Nebraska Financial Innovation Act: Bringing Regulated Cryptocurrency Storage, Securitization, and Lending to Banks, Businesses, and Consumers
By David J. Skalka, Partner, Croker Huck, and Rachel Geelan, Creighton Law ’23.
The recent Nebraska Financial Innovation Act (“NFIA”) (LB 649, 2021) places Nebraska at the forefront of cryptocurrency banking, finance, and securitization. With it, Nebraska became the second state to charter digital asset depositories, a new type of financial institution that holds valuable, self-contained, uniquely identifiable, liquid financial assets— such as cryptocurrency and defined in the law as digital assets. With the NFIA, Nebraska became the first state to adopt Article 12 and revisions to Article 9 Uniform Commercial Code proposed by the U.C.C. Committee on Emerging Technologies regarding “controllable electronic records.”
These digital asset depositories will be authorized to lend and borrow cryptocurrency and take digital assets as collateral, provide cryptocurrency payment services, issue stablecoins (cryptocurrency pegged to the U.S. Dollar via collateral, algorithms, or reserve assets such as the cryptocurrencies DAI, USDC, and USDP), and hold stablecoin deposits at an FDIC-insured financial institution, and become a member of the federal reserve. The NFIA permits a state financial institution to invest up to 10% of its capital and surplus in a digital asset depository institution, and may seek consent from the Nebraska Department of Banking for a higher percentage.
Businesses in good standing with their incorporated state and engaged in lawful business may open an account with these institutions and deposit, borrow, and buy cryptocurrency. The availability of regulated digital asset depositories creates a more reliable opportunity for businesses to invest in digital assets and capitalize on their benefits. This aspect of NFIA took effect October 1, 2021; however, not only does regulation need to be developed, in the view of this author the law will have to be modified in places to correct language inconsistent with how cryptocurrency operates. For example, a portion of the law states, “At all times, a digital asset depository shall maintain unencumbered liquid assets denominated in United States dollars valued at not less than one hundred percent of the digital assets in custody.” This requirement is stated for all purposes rather than solely for loan collateral purposes, which would make cryptocurrency custody services needlessly unworkable.
While the charter of this new financial institution is the primary focus of the law, there are pertinent changes to the Uniform Commercial Code (“UCC”) that will help bridge the gap between cryptocurrency and tangible world financing using cryptocurrency, i.e., decentralized finance (“DeFi”). The new law adds to UCC Article 9, which governs secured transactions, and adopts UCC Article 12 to govern priority, perfection, and discharge of interests in digital assets. While not effective until July 1, 2022, lenders can develop legal structures and transactions knowing that security interests in such assets will be fully recognized in any post-July 1, 2022 default and repossession. The provisions provide regulation so that creditors, borrowers, and purchasers of digital assets can participate in the digital economy with confidence that their interests are protected by law.
As the uses of cryptocurrency and digital assets expand, people are using them as collateral to obtain fiat money. When this happens, a self-executing contract containing the rights and responsibilities of the creditor and borrower (a “smart contract”) attaches to the crypto. Article 12, along with the additions to Article 9, now govern what interests in the digital assets are given priority, how those interests are perfected, how one obtains control over the crypto, and how obligations are discharged. For example, what happens if the crypto to which the smart contract is attached is subsequently sold to a third party? Does that person receive both the electronic record (merely the crypto token) and the rights and responsibilities of the smart contract (the digital asset) attached to it? Articles 9 and 12 tell us when those rights do or do not attach to the purchase. While that is just one example of many issues that may come up in digital asset transactions, having the Articles to answer those questions will decrease the skepticism that often accompanies participation in the digital economy.
