Cryptocurrency Assets Under Insolvency And Personal Property Security Law

 
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Encrypted digital currencies ("cryptocurrencies"),1 particularly Bitcoin, have recently become the target of enormous international speculation and market scrutiny. Some expect cryptocurrency payments and other transactions tracked via distributed ledger technology ("DLT", of which "blockchain" technology is one example) to be the future of commercial interaction. The theory is that cryptocurrencies could become "the holy grail of commerce - a payment system that would eliminate or minimize the roles of third party intermediaries."2

Is Canadian commercial law ready for this brave new world? Specifically, how do the laws governing debtor-creditor relationships apply to cryptocurrencies?

This article discusses the legal characterization of cryptocurrency units ("tokens"), their utility as a commercial payment medium given current Canadian personal property security law, and, in light of several high-profile insolvencies of the platforms on which cryptocurrencies are traded ("exchanges"), the treatment of tokens in insolvency scenarios. It considers the following questions:

Does Canadian law treat digital currencies as cash, commodities or something else? Can a lender take security over a borrower's cryptocurrency assets - and if so, can a third party accept a payment in tokens free and clear of the lender's security interest? If a token exchange or wallet provider enters insolvency proceedings, does a tokenholder have a creditor claim or a property claim in the estate? If such a claim is recoverable, will the tokenholder get tokens back or only their pre-filing cash value - which may be considerably lower or higher than the present-day value of the token in a volatile market? What challenges does an insolvency professional face in dealing with cryptocurrency assets? As the term would suggest, cryptocurrencies are designed as payment systems, not simply targets for speculative investment (as Bitcoin is arguably becoming). The high valuations of many cryptocurrencies only make sense if they can one day be exchanged for a range of goods and services, circulating without friction and with finality and certainty.

Unfortunately, North American personal property security law does not treat cryptocurrencies as negotiable instruments, and cryptocurrency assets (or claims against them) can be challenging to realize in insolvency scenarios. Both of these problems obstruct the mainstream adoption of cryptocurrencies as payment systems.

The Legal Characterization of Tokens

As Aird & Berlis partner Donald B. Johnston has written, the legal characterization of cryptocurrency tokens is controversial, unsettled and variable by jurisdiction.3

Many cryptocurrencies, as the term suggests, are designed to function as digital currency or money. But is a token money? Is it even the holder's personal property at all?

The Canada Revenue Agency characterizes4 cryptocurrencies as commodities rather than currency for tax purposes and applies the so-called "barter rules" to transactions in cryptocurrencies. Indeed, at the moment, a commodity like gold is a reasonable analogy to a cryptocurrency like Bitcoin; it is "mined," it is used as a target of speculation, and tokens, like gold certificates or gold itself, are somewhat fungible and occasionally used for commercial payments.

A Bank of Canada position paper5 expressed a similar viewpoint in 2014, positing that no form of cryptocurrency had, at that time, the essential qualities that are ascribed to money: (i) a medium of exchange, (ii) a unit of account, and (iii) a stable store of value. Despite Bitcoin's price spike, this analysis still rings true.

Personal property security law in Canada (and its analogous legislation in the U.S.), as currently constituted, does not include tokens in the definition of "money," but rather treats them as "intangibles," a classification that severely restricts their utility as a mainstream payment medium and as an asset that can easily be made the subject of a security interest.

Other jurisdictions may differ significantly in their legal characterization of tokens. Indeed, a Japanese court has held that, under Japan's Civil Code, tokens are not capable of personal ownership at all - a holding that had significant implications for creditors in an insolvency proceeding, as this article discusses subsequently.

Secured Transaction Issues - the "Achilles Heel" of Cryptocurrency Adoption?

Currently, there is no administrative guidance or case law that specifies how cryptocurrency tokens should be treated for the purposes of Canadian personal property legislation (in each common-law province, the "PPSA"). No PPSA has yet added definitions or collateral classifications that directly reference cryptocurrency assets.6 Under the current definitions in the PPSA, a cryptocurrency token held directly by its owner would fall into the catch-all category of "intangible." The definitions under the U.S.' Uniform Commercial Code ("UCC") are similar and point to the same conclusion.7

As currently defined, cryptocurrency tokens would not qualify as "money." Money is a defined term under the PPSA, referring to a medium of exchange adopted by a government as part of a country's currency.8 (Interestingly, this suggests that if a...

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