking or securities law. The term is defined in UCC Section 8-501(a) as “an account to which a financial asset is or may be credited in accordance with an agreement under which the person maintaining the account undertakes to treat the person for whom the account is maintained as entitled to exercise the rights that comprise the financial asset.”
Finally, the definition of “financial asset” is not confined to a security, but defined in UCC Section 8-102(a)(9)(iii) to include “any property that is held by a securities intermediary for another person in a securities account if the securities intermediary has expressly agreed with the other person that the property is to be treated as a financial asset under [Article 8].”
The Uniform Law Commission maintains that, taken together, the definitions indicate that a licensee or registrant, which maintains accounts for users to which virtual currency is or may be credited as a financial asset, could agree expressly with the users to be subject to the rules of UCC Article 8. Below are several key provisions of the model law:
- Opt-In: A licensee or registrant in the business of maintaining control of virtual currencies for users may expressly agree with the users that virtual currency of which the licensee or registrant has control for the users will be treated as “financial assets” credited to the users’ “securities accounts” under UCC Article 8. Article 8 does not dictate what form the express agreement might take, but it would certainly permit the express agreement to be contained in the account agreement between the licensee or registrant and a user.
- Application of UCC Article 8, Part 5 Duties: When the licensee or registrant expressly agrees with users to treat virtual currency as financial assets credited to the users’ securities accounts, then the licensee or registrant assumes certain UCC Article 8, Part 5 duties as relevant for the virtual currency and enforceable by the users. For instance, the licensee or registrant would need to maintain control of sufficient virtual currency of each type to satisfy all entitlements of the users to virtual currency of that type. Additionally, the licensee or registrant must comply with a user’s instructions to transfer virtual currency to another person, as and when, for example, the user wishes to exchange the virtual currency for goods, services, fiat currency, or any other type of virtual currency.
- Protection of Licensee or Registrant Following Instructions of its Customers: If a licensee or registrant with control over a customer’s virtual currency transfers virtual currency as instructed by the user, the licensee or registrant generally cannot be held liable for the transfer by an adverse claimant to the virtual currency unless the licensee or registrant acted in collusion with the wrongdoer in violating the rights of the adverse claimant.
- Claims of Creditors of Licensee or Registrant: If a licensee or registrant has expressly agreed with users to treat virtual currency of which the licensee or registrant has control for the benefit of users as financial assets credited to the users’ securities accounts, then such a financial asset giving rise to a security entitlement generally is not subject to the claims of creditors of the securities intermediary in priority over the security entitlement. As a result, virtual currency of which a licensee or registrant has control for a user would not be subject to claims of creditors of the licensee or registrant. However, the virtual currency would be subject to a claim of a creditor of the licensee or registrant, senior in priority to the user’s entitlement, if (a) the licensee or registrant has granted to the creditor a security interest in the virtual currency, (b) the creditor has “control” of the virtual currency as defined in UCC § 8-106, and not as in the URVCBA, and (c) the licensee or registrant has not complied with its duty to maintain sufficient virtual currency of that type to satisfy the entitlement in addition to satisfying the security interest of the creditor. The licensee or registrant, though, is not permitted under Article 8 to grant a security interest in the virtual currency without the consent of the user. Under the Companion Act, the licensee’s or registrant’s grant of a security interest in its users’ virtual currency in most circumstances will not be effective.
As explained by the Uniform Law Commission, the provisions are based on Article 8, but are not intended to affect its provisions or their interpretation. However, third-party intermediaries maintaining “control” of virtual currencies for their customers, as well as customers of those providers, should be able to take advantage of judicial decisions affecting obligations under UCC Article 8.
The laws governing virtual currency are constantly evolving. Scarinci Hollenbeck’s Corporate Transactions & Business Group will continue to track the progress of the Uniform Regulation of Virtual-Currency Businesses Act and the Companion Act. Please stay tuned for updates.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work at 201-806-3364.