At cryptocurrency and fintech conferences, FT Alphaville often hears
Bitcoin enthusiasts make the assertion that Bitcoin is superior to fiat
currency because it eliminates debt from the monetary system.
But this, of course, is a fallacy.
Bitcoin may have the potential to create a fully-funded reserve system, but it certainly doesn’t eliminate debt from any system.
At best, Bitcoin’s public ledger records a transfer of digital access rights in the eyes of the clearing network. It does not, however, record or see the terms and conditions of that transfer.
Indeed, as far as the clearing network is concerned all it knows is that a transfer has occurred. Party A’s wallet has been debited while party B’s wallet has been credited.
This is something akin to witnessing a physical coin being passed from one hand to the other. Yet what the process doesn’t do is log the conditionality of the transfer — which is still the subject of private agreement and contract law.
For example, let’s hypothesise that Tony Soprano was to start a bitcoin loan-sharking operation. The bitcoin network would have no way of differentiating bitcoins being transferred from his account with conditions attached — such as repayment in x amount of days, with x amount of points of interest or else you and your family get yourself some concrete boots — and those being transferred as legitimate and final settlement for the procurement of baked cannoli goods.
Now say you’ve lost all the bitcoin you owe to Tony Soprano on the gambling website Satoshi Dice. What are the chances that Tony forgets all about it and offers you a clean slate? Not high. Tony, in all likelihood, will pursue his claim with you.
If and when Soprano’s done bruising you the distressed borrower — figuring out, perhaps, that you don’t have physical bitcoin to shakedown after all– what are the chances he follows up the debt trail and goes on to shake down Satoshi Dice? We’d argue pretty high, at least if the sum in question makes the collection effort worthwhile.
As far as contract law is concerned, even if Satoshi Dice received the bitcoin in good faith from Soprano’s debtor, Soprano himself (despite his unorthodox shake-down tactics) retains a right to seize his property back. And if they passed it on, he can pursue the next party. And so on. Especially since the bitcoin network makes it so easy to follow the trail due to the public nature of the ledger. Eventually, if the coin ends up with a high-value investor or institutional account whose identity is known to the system a formal claim can be made by means of the judicial system.
It’s these sorts of preceding property claims that the bitcoin system not only fails to eliminate, but arguably empowers by making the paper trail so incredibly transparent. But to what degree is the law really on Tony Soprano’s side when it comes to his claim? (And we’re not referring to his violent retrieval methods, which obviously remain illegal.)
George K Fogg at law firm Perkins Coie has been thinking about the problem of past claims (or liens) on bitcoins for nearly 14 months now.
His conclusion: under the United States’ UCC code (uniform commercial code) as long as bitcoins are treated as general intangibles, no high value investor can be sure that an angry Tony Soprano won’t show up one day to claim that the bitcoins they thought they received in a completely unencumbered manner are actually his. In fact, it’s only if and when Tony Soprano publicly renounces his claim to the underlying bitcoin collateral he is owed that the bitcoins stand a chance of being treated as unencumbered. Until then, a hot potato claim risk exists for every future acquirer of Soprano’s bitcoin.
Indeed, given the high volume of fraud and default in the bitcoin network, chances are most bitcoins have competing claims over them by now. Put another way, there are probably more people with legitimate claims over bitcoins than there are bitcoins. And if they can prove the trail, they can make a legal case for reclamation.
This contrasts considerably with government cash. In the eyes of the UCC code, cash doesn’t take its claim history with it upon transfer. To the contrary, anyone who acquires cash starts off with a clean slate as far as previous claims are concerned. It is assumed, basically, that previous claims on cash are untraceable throughout the system. Though, liens it must be stressed can still be exercised over bank accounts or people.
According to Fogg there is currently only one way to mitigate this sort of outstanding bitcoin claim risk in the eyes of US law. Rather than treating cryptocurrency as a general intangible, Fogg argues, investors could transform bitcoins into financial assets in line with Article 8 of the UCC. By doing this bitcoins would be absolved from their cumbersome claim history.
The catch: the only way to do that is to deposit the bitcoin in a formal (a.k.a licensed) custodial or broker-dealer agent account.
