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Implications of UCC on Crypto

Implications of UCC on Crypto

The Uniform Commercial Code’s (UCC) amendments are streamlining crypto transactions and creating uniformity in handling digital assets across different states.

As of 2022, the Uniform Commercial Code (UCC) made amendments to better cater to crypto transactions and secure digital asset lending. Five states including Washington, New Mexico, Colorado, Indiana, and North Dakota have put these changes into practice while 21 other states are considering doing so. By adopting the UCC’s amendments, the legal uniformity and transaction risk within the cryptocurrency space could greatly improve.

Introducing Controllable Electronic Records (CERs)

The UCC introduced a new form of digital assets known as “Controllable Electronic Records” or CERs. CERs are a category of digital assets legally recognized for transactions under a new Article 12. The definition of a CER is a digital record that can be controlled according to Section 12-105 of the UCC.

A person controls a CER if they meet three specific requirements. First, they must have the power to greatly benefit from the CER. Second, they should have exclusive power to prevent others from doing so and to transfer control. Lastly, the CER should enable the person to easily identify themselves as having these powers. This control concept is similar to the physical possession of a tangible asset. For instance, possessing Bitcoin or non-fungible tokens (NFTs) in your digital wallet likely considers control under this standard.

Interestingly, the UCC designed the definition of CERs to be broad enough to include types of digital assets that have not yet come into existence. However, it specifically excludes items such as deposit accounts and electronic money (virtual currency endorsed by governments).

Crypto Assets as Negotiable Instruments

Recognizing the frequent use of cryptocurrency as a method of payment, the UCC amendments aim to enhance the negotiability or transferability of CERs. The new Article 12 established a shelter rule that allows a CER purchaser to acquire all rights that the transferor possessed or had the power to transfer.

There’s also a “take-free” rule that allows a qualifying purchaser to acquire their interest in a CER free from any competing property claims. A qualifying purchaser refers to a buyer who gains control of a CER in good faith, for value, and without knowledge of a property claim to the CER. These rules, in effect, eliminate the need for a UCC-1 search before each cryptocurrency transaction, simplifying the process for qualifying purchasers.

Priority Rules for Digital Assets

Under the UCC amendments, CERs are now formally included in Article 9’s definition of general intangibles. Ordinarily, a person creates a security interest in a general intangible by filing a UCC-1 financing statement.

However, this contradicts market expectations and creates issues for participants using digital assets for payments. To resolve this, the UCC outlined that a security interest in a CER can reach perfection either by control under Section 12-105 or by filing a financing statement. A security interest in a CER perfected by control takes precedence over a security interest perfected only by filing a financing statement.

Additional Improvements in the UCC Amendments

In addition to fundamental commercial issues like negotiability of CERs and priority of security interests, the UCC amendments cover other significant matters regarding digital assets. They include amendments to UCC Article 8 addressing custody and ownership rights of CERs in case of insolvency or bankruptcy and choice-of-law rules for CERs in the new Article 12.

Influence of the UCC Amendments on State and Federal Laws

The introduction of crypto laws in states such as Idaho, Kentucky, Wyoming, and Tennessee in recent years, regulating the transfer of digital assets, have used different terminology and conflicting concepts. As more states adopt the UCC amendments, market participants will benefit from clearer, more uniform rules governing virtual currency transactions.

Certain state laws conflict with the UCC amendments, necessitating some states planning to adopt the amendments to amend their existing crypto regulations.

Lastly, the UCC’s new rules could also impact federal lawmaking. Since digital assets emerged, regulators and lawmakers have been trying to classify them – as securities, commodities, or something else. The UCC amendments have made it clear that digital assets can be negotiable instruments, contributing to the ongoing conversation.

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