digital asset – Duane Morris Banking and Finance Law

July 9, 2024 by Roger S. Chari

Has Your State Passed the Crypto UCC Amendments?

There’s less than a year to go until the proposed implementation of the Uniform Commercial Code amendments relating to cryptocurrencies and other digital assets. The drafters of the amendments contemplated a gradual phase-in of the rules over a period of at least a year, but no earlier than July 1, 2025, to give secured parties time to assess their secured status and take any necessary actions. Many states that have approved the amendments opted for a July 1, 2025 start date, but some of them selected a later date. In addition, slightly more than half of the states have not yet approved the amendments. It’s likely that these states will also choose a later start date.

For a secured lender operating in multiple states, keeping track of the implementation dates can be confusing. Losing track of them can potentially lead to significant consequences, including loss of priority in crypto assets. For an overview of the adoption of the UCC amendments by the various states so far, take a look at our recent Alert.

June 10, 2024 by Roger S. Chari

Congressional Disapproval of SAB 121 Vetoed

On May 31, 2024, the President vetoed H.J.Res 109, which evidenced the disapproval by Congress of Staff Accounting Bulletin 121 of the Securities and Exchange Commission. This followed several years of industry and bipartisan efforts in Congress to blunt the effect of or nullify the rule.

On its face, SAB 121 is fairly innocuous. Crypto assets held in custody by an SEC reporting company for its clients must be reported both as an asset and as a liability on its balance sheet. From an accounting perspective, this is balance sheet neutral since the asset and liability cancel each other out.

For regulated banks that want to expand their traditional client custody business from securities and other financial assets to crypto, this is a departure from the standard accounting treatment that can be prohibitively expensive. Assets held in custody are usually balance sheet neutral to a bank since they belong to the bank’s customers and are not included on the bank’s balance sheet. Adding the asset and subtracting it as a liability is mathematically neutral. However, treating crypto in custody as a liability of the bank triggers the minimum capital requirements that banks are required by regulators to maintain to manage investment risk and prevent a collapse if there is a run on the bank.

Why did the SEC change the rule for crypto assets in custody? Did they have the authority to do so? Why does it apply to banks? We discuss these and other questions in our recent Alert.

May 22, 2024 by Roger S. Chari

Happy Bitcoin Pizza Day!

In case you haven’t heard of it, today marks the 14^th anniversary of the first recorded use of bitcoin to pay for goods and services, the delivery of two large pizzas. With the price of bitcoin currently hovering around $70,000, it is shocking to hear that the price paid was 10,000 bitcoins. However, at the time, bitcoin was worth less than half a cent, around $0.0041, making the purchase price about $41.

While Bitcoin Pizza Day is a fun milestone for the cryptocurrency community to celebrate, in many ways the commercial use of bitcoin in the United States has not evolved much since 2010. Buying, holding and using bitcoin is generally not illegal, and the Financial Crimes Enforcement Network of the US Department of the Treasury has acknowledged that a seller may accept payments in bitcoin as a medium of exchange. However, bitcoin is still not legal tender (except in El Salvador). Sellers in the U.S. are not required to accept bitcoin, and most of them do not.

For banks that want to facilitate crypto payments by their customers, there are a number of hurdles to overcome. Pursuant to a joint statement on January 3, 2023 by the Federal Reserve Board, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, banks are “neither prohibited nor discouraged from providing banking services to customers of any specific class or type.” Nonetheless, the regulators believe that the holding of crypto assets by banks “is highly likely to be inconsistent with safe and sound banking practice,” and they are continuing to assess whether crypto activities “can be conducted in a manner that adequately addresses safety and soundness, consumer protection, legal permissibility, and compliance with applicable laws and regulations, including anti-money laundering and illicit finance statutes and rules.”

Alternatively, there are now a number of non-bank apps and other payment services that will convert bitcoin into dollars for purposes of facilitating payments. These services tend to be treated as money services businesses or money transmitters subject to strict anti-money laundering rules under the Bank Secrecy Act, FinCEN regulations and state law. Different states take varying views on the use of crypto, and these services may not be licensed to operate in every state.

In addition to these challenges, a buyer has to be careful of the tax law consequences of using cryptocurrencies to make purchases. Under Internal Revenue Service notice 2014-21, cryptocurrencies are property, and capital gains tax is due if the fair market value of the property or services purchased exceeds the purchaser’s adjusted basis in the cryptocurrency used to make the purchase. In other words, if a person bought one bitcoin in 2010 and used that bitcoin in 2024 to splurge for a Porsche (or a Bored Ape Yacht Club NFT) for $70,000, that person would owe capital gains tax on $70,000 (minus the $0.0041 cost of buying the bitcoin).

With all that in mind, spend your crypto wisely.

May 16, 2024 by Roger S. Chari

UCC Amendments for Digital Assets Effective in DC

On May 3, 2024, Law L25-0158 was published in the District of Columbia Register. Titled the “Uniform Commercial Code Amendment Act of 2024,” it is the codification in Washington, DC of the 2022 Amendments to the UCC drafted by the Uniform Law Commission and the American Law Institute. The 2022 Amendments hold out the promise of establishing uniform rules (at least in the US) for transferring digital assets such as cryptocurrencies and non-fungible tokens, and granting lenders a security interest in those assets that can be perfected by control.

Although the DC law is effective as of April 20, 2024, per the uniform transition rules adopted by the law, the provisions will not have substantive effect until July 1, 2025. This time delay was built into the rules to give market participants time to learn and adjust to the new rules and implement any changes that the new rules will require. Washington, DC is not the first jurisdiction to adopt the 2022 Amendments, but it is arguably the most important. Under the uniform choice of law rules in the 2022 Amendments, the UCC in effect in the District of Columbia will govern most, if not all, matters relating to perfection and priority of security interests in digital assets, at least for the foreseeable future.

Many questions and challenges are posed by the 2022 Amendments. Are all digital assets covered? Are cryptocurrencies money? Are digital tokens securities? What does it mean to perfect a security interest in a bunch of ones and zeros that only exist on a decentralized blockchain that isn’t located on a particular server or controlled by any particular entity? We will explore these and other issues in the coming weeks and months.