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Beware the Risks of Taking Cryptocurrency as Collateral

On Behalf of | Jun 14, 2022 | Articles, Blog, Business Law, Corporate Transactions, Creditors' Rights & Bankruptcy, Lending & Finance, Publications

By Mauro Viskovic, Esq. Email Mauro

A lender who takes cryptocurrency as collateral for a loan must be careful to follow the specific requirements applicable to perfecting a security interest in crypto assets.  Otherwise, if the borrower ends up in bankruptcy, that lender would be deemed an unsecured creditor and possibly have no recourse for recouping any of its loan to the borrower.

Article 9 of the Uniform Commercial Code provides instruction on how to perfect a security interest in loan collateral, however, the instructions are different depending on the type of asset provided as collateral.  The potential categories that crypto assets may fall under are: (1) money; (2) investment property; or (3) general intangibles.

Cryptocurrency is not recognized as “money” under the UCC because it is currently not a form of currency authorized by a government.  The analysis of whether crypto assets would be deemed “investment property” is more complicated.  A crypto asset is not a “security” under the UCC if it is not an obligation of an issuer or an interest in the issuer.  However, it is possible that cryptocurrencies may nevertheless qualify as “investment property” under applicable provisions of the UCC if a securities intermediary and a customer agree that that the specific crypto assets are financial assets and those assets are held by the securities intermediary in a securities account.  If the crypto asset does not so qualify, then it would fall in to the catch-all “general intangibles” category.

If the crypto asset is deemed an investment property, then the associated security interest is perfected by taking “control” of the asset.  Conversely, perfecting a security interest in general tangibles requires the mere filing of a UCC financing statement identifying the debtor and describing the collateral in the appropriate jurisdiction.

For practical purposes, however, irrespective of the designation as investment property or general intangible, the lender should both take control of the crypto asset and file the UCC financing statement.  Control over the asset is critical because, once a crypto asset is sold on an exchange or elsewhere, a lender may not be able to track down the transferee (who may be anonymous and located overseas) to assert the lender’s rights to the assets under its lien.  Establishing control over a crypto asset can be accomplished by placing the crypto asset in a digital wallet controlled by the lender and held there until full repayment of the loan.

As cryptocurrencies continue to increase in value and become more common, more borrowers will seek to pledge those assets as loan collateral.  Accordingly, lenders who accept such collateral will need to ensure that they take the necessary steps to be deemed a secured creditor with respect to such crypto assets.  Should you have any questions or require assistance with the loans secured by crypto assets, please contact Mauro Viskovic at 516-751-6537 or  [email protected].

Weiss Zarett Brofman Sonnenklar & Levy, P.C. is a New York law firm providing a wide array of legal services to the members of the health care industry, including corporate and transactional matters, civil and administrative litigation, healthcare regulatory issues, bankruptcy and creditors’ rights, and commercial real estate transactions.