The precedent for this sort of action, Fogg states, comes in how society came to deal with the explosion of stock certificate trading in the 20th century. As stock trading intensified, he says, it soon became obvious that couriering bearer stock-certificates from one entity to the other multiple times in a day was not an efficient process.
In the US, the Depository Trust Company was established in 1973 to deal with the inefficiency. All stock certificates would now be centrally held in one location, reducing the need for couriers, whilst still allowing for the certificate’s ownership status to be changed according to instructions. For the system to gain the trust of the financial market, however, it was imperative for the UCC to treat such transfers as if they had been exchanged on a bearer basis (i.e. without granting seniority to those with previous claims on the certificates being transferred).
The UCC law thus grants a “security entitlement” to the holder which guarantees his claim will be prioritised versus that of the securities intermediary or the security intermediary’s creditors. In this way, the law allows investment securities to be transferred free of adverse claims that are not known about.
Critically, it’s a protection that is only granted to assets if and when the securities are pooled in an indirect way by licensed custodians or broker-dealers. Furthermore, the law doesn’t protect clients from the risk that the underlying collateral isn’t at the broker-dealer to begin with. But providing the assets are there, the claims of the holder in such a depository structure supersede all others.
The irony of all this for anti-government minded Bitcoin investors is that it’s only by transferring bitcoins into the established financial system that they can be sure to be protected from outstanding Tony Soprano claims on their bitcoin.
As Fogg notes:
The only way around that problem (at least the second one), says Fogg, is if all lenders to bitcoin businesses publicly renounced their rights to pursue claims on bitcoins transferred in and out of their accounts. This, he notes, could be achieved with contract law.
But even that won’t stop an angry Tony Soprano from showing up with a preceding claim to the bitcoin you think you own outright.
But this, of course, is a fallacy.
Bitcoin may have the potential to create a fully-funded reserve system, but it certainly doesn’t eliminate debt from any system.
At best, Bitcoin’s public ledger records a transfer of digital access rights in the eyes of the clearing network. It does not, however, record or see the terms and conditions of that transfer.
Indeed, as far as the clearing network is concerned all it knows is that a transfer has occurred. Party A’s wallet has been debited while party B’s wallet has been credited.
This is something akin to witnessing a physical coin being passed from one hand to the other. Yet what the process doesn’t do is log the conditionality of the transfer — which is still the subject of private agreement and contract law.
For example, let’s hypothesise that Tony Soprano was to start a bitcoin loan-sharking operation. The bitcoin network would have no way of differentiating bitcoins being transferred from his account with conditions attached — such as repayment in x amount of days, with x amount of points of interest or else you and your family get yourself some concrete boots — and those being transferred as legitimate and final settlement for the procurement of baked cannoli goods.
Now say you’ve lost all the bitcoin you owe to Tony Soprano on the gambling website Satoshi Dice. What are the chances that Tony forgets all about it and offers you a clean slate? Not high. Tony, in all likelihood, will pursue his claim with you.
If and when Soprano’s done bruising you the distressed borrower — figuring out, perhaps, that you don’t have physical bitcoin to shakedown after all– what are the chances he follows up the debt trail and goes on to shake down Satoshi Dice? We’d argue pretty high, at least if the sum in question makes the collection effort worthwhile.
As far as contract law is concerned, even if Satoshi Dice received the bitcoin in good faith from Soprano’s debtor, Soprano himself (despite his unorthodox shake-down tactics) retains a right to seize his property back. And if they passed it on, he can pursue the next party. And so on. Especially since the bitcoin network makes it so easy to follow the trail due to the public nature of the ledger. Eventually, if the coin ends up with a high-value investor or institutional account whose identity is known to the system a formal claim can be made by means of the judicial system.
It’s these sorts of preceding property claims that the bitcoin system not only fails to eliminate, but arguably empowers by making the paper trail so incredibly transparent. But to what degree is the law really on Tony Soprano’s side when it comes to his claim? (And we’re not referring to his violent retrieval methods, which obviously remain illegal.)
George K Fogg at law firm Perkins Coie has been thinking about the problem of past claims (or liens) on bitcoins for nearly 14 months now.
