Despite the recent turmoil in the bitcoin market, this cryptocurrency remains, at the moment, a viable medium of exchange that may be on the rise again. For example, the satellite TV company Dish Network announced in late May that by September, it will become the largest company yet to accept payment in bitcoin through the payment processor Coinbase.
Still, the future of bitcoin as a payment medium and store of value remains unclear, and this presents a significant problem for lenders whose customers may want to use their bitcoin accounts as collateral.
Bitcoin is an online medium of exchange that enables buyers and sellers to interact on an anonymous basis, without the involvement of banks. They are typically stored on a user’s personal computer, or in cloud-based accounts called “wallets.” The bitcoin market is decentralized, with little government oversight or regulation.
The value of bitcoins has been volatile. They tumbled precipitously earlier this year, following the bankruptcy filing of Japan-based Mt. Gox, until then the largest bitcoin exchange. The cloud-based currency has been under fire from regulators, and others seeking to increase oversight of bitcoin or eliminate them from the market altogether. More recently, bitcoins have rebounded since their mid-April low point.
Despite the volatility of bitcoin pricing, the currency has significant appeal to merchants and other business people, in part because of low transaction fees and quick transaction confirmations compared with credit card payments.
The Downsides of Bitcoin as Collateral
For lenders, it’s an entirely different story. There are a number of reasons why lenders need to be cautious when considering taking bitcoin as collateral. For example, bitcoin volatility means that their value can drop sharply, and this is a real risk for lenders seeking to ensure the stability of their collateral.
Second, bitcoin wallets are subject to cyber attacks—making it possible for the contents of a wallet to be reduced or totally wiped out by hackers.
Furthermore, the anonymity of bitcoin transactions makes it ripe for money laundering and other criminal activity. Bitcoin exchanges could be subject to money laundering rules under the Bank Secrecy Act. As a result, law enforcement authorities may, in the future, decide to close down bitcoin exchange platforms; this would prevent immediate access to bitcoin collateral.
Uncertainty about Security Interests in Bitcoin
In addition, it is uncertain how bitcoin transactions should be treated under existing commercial law. Because bitcoins are intangible, yet act as a store of value and a medium of exchange, it is difficult to classify them as a type of property in connection with commercial transactions.
Under the Uniform Commercial Code (UCC), the legal structure that governs commercial transactions across the country, bitcoin wallets are not considered to be deposit accounts. Rather, they are considered “general intangibles” or “payment intangibles.” For this reason, a lender’s interest in bitcoin as collateral cannot be protected as well as can traditional forms of collateral under UCC Article 9, which covers secured transactions.
Given the inherent volatility of bitcoin value, as well as the difficulty secured creditors may face collecting against them, their use as collateral in traditional lending provides significant reason for concern. Therefore, lenders should be cautious when faced with a borrower’s efforts to use bitcoin as collateral.
Would you like the opportunity to use bitcoin as collateral in the lending process, or do the downsides make you nervous? Would you ever consider accepting bitcoin in your business? Tell us what you think in the comments!
Lew Koflowitz is an associate of Harborcove Financial. He is a highly experienced financial writer, editor, and public relations professional.
