ContractsProf Blog

Editor: Jeremy Telman
Oklahoma City University
School of Law

Friday, March 31, 2023

Saving Bitcoin (Yes, Really!): The 2022 Uniform Commercial Code Amendments

A great thing is happening in commercial law as I type these words: Musty corners of the Uniform Commercial Code are in the process of being brought up to date to deal with the realities of twenty-first century commerce. The 2022 UCC Amendments now being considered in state legislatures across the country are replacing the "writing" requirements baked into Article 2 (Sales), Article 3 (Negotiable Instruments) and elsewhere with the more flexible "record" that can be electronic or written and represents commercial reality. The comprehensive system of secured lending contained in Article 9 is being updated as well. These revisions will provide a stable system of rules that address once-unimagined electronic assets like NFTs (non-fungible tokens) and cryptocurrency to enable them be safer and more attractive forms of collateral because of the certainty with which a lender can secure its position.

UCC BookSo yes, that "electronic basketball card" NFT your cousin bought last year could actually end up being pledged as collateral that helps that cousin get a loan. As Yakov Smirnoff used to say, "What a country!"

But I digress. To this professor of payment systems law, the most exciting part of the package of 2022 UCC amendments is new Article 12, entitled "Controllable Electronic Records." Article 12 creates state commercial law rules to govern blockchain assets like bitcoin and other cryptocurrency, as well as any other technology (present or future) where a purely digital record is capable of being under exclusive control.

For those unfamiliar, the paradigm-changing innovation brought about by bitcoin circa 2009 was that, through blockchain programming methodology, it allowed for the creation of a digital token that could not be copied (or in currency terms, counterfeited). A thought experiment with paper currency will demonstrate how useful blockchain programming actually is. While counterfeiting is an occasional problem for paper currency like the U.S. dollar, imagine the disaster for the use of cash as a store of value if any trickster with a photocopier could make unlimited and undetectable copies. Eventually, no one would accept cash as payment. Why would you when you could just as easily print your own? Increased money supply facilitates inflation, which is bad enough, but an infinite increase in the money supply would eventually reduce its value to zero.

Blockchain-ImageThe trouble with digital files, then, is that they are susceptible to the infinite creation of perfect copies. Bitcoin changed all that through blockchain programming. Because of verification on a decentralized computer network, only one bitcoin token could demonstrably exist as the verified real thing, even in the face of dozens of ostensible duplicates. In payment system terms, this means that bitcoin solved the "double-payment" problem preventing the creation of a digital and decentralized asset. Yay for bitcoin!

But not quite. The creation of non-counterfeitable digital assets has spawned (and is continuing to spawn) numerous applications, such as "trading card" collectable NFTs, digital shareholder governance, smart contracts, and even the possibility of marketable electronic title for real property. Meanwhile, bitcoin and its crypto-progeny have fallen quite short on the original use case for blockchain: a mainstream payment system. Instead, cryptocurrency has become largely the province of high-risk speculative investment and hobbyists. The recent collapse of the FTX cryptocurrency exchange and some high profile crypto-heavy commercial banks suggests that pure speculation is ultimately not a viable path forward. What bitcoin-and-company are truly lacking is widely accepted use as a payment system.

UCC Article 12 is primed to change that. It creates the legal safeguards and commercial certainty that bitcoin needs break out of its niche. Article 12 does this by establishing a basic legal regime for the ownership and transfer of "controllable electronic records"—a category that includes all decentralized cryptocurrency. Rather than focus on physical concepts of possession, the UCC revisions focus on control, as shown in this excerpt from subsection (a) new section 12-105:

§ 12-105. Control of Controllable Electronic Record.

(a) [General rule: control of controllable electronic record.] A person has control of a controllable electronic record if the electronic record, a record attached to or logically associated with the electronic record, or a system in which the electronic record is recorded:

(1) gives the person:

(A) the power to avail itself of substantially all the benefit from the electronic record; and

(B) exclusive power, subject to subsection (b), to:

(i) prevent others from availing themselves of substantially all the benefit from the electronic record; and

(ii) transfer control of the electronic record to another person or cause another person to obtain control of another controllable electronic record as a result of the transfer of the electronic record; and

(2) enables the person readily to identify itself in any way, including by name, identifying number, cryptographic key, office, or account number, as having the powers specified in paragraph (1).

This provision is technology neutral. It clearly covers blockchain assets like bitcoin while still leaving room for other technological innovation in the realm of decentralized digital assets. The only inquiry in connection with making a transaction occur is the existence of control, and the ability to transfer it to another. Article 12 gives bitcoin the legal certainty that existed for centuries in the world of commercial paper by establishing a clear and comprehensible regime of control to stand in the place of the (literally impossible for bitcoin) regime of physical possession.

And there is much more. What good is digital value as a cash substitute if you can't spend it? New Article 12 takes care of that by adapting the centuries-old regime that made a success of commercial paper: negotiability. While the musty negotiable instruments term of "holder in due course" does not appear in the statutory text of Article 12, the definition of a "qualified purchaser" is clearly inspired by it. Section 2-102(a)(2) provides:

“Qualifying purchaser” means a purchaser of a controllable electronic record or an interest in a controllable electronic record that obtains control of the controllable electronic record for value, in good faith, and without notice of a claim of a property right in the controllable electronic record

What then is the result of being a qualified purchaser, of (for instance) taking bitcoin as payment in exchange for vale, in good faith, and without notice of a claim to asset? Article 12 provides that the party taking the bitcoin takes it free-and-clear as against anyone else in the world. Subsection (e) of section 12-104 provide for this important commercial law legal right:

§ 12-104. Rights in Controllable Account, Controllable Electronic Record, and Controllable Payment Intangible.

[* * *]   

(e) [Rights of qualifying purchaser.] A qualifying purchaser acquires its rights in the controllable electronic record free of a claim of a property right in the controllable electronic record.

Bitcoin_logo1Now,let's tie this all together. Based on the above statutes, a seller of goods or services now knows—from a legal perspective—exactly what it must do to accept cryptocurrency payments with the assurance that the transaction is not going to be undercut by an unknown party. If Joe's Hardware Store takes the steps necessary to obtain "control" of bitcoin and it does so as a "qualifying purchaser" of the bitcoin in exchanging its valuable goods and services for that bitcoin, then the transaction is complete. Period. No one else can show up on Joe's doorstep and claim a lien or other legal right to the bitcoin. The legal uncertainties that arise from taking this "mysterious" cryptocurrency as payment are now resolved. It works with as much certainty as credit cards, checks, or—dare I say it—cash.

The 2022 amendments to the Uniform Commercial Code are set to play a crucial role in "saving" bitcoin by empowering it and other cryptocurrency to live up to its original potential, not as some quirky, speculative investment, but as an actual payment system.

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