What! You said we can use bitcoin for cash loans

What just happened?

Goldman Sachs is among a handful of tier-one U.S. banks figuring out how to use bitcoin as collateral for cash loans to institutions, according to three people familiar with the plans. (1)

What does this mean?

The basic principle is similar to a mortgage or car loan: You invest in crypto assets to get a loan and then pay it off over time. You can obtain this type of loan through a cryptocurrency exchange or a cryptocurrency lending platform. An encrypted loan is a secured loan, similar to a car loan, in which assets are used as collateral to ensure financing. Cryptocurrency-backed loans use digital currencies as collateral, similar to securities-based loans. (2)

These loans usually operate like traditional instalment loans, and depending on your cryptocurrency loan plan; you may have less than a year to repay the loan. In addition, if you plan to retain digital assets for a long time, lending them through an encrypted interest account may be an excellent way to maximize their value. People might consider crypto loans because of the benefits they provide, and they do not plan to trade or use their crypto assets in the near future. There are obvious benefits to using your digital currency to obtain a loan. (3)

For this reason, digital currency developers and startups have focused so much attention on creating secure storage facilities for digital coins and tokens. However, new types of wallets are constantly being released. Although cryptocurrency exchanges are constantly improving their security measures, investors still have not been able to eliminate the legal risks associated with owning cryptocurrencies, and probably never. As governments worldwide, regulators, central banks, and other financial institutions work to understand the nature and meaning of digital currencies, individual investors can make big bucks by investing in this new space. (4)

How does this impact the legal sector?

Article 8 of the UCC, which governs the possession and transfer of securities, may provide a better regime for creating and improving a security interest in bitcoin if the owner wishes to hold bitcoin indirectly through a third party. As a result, the parties to the transaction can order the securities broker to transfer bitcoin, and the recipient (in almost all cases) will receive free and unlimited bitcoin. If the parties use a third-party securities broker, the next step is to provide the lender with an enhanced security interest in bitcoin through a control agreement. (5)

A written control agreement will govern the terms a borrower can transfer bitcoins to an account through instructions to a securities broker. The borrower, lender and securities broker will agree to treat bitcoin held in a securities account as a "financial asset" within the meaning of clause 8. At this point, the borrower will no longer own bitcoins directly. (6)

Before contacting the lender, the borrower could have provided the protected party with a security interest in bitcoins or provided a security interest in "all assets now owned or acquired after that," thus acquiring bitcoin. If the bank wants to provide a loan secured by bitcoin, the borrower can open a securities account with a securities broker and transfer the bitcoins to the securities broker. (7)

Since cryptocurrencies support their lending, services usually do not require a credit check, although some use customer credentials for tax reporting and anti-fraud purposes. The protected party perfects its security interest in money through physical ownership, but physical ownership is not possible since bitcoin is virtual. Traditional money can be that too (as seen in foreign exchange speculation), but it is far from comparable to bitcoin price fluctuations, which excludes it as a store of value. Bitcoin does not fulfil the critical functions of money and, therefore, will not be recognized by law. (8)

It is expected that the government will set up a trust fund in the El Salvador Development Bank to convert bitcoins into U.S. dollars for sellers immediately. According to reports, the approved bill will require all businesses to accept Bitcoin as a commodity or service. Still, the government will support organizations that are unwilling to risk the use of this unstable cryptocurrency. The new law amends the Uniform Commercial Law of Texas to apply commercial law to blockchain and digital assets, formally define virtual currencies, and provide individuals and businesses with a legal environment for investing in encrypted currencies. (9)

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¹ Goldman Sachs, Other Wall Street Banks Exploring Bitcoin-Backed Loans: Sources (coindesk.com)

² https://www.bankrate.com/loans/personal-loans/cryptocurrency-lending/ and https://www.nerdwallet.com/article/loans/personal-loans/what-is-a-crypto-loan

³ https://www.bankrate.com/loans/personal-loans/cryptocurrency-lending/

⁴ https://www.investopedia.com/tech/what-are-legal-risks-cryptocurrency-investors/

⁵ https://www.wardandsmith.com/articles/can-i-secure-a-loan-with-bitcoin-part-ii

⁶ https://www.wardandsmith.com/articles/can-i-secure-a-loan-with-bitcoin-part-ii

⁷ https://www.wardandsmith.com/articles/can-i-secure-a-loan-with-bitcoin-part-ii and https://www.natlawreview.com/article/can-i-secure-loan-bitcoin-part-i

⁸ https://www.natlawreview.com/article/can-i-secure-loan-bitcoin-part-i, https://www.nytimes.com/2021/09/05/us/politics/cryptocurrency-explainer.html and https://www.euronews.com/next/2021/10/15/analysis-cryptocurrencies-won-t-become-part-of-the-modern-monetary-system

⁹ https://www.jdsupra.com/legalnews/ether-backed-loans-and-blockchain-4649034/