His conclusion: under the United States’ UCC code (uniform commercial code) as long as bitcoins are treated as general intangibles, no high value investor can be sure that an angry Tony Soprano won’t show up one day to claim that the bitcoins they thought they received in a completely unencumbered manner are actually his. In fact, it’s only if and when Tony Soprano publicly renounces his claim to the underlying bitcoin collateral he is owed that the bitcoins stand a chance of being treated as unencumbered. Until then, a hot potato claim risk exists for every future acquirer of Soprano’s bitcoin.
Indeed, given the high volume of fraud and default in the bitcoin network, chances are most bitcoins have competing claims over them by now. Put another way, there are probably more people with legitimate claims over bitcoins than there are bitcoins. And if they can prove the trail, they can make a legal case for reclamation.
This contrasts considerably with government cash. In the eyes of the UCC code, cash doesn’t take its claim history with it upon transfer. To the contrary, anyone who acquires cash starts off with a clean slate as far as previous claims are concerned. It is assumed, basically, that previous claims on cash are untraceable throughout the system. Though, liens it must be stressed can still be exercised over bank accounts or people.
According to Fogg there is currently only one way to mitigate this sort of outstanding bitcoin claim risk in the eyes of US law. Rather than treating cryptocurrency as a general intangible, Fogg argues, investors could transform bitcoins into financial assets in line with Article 8 of the UCC. By doing this bitcoins would be absolved from their cumbersome claim history.
The catch: the only way to do that is to deposit the bitcoin in a formal (a.k.a licensed) custodial or broker-dealer agent account.
The precedent for this sort of action, Fogg states, comes in how society came to deal with the explosion of stock certificate trading in the 20th century. As stock trading intensified, he says, it soon became obvious that couriering bearer stock-certificates from one entity to the other multiple times in a day was not an efficient process.
In the US, the Depository Trust Company was established in 1973 to deal with the inefficiency. All stock certificates would now be centrally held in one location, reducing the need for couriers, whilst still allowing for the certificate’s ownership status to be changed according to instructions. For the system to gain the trust of the financial market, however, it was imperative for the UCC to treat such transfers as if they had been exchanged on a bearer basis (i.e. without granting seniority to those with previous claims on the certificates being transferred).
The UCC law thus grants a “security entitlement” to the holder which guarantees his claim will be prioritised versus that of the securities intermediary or the security intermediary’s creditors. In this way, the law allows investment securities to be transferred free of adverse claims that are not known about.
Critically, it’s a protection that is only granted to assets if and when the securities are pooled in an indirect way by licensed custodians or broker-dealers. Furthermore, the law doesn’t protect clients from the risk that the underlying collateral isn’t at the broker-dealer to begin with. But providing the assets are there, the claims of the holder in such a depository structure supersede all others.
The irony of all this for anti-government minded Bitcoin investors is that it’s only by transferring bitcoins into the established financial system that they can be sure to be protected from outstanding Tony Soprano claims on their bitcoin.
As Fogg notes:
My libertarian friends have a belief they have created something that is outside of any statutory governance, and my response is you have created something novel that can help in transferring value across borders but you can’t pretend that the UCC doesn’t exist and because it does exist it affects bitcoin. Bitcoin is governed by the UCC. You can be an ostrich and pretend that it’s not covered by it, or you can address that it is in fact covered by the statute and find a way to solve the problem.Fogg adds that it’s unlikely that new entrant bitcoin dealers and brokers would constitute depository broker-dealer agents in the eyes of article 8 of the UCC. That means all bitcoins coming in and out of notable bitcoin brokers today cannot be classified as claim free, and thus do pose a risk to high value investors — either because the brokers may be acquiring bitcoin with previous claims on them without knowing about it, or because their own lenders would judge their bitcoin stock as a claimable security wherever it ends up.
The only way around that problem (at least the second one), says Fogg, is if all lenders to bitcoin businesses publicly renounced their rights to pursue claims on bitcoins transferred in and out of their accounts. This, he notes, could be achieved with contract law.
But even that won’t stop an angry Tony Soprano from showing up with a preceding claim to the bitcoin you think you own outright.
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