For lending lawyers and commercial lenders who have been wondering what the recent fuss over “Bitcoin” is all about, and what, if any, value Bitcoin has as collateral, today is the day you’ll get your answer.
Bitcoin is an online medium of exchange which permits buyers and sellers to interact anonymously to facilitate instantaneous payments for goods and services, without the involvement of a third party. The Bitcoin currency network has a decentralized structure, subject to very little government oversight and free of the control of any particular entity or person.
Bitcoin is typically stored on a user’s personal computer or in cloud based accounts called “wallets.” However, Bitcoin wallets do not meet the UCC’s definition of a deposit account as they are not maintained with a bank. Further, Bitcoin wallets are not insured by the FDIC.
There are a handful of reasons why Bitcoin might be attractive to existing and potential commercial lending customers. Fees in connection with Bitcoin transactions are minimal in comparison to credit card fees. Bitcoin platforms do not allow chargebacks (i.e. Bitcoin transactions are irreversible). Bitcoin transactions are typically confirmed within an hour while payments made with credit cards can take 2-3 days to be credited to a merchant’s account.
Despite its appeal to customers, there are several reasons for lenders to be wary of accepting Bitcoin as collateral. Some primary concerns are as follows:
- Bitcoin’s value has been extremely volatile historically. The worth of a user’s Bitcoin holdings can decrease sharply and could even drop to zero;
- Bitcoin wallets are subject to cyber-attacks; the entire contents of a wallet account can be wiped out by hackers;
- Bitcoin’s anonymity makes it an appealing method of funding criminal activity (e.g. money laundering). Such activity could lead to law enforcement agencies closing exchange platforms and preventing access to and use of Bitcoin collateral;
- Bitcoin investments may result in adverse tax consequences to users, such as value added tax or capital gains tax;
- Bitcoin wallets, as mentioned above, are not deposit accounts under the UCC. This means Bitcoin collateral must be treated as a general intangible and perfected with a UCC-1 financing statement rather than through control. A control agreement is preferable to a UCC-1 because it evidences the prior agreement between the lender and the user’s bank to permit the lender to access and remove funds upon an event of default; and
- Bitcoin’s future is uncertain. While there is currently little oversight, there have been calls for heavier restrictions or the elimination of virtual currencies like Bitcoin altogether.
The preceding concerns clearly indicate that any lender who accepts Bitcoin as collateral for a loan is taking a substantial risk that the value of this collateral will be lost or greatly diminished. However, given the rapid appreciation of the price of Bitcoin over the last several months, it might be difficult for lenders to simply refuse to take it as security. As such, it is important that lenders conduct client specific due diligence on Bitcoin assets in order to make the most informed credit decision possible.