comprehensive statutory framework to govern the creation, perfection, priority and enforcement of security interests in all types of
personal property.
8 “Personal property” is best defined as property
that is not land.
9 “Security interest” is defined in the PPSA as an
interest in personal property that secures payment or performance
of an obligation without regard to the form of the transaction or the
location of title to the collateral.
10 There are evident gaps in the rules
with respect to blockchain assets, exemplified by the fact that
neither the PPSA nor the Securities Transfer Act (STA) contemplate
the perfection of security interests over securities that are digitally
represented. Currently, there are established rules for certificated
and uncertificated securities, but blockchain assets do not seem to
fall into these existing legislative frameworks. Absent specific rules
governing the perfection of security interests over blockchain
assets, it is unlikely that lenders would accept such assets as collateral without having certainty that lenders could legally enforce their
rights against such collateral. Before the legislature catches up, the
blockchain community might have a technical solution that would
significantly disrupt the methods by which financial lenders take
collateral over a borrower’s assets. Through the use of “smart
contracts” on platforms such as Ethereum, parties could program
an autonomous trust agent designed specifically to receive a transfer
of digital assets from a borrower as collateral, and either release the
assets back to the borrower upon satisfaction and repayment of a
loan, or transfer the assets to the lender or some other third party
upon an event of default. The smart contract would read and execute
the terms and conditions of the underlying loan agreement between
the parties. Both the borrower and the lender would have confidence
in this process because the underlying code would be transparent,
unbiased and incorruptible. It would also have virtually no cost to
the parties aside from the nominal electricity costs of operating the
nodes.
At the current state of the technology, it is questionable whether the
more complex terms and conditions of modern loan agreements are
machine-readable. While smart contracts can rely on third-party
data provided by ‘oracles’ (trusted sources) to monitor the bank
accounts of a borrower to determine whether certain financial
covenants are met, smart contracts are unlikely to determine
whether a borrower has made reasonable best efforts to cure an
event of default, or whether a lender acted in bad faith. Many legal
standards are inherently subjective, and until the advent of more
advanced forms of AI, these standards are likely to require human
intellect to be accurately interpreted.
The more overarching concern relates to the fact that transactions
on a blockchain are immutable, and therefore final. In the event that
a nefarious lender or borrower (or other third party) managed to
exploit a bug in the code of a smart contract or blockchain protocol
and misappropriate the collateral funds, there is limited recourse
that the parties may take to recover the funds. Such a scenario is
not outside the realm of possibility; in 2013 an unknown hacker
exploited a bug in the Ethereum platform to steal $150 million
worth of Ether from a fundraiser for a project called the DAO
(decentralized autonomous organization). In the case of the DAO
hack, the majority of the Ethereum community decided that impli-
cations of the hack were significant enough to justify “forking” the
blockchain (effectively an agreement between every node on the
network to “undo” the record of the hack from the history of trans-
actions). At the time this decision as contentious and resulted in the
split between Ethereum and Ethereum Classic, the latter being the
minority of nodes that principally did not agree to update their
record. As blockchains continue to scale, updating every node’s
record of transaction history in order to undo an illegal or otherwise
contested transaction becomes increasingly unrealistic and imprac-
tical. New blockchain projects such as Tezos attempt to address this
issue by incorporating voting rights into the project’s native token,
so that token holders can theoretically address any issue (such as
whether to undo a transaction or otherwise change the protocol)
through an on-chain governance structure. But until the security of
smart contracting is proven quantity, lenders may be hesitant to
incorporate these new technologies into their business processes.
Conclusion
Our goal is not to dismiss blockchain technology’s capacity to
disrupt, but to simply complicate the issues. In order for blockchain
technology to truly replace the status quo, among its many other
obstacles, it has to be able to fit into the rules and practices of the
modern economy. The gaps in the existing blockchain technology
will undoubtedly require an evolution in legal thinking if the
technology can’t adapt to the law.
Disclosure: Some of the authors of this article have invested in
blockchain startups, including initial coin offerings.
1. https://qz.com/947064/sweden-is-turning-a-blockchain-powered-
land-registry-into-a-reality/
2. https://techcrunch.com/2017/04/11/bext360-is-using-robots-and-the-
blockchain-to-pay-coffee-farmers-fairly/
3. https://bitcoinmagazine.com/articles/delaware-blockchain-initia-tive-to-streamline-record-keeping-for-private-compa-
nies-1462812187/
4. The Virtual is Real: An Argument for Characterizing Bitcoins as
Private Property
5. https://www.ethnews.com/legal-experts-call-for-european-regula-tion-of-cryptoassets-as-a-new-asset-class
6. Book Essentials of Personal Property Security Law – page 4
7. Canadian Personal Property Security Law, p. 18
8. PPSA Ontario security interest definition
Adam Armstrong
aarmstrong@torys.com
Marko Trivun
mtrivun@torys.com
