United States: Winning The Wild West: Cryptocurrency, WEB3, And The New UCC Article 12

Cryptocurrency continues to be in the spotlight and calls for cryptocurrency market regulation have accelerated following the collapse of FTX and other recent highprofile matters.¹ The advent of distributed ledger technology ("DLT"), which is used to store and transact cryptocurrency, has given rise to two significant movements in the world of electronic commerce: (1) the assignment of economic value to electronic records that bear no relationship to extrinsic rights and interests and (2) the use of electronic records to "transfer rights to receive payment, rights to receive performance of other obligations . . . and other rights and interests in personal and real property."² These digital assets, which have functioned as a store of value or electronic contract, exist in an unclear legal environment.³ There is debate regarding whether these digital assets are securities, commodities, or another asset altogether; and confusion regarding which laws or regulations apply.⁴

The U.S. Securities and Exchange Commission ("SEC"), Commodity Futures Trading Commission ("CFTC"), Treasury Department, Internal Revenue Service, and a number of states continue to have significant interest in the regulation of cryptocurrency and digital assets. Although multiple bills have been introduced and hearings have been conducted in Congress, nothing has been enacted to date.⁵ In 2022, as a response to this uncertainty, as well as the impending threat of larger-scale disputes, the Uniform Law Commission ("ULC") issued proposed amendments to the Uniform Commercial Code ("UCC"), the most notable of which was Article 12 titled "Controllable Electronic Records," a legal framework addressing electronic commerce.⁶

This article will provide an overview of Article 12 and its potential impact on the cryptocurrency and digital assets industry. Additionally, this article will address recent legal and enforcement trends by regulators in the cryptocurrency space, as well as state and federal legislative efforts to address the legal uncertainty, which continues to cast a cloud over the cryptocurrency and digital assets industry.

OVERVIEW OF UCC ARTICLE 12, CONTROLLABLE ELECTRONIC RECORDS

Article 12 was created to address market concerns about the lack of rules regarding transactions involving digital assets, especially concerns regarding the negotiability for virtual (non-fiat)⁷ currencies, electronic payment rights, secured lending against virtual (non-fiat) currencies, and security interests in electronic (fiat) money, such as central bank digital currencies.⁸ While Article 12 creates a legal framework for existing DLT, it is intentionally general in an attempt to encompass a wider-ranging category of electronic, intangible assets — even those that that have yet to be created or imagined.⁹ To do this, Article 12 creates the term "controllable electronic record" ("CER") to which its framework applies.¹⁰

UCC §1-201 defines a record as "information . . . that is stored in an electronic or other medium and is retrievable in perceivable form."¹¹ The term "electronic" is defined as ". . .technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities."¹² Combined, the term "electronic record" is necessarily expansive, and includes things like emails, photos, information stored on social media platforms, and all types of data stored in an electronic medium.¹³ However, most of these electronic records would not be considered a "controllable electronic record" because they must meet the definition of control under UCC §12-105.

Control of a CER is created when the electronic record meets two elements. First, the electronic record must provide the holder certain powers. The holder must have the power to realize substantially all of the benefits of the electronic record, while also having the exclusive power to prevent others from realizing the same benefit. The holder must also have the exclusive power to transfer control of the electronic record or cause another to obtain control of a different CER due to the transfer of the electronic record.¹⁴ Second, the electronic record must enable the holder to "identify itself in any way, including by name, identifying number, cryptographic key, office, or account number," as retaining the powers provided to holders.¹⁵ Generally, a CER is only a record, not a right evidenced by records.¹⁶ However, Article 12 provides an exception to this rule, specifically for "controllable accounts" and "controllable payment intangibles."¹⁷ These terms represent a CER that provides rights to payment.¹⁸

Most notably, Article 12 provides rights for qualifying purchasers of CERs, controllable accounts, and controllable payment intangibles. The term "qualifying purchaser," and the conditions necessary to become one, are drawn from Article 3. To become a qualifying purchaser under Article 12, one must purchase the CER "for value, in good faith, and without notice of a claim of a property right in the [CER]."¹⁹

