Home Blockchain New UCC Amendments to Establish Ground Rules for Blockchain Transactions and Secure Crypto Funding | Ulmer & Bern LLP

New UCC Amendments to Establish Ground Rules for Blockchain Transactions and Secure Crypto Funding | Ulmer & Bern LLP

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New UCC Amendments to Establish Ground Rules for Blockchain Transactions and Secure Crypto Funding |  Ulmer & Bern LLP

At its annual meeting in July, ULC approved a final version of amendments from the ULC-ALI Joint Committee on Emerging Technologies (ETC) at UCC, which includes an all-new Section 12 devoted to the definition of various classes of digital assets and establishing ground rules. for secure encrypted funding. The new Article 12 will be articulated with a series of amendments to the existing Article 9 (secured transactions) and Article 3 (negotiable instruments).

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

The new Section 12 deals with transfers of interests in a catch-all, forward-looking class of digital assets called “verifiable electronic records” (CER), a term that was intentionally designed to go beyond the concepts distributed ledger and blockchain technologies to capture future intangible digital assets that are yet to be invented. Under new 12-102(a), a CER is nebulously defined as “a record stored in electronic media”, but specifically excludes, among other things, “electronic money”, electronic records of debt in the form promissory note (“controllable payment intangibles”). , and electronic records of accounts receivable (“controllable accounts”). But according to ETC tipsCERs 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 seizure and third-party effectiveness of security interests in CERs and “e-money”, including what constitutes “control” of intangible digital assets that cannot physically be “controlled”. Interestingly, the revised definition of “money” defines “e-money” to mean fiat digital currencies (central bank-issued digital currencies or CBDCs), while non-fiat cryptocurrencies – like Bitcoin and Ether – are excluded (even if later adopted by a government as legal tender, virtual currencies that existed prior to official government adoption are not considered “currency” under the revised definition, but are instead considered CERs). In practical terms, this means that the perfection of a security interest in the CBDC can only be achieved through the “control” of the CBDC by the lender (i.e. a UCC funding statement will not suffice).

Under New 9-105A, a lender will be deemed to have “control” of electronic money if “a record attached to or logically associated with the electronic money or a system in which the electronic money is recorded” gives the lender the “exclusive power” to control its transfer and the underlying blockchain – or “system in which electronic money is recorded” – allows the lender “to easily identify itself” as the controlling party (i.e. via “name, identification number, cryptographic key, office, or account number”) New 9-107A and 12-105(a) create identical rules for establishing control of CERs, controllable accounts, and assets controllable payment intangibles.

In practical application, the “control” rules of New 9-107A and 12-105 mean that, in order to be perfected first in (non-fiat) cryptocurrency collateral, a lender will need to acquire the private key of their borrower and transfer the crypto to a wallet that the lender (or a third party trustee or custodian) controls solely. Alternatively, and more simply, control can be obtained under New 12-105(b) via a self-executing smart contract on the applicable blockchain (i.e., in which the pledged crypto is either automatically returned to the borrower at maturity or transferred to the lender’s portfolio in the event of default).

In substance, the new Article 12 (12-104(e)) clarifies that the “free take” rule set out in Article 8 (8-303) will protect “qualified buyers” of CERs, i.e. i.e. a buyer who obtains control of a CER without notice of any adverse claim or security interest in the CER shall render the CER (and any controllable account receivable or promissory note debt evidenced by it) free and free of any prior security.

These UCC Amendments are released following the enactment by a handful of states (Wyoming, Kentucky, Idaho, and Tennessee) of non-uniform laws that attempt to define and regulate interests in digital assets. Although timelines vary from state to state, most state legislatures will likely pass the changes proposed by the ETC.

The need for the changes is clear: significant and painful disputes over the relative rights of crypto lenders, borrowers and depositors in recent Chapter 11 bankruptcy filings by trading and lending platforms digital travel and Capital of the Three Arrows walk away with little or no statutory guidelines in place. And the business models of existing crypto/NFT secure lending platforms like Arcade and BlockFi continue to rely entirely on the belief that self-executing smart contracts in fact give lenders priority security interest on crypto collateral.

As with all significant new legislation, the real-world interpretation and application of these UCC Amendments by the courts will take some time to develop – time that will be added to the TBA schedule for state-by-state enactment of the proposed amendments. In the meantime, lenders and borrowers secured by digital assets will need to retreat and continue to assess the risks inherent in this rapidly changing and technically complex space.

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