For all the attention crypto assets such as Bitcoin have received in the financial press, can a bank lend against them? They are, after all, a valuable asset. Some advisors even treat crypto as its own asset class, and a key part of a diversified portfolio.

But what are crypto assets, for collateral purposes?

Can a lender foreclose on them as easily as more traditional collateral, such as real estate, or investment securities? Of course, a lender must be willing to make such a loan — crypto’s values are certainly volatile. In other words, the collateral value could fall below the loan balance without warning — or the lender could demand several times the amount of the loan in security. The lender could also ask for additional less volatile, traditional forms of collateral, such as real estate, or receivables.

However, help is on the way for the bank lender facing this question (although that help may be on the proverbial slow boat).

That is not unusual — prior revisions of the Uniform Commercial Code to address technology developments took some time (and a major 2018 proposal was approved in only one state). The Uniform Law Commission, which writes model rules for states, has proposed amendments to the laws governing collateral to include “emerging technologies” — including virtual currencies, distributed ledger technologies, and artificial intelligence. UCC, 2022 Amendments to – Uniform Law Commission (uniformlaws.org)

For technical reasons, crypto assets are not “money” (which a lender must possess for it to serve as collateral). Many practitioners instead lump them into the “general intangibles” catch-all — a far cry from fungible “money.” Therefore, rather than shoehorn crypto assets into the existing structure of the Uniform Commercial Code, the proposed law adds a separate chapter for “digital assets,” formally named “controllable electronic records.” The details of the proposal are complex, but have a business-oriented goal — to “preserve the availability of existing transaction patterns.”

In plain English, the proposed law will adopt key concepts of current secured lending to the practicalities of crypto assets. The proposed rules define such fundamentals as the ability to transfer crypto assets free of liens, and how to take an interest free of third-party claims (key concerns for lenders and buyers).

Until laws are amended to provide some clarity, lenders may consider lending against investment accounts — a familiar asset class — holding crypto assets, rather than against the crypto assets themselves. Lenders will likely also await regulatory guidance on how to value these assets. See https://www.federalreserve.gov/supervisionreg/srletters/SR2206.htmfor the Fed’s August 16, 2022, guidance for banks on “Engagement in Crypto-Asset-Related Activities by Federal Reserve-Supervised Banking Organizations.”

Spoiler alert — the Fed is not a fan.

Instead, it required “A supervised banking organization should notify its lead supervisory point of contact at the Federal Reserve prior to engaging in any crypto-asset-related activity.” (Emphasis added.) The release then catalogs a lengthy list of risks bankers must assess for “relevant supervisory feedback, as appropriate, in a timely manner.”

The FDIC urged similar caution in April. https://www.fdic.gov/news/financial-institution-letters/2022/fil22016.html; https://www.fdic.gov/news/financial-institution-letters/2022/fil22016.html#letter

The OCC had issued its own skeptical warning in late 2021, updating its earlier guidance. https://www.occ.gov/news-issuances/news-releases/2021/nr-occ-2021-121.html; https://www.occ.gov/topics/charters-and-licensing/interpretations-and-actions/2021/int1179.pdf

In fact, the three regulators — the Fed, the OCC and the FDIC — announced in November, “Throughout 2022, the agencies plan to provide greater clarity on whether certain activities related to crypto-assets conducted by banking organizations are legally permissible, and expectations for safety and soundness, consumer protection, and compliance with existing laws and regulations.” https://www.occ.gov/news-issuances/news-releases/2021/nr-ia-2021-120a.pdf

As the banking regulators all emphasized, lenders must understand the risks crypto poses, as with any other type of nontraditional collateral. Not only may you face challenges in foreclosing, but its value may fluctuate so much that your regulators may be skeptical about it — much less your CPA.

However, for those comfortable with those risks, and who can become comfortable about regulatory concerns, crypto lending may be a Gold Rush for the 21^st century. In fact, one local bank has even expanded its lending ability through a deal involving crypto currency participations — but with limits. According to the bank, “We’re not going to put cryptocurrency on our books. We’re not going to take cryptocurrency as collateral. We’re not going to do anything on the blockchain. We’re not going to do anything with smart contracts.”

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For further information on lending secured by atypical collateral, please contact Stanley P. Jaskiewicz, a member of our Business Law Department. sjaskiewicz@sgrvlaw.com; 215-241-8866.