A qualifying purchaser obtains the rights in the CER free of claim of conflicting property rights — otherwise known as the "Take-Free Rule."²⁰ The take-free rule makes CERs highly negotiable and creates a "play at your own risk" type of property right. For example, if a hacker steals a CER and sells it to an individual who meets the qualifying purchaser requirements, the individual retains all rights to the CER even though the hacker would have no right to transfer the stolen CER under external property law.²¹ To avoid falling victim to hacking without any recourse, it is critical for investors and holders of CER to properly safeguard personal and sensitive information, including system login information.

IS CRYPTOCURRENCY ELECTRONIC MONEY?

In regard to conflicting language within the UCC, Article 9 takes precedent over Article 12.²² One significant distinction is the meaning of "electronic money." Article 9 defines the term "electronic money" as "money in electronic form."²³ Article 12, on the other hand, excludes "electronic money" from its definition of a CER.²⁴ The UCC defines "money" as "a medium of exchange that is currently authorized or adopted by a foreign government."²⁵ The UCC amendments further explain that the term "money" does not cover "an electronic record that is a medium of exchange recorded and transferable in a system that existed and operated for the medium of exchange before the medium of exchange was authorized or adopted by the government."²⁶

These changes are significant because they carve out existing cryptocurrency from the definition of "money," effectively leaving the applicable law to Article 12. For example, a cryptocurrency like Bitcoin cannot be classified as "electronic money" because it existed and was used as a medium of exchange before any government adopted it.²⁷

El Salvador's adoption of Bitcoin as legal tender in 2021 provides a perfect example of these amendments in action.28 Prior to the amendments, there could have been an argument that Bitcoin became "money," as defined by the UCC, because it became a "medium of exchange . . . adopted by a foreign government."²⁹ The 2022 changes to the definition of "money" rectify this scenario and ensure that a cryptocurrency like Bitcoin is governed by Article 12.

Though cryptocurrencies like Bitcoin are carved out of the term "money," a Central Bank Digital Currency ("CBDC") would still be considered "money" because it would be created expressly for government adoption.³⁰ This is the basis of concern for some politicians who view CBDCs as a threat to personal and economic freedom.³¹ Governor Kristi Noem of South Dakota vetoed a bill that codified the 2022 UCC Amendments stating that "[b]y expressly excluding cryptocurrencies as money, it would become more difficult to use cryptocurrency," and that by defining "money" as the amendments did, it "opens the door to the risk that the federal government could easily adopt a [CBDC], which then may become the only viable digital currency."³²

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Footnotes

1. Jody Godoy, Ripple Labs notches landmark win in SEC case over XRP cryptocurrency, REUTERS (July 13, 2023, 4:26 PM), https://www.reuters.com/legal/us-judge-says-sec-lawsuit-vsripple-labs-can-proceed-trial-some-claims-2023-07-13/; Cheyenne Ligon, White House Calls on Congress to 'Step Up Its Efforts' on Crypto Regulation, COINDESK (Jan. 27, 2023 at 10:34 AM), https://www.coindesk.com/policy/2023/01/27/ white-house-calls-on-congress-to-step-up-its-efforts-on-cryptoregulation/.

2. U.C.C. Art. 12, Controllable Electronic Records, (Prefatory Note amended 2022).

3. Steven Aquino, Crypto, Part III: Securing Interests in Digital Assets – The Proposed UCC Article 12, AMERICAN BAR ASSOCIATION, (May 23, 2023), https://www.americanbar.org/ groups/litigation/committees/corporate-counsel/articles/ 2023/spring2023-crypto-part-iii-securing-interests-digitalassets-proposed-ucc-article-12/#:~:text=Under%20Article %2012%2C%20a%20party,to%20the%20extent%20allowable% 20under.

