Is UCC Article nine the Achilles Heel of Bitcoin? Credit Slips

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Last week, Professor Lynn LoPucki called me up and asked a good question. Why hasn’t Bitcoin fallen apart because of the operation of Article nine of the Uniform Commercial Code (UCC)? It is a indeed good question. With Lynn’s permission, I am writing up a blog post about our conversation, but it was Lynn who very first identified the issue.

As many readers will know, all fifty states have enacted the UCC with only minor variations. Article nine governs security interests in private property – that is, movable and intangible property as opposed to land and buildings. The bank that gave you a car loan has an Article nine security interest in the automobile serving as collateral for the loan, and the bank providing operating capital for your corner bakery similarly may have an Article nine security interest in the inventory, equipment, and accounts at the store. Article nine is one of those laws that only specialists tend to know, but it plays an significant role in the flow of commerce.

The bakery example was deliberate given this news about a Durham, NC, bakery accepting bitcoins. I have no idea about the financial circumstances of this particular bakery, but to understand the point assume it has loan from a bank secured by the bakery’s “inventory, goods, equipment, accounts, and general intangibles.” Such an arrangement would not be uncommon and would effectively give the bank an Article nine security interest in all of the bakery’s property that is not real estate, sometimes referred to as a “blanket lien.”

When a customer pays the bakery with bitcoins, those bitcoins certainly now become part of the bank’s collateral. Given that one bitcoin is worth over $600 today, the customer either has ordered the world’s most expensive donut or technically will have paid with bitcoin subunits. For ease of exposition, let’s just call them “bitcoins.”

The bank’s security interest will link to the bakery’s bitcoins. When the bakery uses bitcoins to buy flour from a supplier, the bank’s security interest will proceed to encumber them. UCC section 9-315(a)(1) provides that the bank’s security interest “continue in collateral notwithstanding . . . disposition thereof unless the security party authorized the disposition free of the security interest. The supplier is not protected by the “buyer in ordinary course” provision of 9-320(a) because that provision only strips security interests from “goods.” 

Further, the security interest will remain with the bitcoins through subsequent transfers (UCC § 9-325). A remote transferee of the bitcoins will take the bitcoins subject to the bank’s security interest. Assuming the bank has taken the effortless steps to ideal its security interest, which it almost always will have, the bank can seize the bitcoins as collateral if the bakery’s debt goes unpaid. The possibility of another party with superior property interest in a bitcoin would seem to substantially dampen their utility as a medium of exchange.

Transferees of money take free of a preexisting security interest (UCC § 9-332). Thus, you do not have to worry that the U.S. currency the bakery gives you as switch for your transaction is encumbered by a security interest.  That way, money circulates like . . . well, money.

A Bitcoin defender might react that the UCC should treat bitcoins like money. Regardless of the merits of such a principle in the abstract, the UCC has a definition of money, and it does not emerge to include bitcoins. Specifically, “money” is a “medium of exchange presently authorized or adopted by a domestic or foreign government” (UCC § 1-201(b)(24)). To the best of our skill bitcoins are not presently authorized or adopted by a domestic or foreign government. One solution to the UCC problem might be to get a domestic or foreign government to authorize bitcoins as a medium of exchange such that they then may receive the UCC treatment for “money.” But that solution will come too late for the thousands of wallets very likely already infected with bank liens.  Those liens will remain with the coins to which they affixed.

Another out for Bitcoin defenders might be the rules for commingled collateral. For example, if the bakery deposits your payment for donuts in its bank account, the bank account may contain some of the bank’s collateral and some of the bank account may be non-collateral. In these situations, the UCC simply directs that the court is to use “equitable principles” to resolve any disputes that arise. In the context of traditional bank accounts these “equitable principles” are a series of well-established practices. Once in a bitcoin wallet, a free-wheeling interpretation of “equitable principles” might wash the security interest away, but that would be a very untethered free-wheeling.

Even if there some arguments that the security interest does not stay with the bitcoins, the problem is the uncertainty, and the uncertainty would seem to be enough to undo the appeal of bitcoins. Either Lynn and I have missed something about how bitcoins work and their interaction with Article 9, or the Bitcoin proponents have failed to notice how Article nine could unravel the entire enterprise. Up until now, bitcoins have not become a substantial part of mainstream commerce such that the Article nine problem may have been of little consequence, but if bitcoins are to become part of mainstream commerce, the Article nine problem must be solved.

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