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Some Practical Thoughts About the Brave New World of Virtual Currencies

A few days ago, I was speaking with some friends about the “cryptocurrency” called Bitcoin.  We laughed about the bubble in the Bitcoin market (it gained 1200% on the US Dollar in the past six months), the perceived need for such a “currency” untethered from any nation or central bank, and whether Bitcoin would be subject to U.S. regulation in the near future.  It was a good time.  If you’re interested in investing in our new Bitcoin fund, let me know. [1]Then I saw this. Evidently, JP Morgan filed a patent for something with features suspiciously similar to Bitcoin.  The application is available here. Whatever the merits of Bitcoin itself, the JP Morgan application makes some good arguments about the friction created by online credit card transactions, and the way that Bitcoin-like currencies and related transaction practices may reduce that friction and become an important part of our lives.  The possibility of such novel transaction mechanisms raises questions about how to do some things we’ve taken for granted in our current system, like attaching and perfecting wall-to-wall security interests.

The patent application contemplates a “payment portal processor” (“PPP”) that will serve as a convenient user interface that allows easy access to a “digital wallet,” an “Internet Pay Anyone” account (“IPA”), a “Virtual Private Lockbox” (“VPL”), and some other things that aren’t really important for our purposes here, because their consideration would make this post intolerably long.

According to the application, the PPP “provides the user with a form of virtual cash that is secured and guaranteed.” [2]  That virtual cash is “held” in accounts like the IPA or VPL.  Significantly, neither the IPA nor the VPL is actually deposit accounts containing currently-recognized currency; rather, “[u]sing functionality from online banking services, the PPP enhanced wallet . . . is able to be associated with (linked to) some or all of the accounts maintained by the user at the bank[.]  The user is thus able to transfer funds, amounts, value, from one account to another (e.g. to an IPA account . . . from a savings account, or VPL account) with ease.” [3]  The application continues to note that, although it would be preferred that the IPA and VPL accounts be maintained at a bank, it is not necessary.

In connection with the foregoing, consider the proposed use of the VPL account.  The VPL account “cannot be used for initiating EFT credit messages.”  Rather, it can only receive electronic payments through EFT.  The funds in the VPL account would then be swept to the user’s other accounts associated with its PPP and digital wallet, but need not ever be converted into conventional currency held in a deposit account.

That last part should be emphasized: a deposit account – as defined in Article 9 of the UCC – is entirely unnecessary for the VPL account to work. [4]. Now, consider that you are a lender to a merchant with a VPL account.  That merchant may never transfer its virtual cash from its VPL account to a traditional deposit account, except perhaps as necessary to pay creditors who are not participants in this virtual currency system.  How do you ensure that your intended wall-to-wall security interest attaches to the virtual funds in this virtual account?  And how do you perfect that interest to the extent it attaches to virtual funds in a virtual account?

As to the first question – attaching a security interest to a VPL account and the “funds” contained therein – a couple of solutions spring to mind, but neither is entirely satisfying.  The first is to specifically include such accounts in the security agreement, though the precise wording might be difficult, especially if, for instance, JP Morgan’s contemplated payment system is not the only one out there (think back to the VHS/Beta wars).  The other is to require that any such accounts be “maintained” by the lender so that they may fall within the definition of a deposit account, but that requires (a) that the lender be equipped to maintain such accounts, and (b) that the contractual requirement is sufficient to ensure that the borrower actually follows instructions.  These are not small problems.

But the thornier problem is how to perfect such a security interest.  If the VPL account is a deposit account, that’s simple enough to deal with – perfect by control as you would a deposit account.  But what if it’s not?  What if you need to take a security interest in the virtual cash itself?  That would be hard.  Say the virtual cash is “money.”  There is some sort-of authority for this from a district court in Texas, which held that, at least for purposes of the Securities Act, Bitcoin “is a currency or form of money” in that it can be used to pay for things or exchanged for conventional currency. [5]  If that’s correct, then one can only perfect by securing possession of same (§ 9-312(b)(3)), and that would be particularly difficult in case of a virtual currency.  Of course, if it is a “good,” one could simply perfect by filing.  The purpose of this post is not so much to resolve the question – thank goodness – but rather to highlight the difficulty in doing so.

The JP Morgan application suggests that credit cards will remain the dominant form of payment for online transactions for at least the next five years, and I can’t disagree with that (in fact, I think the five-year timeline to relevance is wildly optimistic of the applicant).  But given the identified problems with credit card transactions, especially in small-dollar sales, it is also hard to disagree with the underlying concept that a simpler and secure form of payment will gain traction in the market.  I hope banks, legislators, and attorneys are considering how to deal with the issues that will arise. 

[1] Don’t. That’s a joke.

[2] It’s unclear what the application means by “guaranteed.”  I would like to know.

[3] The “funds, amounts, value” language makes me think that the drafters of the application were just as confused about what, exactly, this virtual currency actually is.

[4] The definition of deposit account includes a requirement that same be “maintained with a bank.”  Although the PPP and VPL can be “associated with” or “linked to” a bank account maintained with a bank, they do not themselves appear to be “maintained with a bank,” though I could be persuaded otherwise.

[5] Securities Exch. Commn. v. Shavers, 2013 WL 4028182 (E.D. Tex. August 6, 2013).