4. Id.

5. Joint Financial Services-Agriculture Subcommittee Hearing Entitled: The Future of Digital Assets: Measuring the Regulatory Gaps in the Digital Asset Markets, FINANCIAL SERVICES COMMITTEE (May 10, 2023, 9:30 AM), https://financialservices.house.gov/calendar/eventsingle.aspx?E ventID=408754; Eleanor Mueller, House GOP plots crypto overhaul, POLITICO (March 8, 2023, 1:56 PM), https://www.politico.com/news/2023/03/08/house-gop-cryptooverhaul-00086079.

6. U.C.C. Art. 12 (Prefatory Note).

7. Fiat simply means decree, and fiat money is a currency that is decreed and backed by the government that issues it. See, e.g., What is Fiat Money?, MONEY.COM (Feb. 13, 2023), https://money.com/what-is-fiat-money/.

8. A Summary of the 2022 Amendments to the Uniform Commercial Code, Uniform Law Commission (July 21, 2022), https://higherlogicdownload.s3-external-1.amazonaws.com/ UNIFORMLAWS/2a18c952-5db5-ca16-2274-8c7531990903_ file.pdf? AWSAccessKeyId=AKIAVRDO7IEREB57R7MT& Expires=1690415567&Signature=9sHw9r9gnzf%2F73gjMJhZp p0OJ%2FQ%3D.

9. U.C.C. Art. 12 (Prefatory Note).

10. Id.

11. U.C.C. § 1-201.

12. Id.

13. U.C.C. Art. 12 (Comment).

14. U.C.C. § 12-105(a)(1).

15. U.C.C. § 12-105(a)(2).

16. Article 12 (Note).

17. Id.

18. Id.

19. U.C.C. § 12-102.

20. U.C.C. § 12-104(e).

21. U.C.C. § 12-104 (Comment).

22. U.C.C. § 12-103.

23. U.C.C. § 9-102.

24. U.C.C. § 12-102; Steven Aquino, Crypto, Part III: Securing Interests in Digital Assets – The Proposed UCC Article 12, AMERICAN BAR ASSOCIATION (May 23, 2023), https://www.americanbar.org/groups/litigation/committees/corp orate-counsel/articles/2023/spring2023-crypto-part-iii-securinginterests-digital-assets-proposed-ucc-article-12/#:~:text=Under %20Article%2012%2C%20a%20party,to%20the%20extent%2 0allowable%20under.

25. U.C.C. §1-102.

26. Id.

27. U.C.C. § 1-102 (Comment 12A).

28. Laurent Belsie, El Salvador's Experiment with Bitcoin as Legal Tender, NATIONAL BUREAU OF ECONOMIC RESEARCH DIGEST, Vol. 7 (July 2022), https://www.nber.org/digest/202207/elsalvadors-experiment-bitcoin-legal-tender.

29. U.C.C. § 1-102.

30. Uniform Commercial Code Amendments (2022), UNIFORM LAW COMMISSION AND AMERICAN LAW INSTITUTE, at P. 109, Summary of 2022 Art. 9 Revisions (June 1, 2023), https://higherlogicdownload.s3-external-1.amazonaws.com/ UNIFORMLAWS/d5bcf850-366f-b4b5-e7d6-6749ba 2382c6_file.pdf?AWSAccessKeyId=AKIAVRDO7IEREB57R 7MT&Expires=1690862443&Signature=b8ke0l40s%2FHottQ L3wMdXfChkmM%3D.

31. Carla L. Reyes and Andrea Tosato, Crypto's Future Is at Stake in a Dispute Over Commercial Law's Definition of Money, Barron's (April 7, 2023 4:00 AM), https://www.barrons.com/ articles/crypto-commercial-laws-definition-of-money-5fbd8fe4.

32. Gov. Noem VETOES Attack on Economic Freedom, NEWS.SD.GOV (March 10, 2023), https://news.sd.gov/news? id=news_kb_article_view&sysparm_article=KB0039891&sys_ kb_id=1d1a38781b21a15031b1ebdbac4bcbbf&spa=1.

Originally published by The Review of Banking & Financial Services Journal.

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