Fans of the Harry Potter books will recall the first book when young Harry was living with his muggle (non-wizard) family and he started receiving letters from Hogwarts, the wizard school, inviting him to attend during the next school session. At first his muggle uncle and aunt vainly attempted to discard or hide the letters from the school, but they persisted, unabated, with multiple letters ultimately streaming through cracks in the doors and out of the fireplace until his muggle family relented and let Harry leave to attend Hogwarts.

Cryptocurrency is the new Hogwarts invitation to those charged with drafting laws relating to currency, securities, and secured transactions (among others). After several years of ignoring it and hoping that it would just go away, bank regulators and legal scholars have recognized that crypto appears to be here to stay and have set about to remedy various defects in the current legal structure to address crypto issues. One example of these developments is the anticipated proposed amendments to the Uniform Commercial Code.

The Uniform Commercial Code (“UCC”) is a set of form statutes drafted with a goal of ensuring uniformity among the states as to the law pertaining to commercial transactions. The UCC itself is not law. Rather, the UCC sets out a recommended set of statutes for individual states to adopt. The UCC is drafted, and modified from time to time, by the American Law Institute and the National Conference of Commissioners on Uniform State Laws. In 2019, these two entities, recognizing a need in the area, appointed a committee to consider amendments to the UCC to address “digital assets” in general. The committee has nearly completed its work and it is anticipated that the updates will be approved and recommended to state legislatures in July 2022.

Many pundits have observed that the current version of the UCC does not really include adequate definitions and structure to cover digital assets, including crypto currencies and non-fungible tokens (“NFTs”). In order to remedy the deficiencies, and to provide the necessary predictability to commercial transactions, the drafters of the UCC plan to propose substantive edits to Article 9 (the chapter governing security interests in personal property) and an entirely new Article 12. While the proposed edits are significant and beyond the space limitations of this article (and likely the patience of the reader), bankers should become familiar with a few of the basic concepts and definitions used in the revisions. These include the following:

  1. New UCC Article 12 adopts a new definition of “controllable electronic records” or “CERs” for short. CERs generally include records stored in an electronic medium that can be subjected to control as defined in the Article. While new Article 12 has been drafted to allow for flexibility as technologies develop, CERs will include certain virtual currencies (that have not been adopted by a central government), NFTs, and digital assets in which specific payment rights have been imbedded.
  2. CERs are classified as “general intangibles” under Article 9, meaning that existing security agreements granting the secured party a lien in general intangibles will now also be defined to cover any CERs owned by the debtor.
  3. A security interest in a CER may be perfected by filing a UCC-1 or by taking control of the CER. Similar to existing law relating to other forms of collateral, perfection of a CER by control will take priority over an interest perfected by filing a UCC-1. In order to exercise “control” over a CER, a party must have the exclusive power to prevent others from enjoying substantially all the benefits of the CER and the exclusive power to transfer control of the CER.
  4. Similar to transfers of cash today, the transfer of a CER to a good faith purchaser allows the purchaser to “take free” of any existing claims against the CER. Obviously, this will make “control” of the CER the preferred method of perfection for a lender relying on the CER as collateral.
  5. The UCC definition of “money” will still exclude crypto currencies unless the crypto currency is authorized or adopted by a government. This definition will leave open the possibility that a central bank digital currency (as is currently being considered by the Federal Reserve), could be classified as “money” under the UCC despite its digital nature.

The drafters anticipate having the proposed revisions to the UCC finalized and ready for consideration by state legislatures starting later this summer. It will be interesting to see how quickly legislatures move to adopt the recommendations into law. Some states may desire to be early adopters to project an innovation friendly climate in their state, while others may hold back to see how the laws are implemented in other states. Nevertheless, it appears that crypto currencies, NFTs, and digital assets in general are here to stay and bankers (and their counsel) will need to continue to educate themselves on the legal issues surrounding these new forms of assets.

Davenport Evans stands ready to help our banking clients with questions. Contact a lawyer at 605-336-2880, [email protected], or find a specific lawyer here.

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Davenport, Evans, Hurwitz & Smith, LLP, located in Sioux Falls, South Dakota, is one of the State’s largest law firms. The firm’s attorneys provide business and litigation counsel to individuals and corporate clients in a variety of practice areas. For more information about Davenport Evans, visit www.dehs.com.