Purchaser Interests. Article 12 governs priority of interests in electronic records and the digital assets attached to them. Generally, a purchaser of an electronic record only acquires the rights the transferor had power to transfer, and purchasers of a limited interest only acquire rights to the extent of the interest they purchased. However, a transferor who has “control” over the electronic record, but does not have any rights (e.g. the rights of a smart contract) in it, still has the power to transfer the rights by voluntarily transferring control to a “qualified purchaser”. Article 12 §§ 104-05 protect qualified purchasers from adverse claims. A qualified purchaser is someone who purchases an interest in, and obtains control of, the electronic record that represents the digital asset without notice of an adverse claim.
The first requirement, control, can be established in two ways. First, the electronic record system must give the purchaser (a) the power to use the digital asset it represents, (b) exclusive power to prevent others from using the digital asset, and (c) exclusive power to transfer control to another who uses the asset it represents. The purchaser’s power is still “exclusive” even if the electronic record system limits use of the digital asset—the powers only have to apply to digital assets that the system makes available. Additionally, the electronic record or the system where its recorded must enable the purchaser to readily identify (by name, identifying number, cryptographic key, office, or account number) that they have those three powers. Second, a purchaser may obtain control through an agent.
In addition to having control over the electronic record, a qualified purchaser must not have notice of an adverse claim. A person has notice if they (a) have actual knowledge of the adverse claim, or (b) are aware of facts sufficient to indicate a significant probability that an adverse claim exists, but deliberately avoid information that would establish such existence. However, filing an Article 9 financing statement does not put purchasers on notice. If a qualified purchaser can meet the control requirements, does not have notice of an adverse claim, and purchases the electronic record for value, their interest takes priority over adverse interests. The qualified purchaser rule preserves the highly negotiable nature of crypto assets by freeing qualified purchasers from any obligation to (a) investigate the existence of adverse claims or (b) to take subject to interests attached to the crypto.
Debtor Interests. Article 12 § 106 governs discharge of a debt represented by an electronic record. A debtor who borrows against their digital asset can discharge their obligations on the debt in two ways. They can either pay the person who currently has control of the electronic record, or they can pay a person who formerly had control of the record unless they receive notice from the person who presently has control containing: (a) a statement that they presently have control, (b) reasonable identification of the electronic record, and (c) reasonable method by which the debtor should make payments. The debtor has the right to request reasonable proof that the sender of the notice has control of the electronic record, and if the sender does not seasonably comply, the notice is ineffective. Notice is also ineffective if the debtor has an agreement with the person who sold them the digital asset which only requires the debtor to pay that particular person. If the notice directs the debtor to divide payment and send portions by more than one method, the debtor has the non-waivable option to treat the notice as ineffective. If the debtor receives notice and it is not ineffective, the debtor must pay according to the notice to discharge their debt. These rules relieve account debtors of any burden to identify to whom they should make payment and protect purchasers of digital assets from the risk that the debtor may satisfy their obligation by paying a person who formerly had control. Consumer protection is incorporated by providing exceptions for transactions governed by consumer protection law.
Creditor Interests. Those who hold a security interest in a digital asset evidenced by an electronic record can perfect that interest to gain priority in two ways: (a) by filing an Article 9 financing statement, or (b) by obtaining and retaining control over the electronic record. The first to perfect their interest will have priority. However, as explained above, a perfected security interest will not have priority over the interests of a qualified purchaser. So, someone who is not first to perfect can still obtain the senior security interest by becoming a qualified purchaser.
The adoption of Article 12 and revisions to Article 9 open up the world of utilizing cryptocurrency to finance real world asset, particularly intangible assets. For example, if a business sought to obtain financing for accounts receivable or contract rights, those could be digitized into an on-chain token providing that ownership of the token reflects ownership of the underlying contract right, or the assets could be deposited into an LLC wherein its operating agreement provides that its member interests are represented by an on-chain token. A possessory security interest is then recognized in the “controllable electronic record,” or a UCC-1 could be filed. Stablecoin such as DAI is then borrowed against the tokenized member interests held in a manner the lender can access the tokens upon default to foreclose upon; the sale of the tokens would assign ownership of the contract rights or LLC containing the assets.