Many creditors require some form of security to be given by their debtors to ensure the payment of a debt. The creditor acquires a right over property of the debtor which may be exercised if the debt is not paid. One of the most common examples is a mortgage bond over immovable property in favour of the bank which finances its purchase. What security can be taken over cryptocurrencies?
Bitcoins and other cryptocurrencies have value and are assets of their owners. But because their legal nature has not been determined in most jurisdictions, it is unclear whether it will be possible to take security over cryptocurrencies in the same way that it is taken over other movable and immovable assets. Here are some of the issues to consider.
- Is cryptocurrency capable of being given as security?
In order for security to be taken over cryptocurrencies, they must be the legal property of their owners. South African case law and consumer protection legislation suggest that our courts will consider cryptocurrencies as intangible, movable property.
Creditors will want assurance that the party giving security actually owns the cryptocurrency and is not prevented from giving security over it. While it is possible to confirm, for example, that Bitcoins belong to the owner of a particular digital wallet, establishing the identity of the owner is often complicated.
- Regulatory risks
Regulators in a number of jurisdictions, including South Africa, have warned users about the financial and operational risks in dealing with unregulated cryptocurrencies. Many regulators have however expressed the intention to regulate certain cryptocurrency activities. (See our previous blog post on Bitcoin.)
- What kind of security could be created?
Accepting that Bitcoins and other cryptocurrencies are property over which security can be taken, there are various ways for A to give security over their Bitcoins to B:
- The Bitcoins could remain in A’s ownership and possession, subject to a limited security interest in favour of B. A cession or assignment of a right of action to claim the cryptocurrency operates in this way.
- The Bitcoins could be transferred to B, subject to an obligation to transfer them back to A if the underlying debt is repaid. An out-and-out cession of book debts and a pledge are examples of how this can be done.
- Because of the ownership and enforcement concerns, it may be necessary for the Bitcoins to be held by a third party stakeholder. As long as the debt is outstanding, they would be held in favour of B, but when the debt is repaid they are either held for, or returned to, A. This is an escrow arrangement.
Depending on the type of security, it may need to be perfected before it can be enforced. This sometimes involves taking possession of the secured assets. The balance of a digital wallet is controlled by the person who holds the private key for that wallet. It is impossible to access the contents without this person’s cooperation. Taking security could therefore include getting access to the private key. Enforcement would however be simplest if the secured cryptocurrencies are not kept in the wallet of the party giving security, but held in escrow by a trusted third party.
Our global cryptocurrency team has produced a guide to the legal and regulatory framework within which cryptocurrencies operate. The guide will be published in eight chapters. Click here to read the fifth chapter, Taking security over cryptocurrencies.
Click here to register for subsequent chapters.