26 August 2015

Bitcoin, the UCC and payment system regulation

'Bitcoin and the Uniform Commercial Code' by Jeanne L. Schroeder comments
Much of the discussion of bitcoin in the popular press has concentrated on its status as a currency. Putting aside a vocal minority of radical libertarians and anarchists, however, many bitcoin enthusiasts are concentrating on how its underlying technology – the blockchain – can be put to use for wide variety of uses. For example, economists at the Fed and other central banks have suggested that they should encourage the evolution of bitcoin’s blockchain protocol which might allow financial transactions to clear much efficiently than under our current systems. As such, it also holds out the possibility of becoming that holy grail of commerce – a payment system that would eliminate or minimize the roles of third party intermediaries. In addition, the NASDAQ and a number of issuers are experimenting with using the blockchain to record the issuing and trading of investments securities.
In this Article, I examine the implications for bitcoin under the Uniform Commercial Code (the “U.C.C.”). Specifically, I consider three issues. In Part 1, I discuss the characterization of bitcoin – which I am using generically to refer to any virtual or cryptocurrency – under Article 9. The bad news is that it does not, and cannot be made to fit into, the U.C.C.’s definition of “money”. If held directly by the owner, bitcoin constitutes a “general intangible”. Unfortunately, general intangibles are non-negotiable. This could greatly impinge on bitcoin’s liquidity and, therefore, its utility as a payment system.
In Part 2, I show how this may be mitigated by the rules of Article 8 governing investment securities. If the owner of bitcoin were to choose to hold it indirectly through a financial intermediary, then she and the intermediary could elect to have it treated as a “financial asset” which is super-negotiable. Unfortunately, this comes at the cost of eliminating one of the primary attractions of cryptocurrency, namely the ability to engage in financial transactions directly without a third-party intermediary. However, Article 8, may already provide a legal regime for another contemplated use for the blockchain – namely as a readily searchable means of recording the ownership and transfer of property generally.
In Part 3, I explain how cryptosecurities fall squarely within Article 8's definition of “uncertificated securities.” Ironically, therefore, the creation of bitcoin securities may finally breathe life to little used provisions that were invented almost 40 years ago in a failed attempt to solve a completely different problem.
'The Coming of Age of Digital Payments as a Field', a paper by Ignacio Mas and Ross P. Buckley, has
three objectives. It lays out the key differences between a banking and a payments mindset, within the historical context in which these fields have developed. It initiates a discussion on whether it is useful to articulate the digital payments space as an emerging profession distinct from banking, and if so, what might be the core elements of its identity and how might a sense of a profession emerge. Finally, it looks at the main vision, information and human capacity gaps that are at present limiting the pace of development of the digital payments space.
In referring to 'Breaking the payment innovation floodgates' the authors comment
Given bankers´ traditional reticence to develop stand‐alone payment services with the levels of convenience and certainty that customers demand, a host of players have entered the space in the last decade. They come from diverse backgrounds —from large mobile operators and retailers to tiny specialist internet start-­‐ups— but they all share the technology focus that enables transactions to happen fast, with as few clicks as possible, anytime and anywhere. The digital payments sector has grown beyond all recognition and continues to evolve fast.
The innovation floodgates are being torn asunder by two main forces. From a technology standpoint, the internet and smartphones make it possible to design rich and scalable solutions at a fraction of the cost it would have taken a decade earlier. From a regulatory standpoint, there is a growing trend for regulators to allow new specialist payment service providers or e-­‐money issuers the opportunity to get into the business without having to acquire a banking license or partner with a sponsor bank.
Banking is centuries old, but the field of digital payments is only fifty years old. With hindsight, we can identify at least four waves of innovation around digital payments. The first wave of payment innovators sought to ride on top of, rather than displacing, banking services. Such was the case with the VISA and MasterCard credit associations that emerged in the 1950s, and with internet payment service providers such as PayPal that emerged in the late 1990s. These systems rely on banks to conduct all customer due diligence and provide cash in and cash out services. If you don´t have a bank account, you simply cannot have a credit card or a PayPal account.
A second wave of payment innovators sought to stand alongside banks, and even became a direct competitor to them. Their innovation was to go beyond the purely digital and establish a brick-and-mortar network of stores where customers could complete their registration and conduct cash in/cash out transactions. These were the mobile money systems that emerged in a number of developing countries following the launch of Smart Money in the Philippines and is epitomized by M-PESA in Kenya. Now you can be part of a digital payment network even if you don´t have a bank account.
A third wave of payment innovators has been making headlines in the last five years, mainly in developed countries and the US in particular. They are seeking to unbundle the payments landscape and entrench themselves in particular stages of the payments value chain. They depend on other players in the ecosystem to do the rest, but through their bottleneck control of their stage they seek to exert a major control over their partners and have substantial influence on the development of the market. Examples are Square, for low cost merchant payments; Google Wallet and Apple Pay for payment applications; and Stripe, as an integrated suite of application programming interfaces (APIs) or hooks into a host of payment options for businesses.
A fourth wave of payment innovators is now emerging, with a much more disruptive agenda: they seek to lay an entirely new foundation for financial transactions that is based on decentralized trust, peer-­‐to-­‐peer networks running on standard internet infrastructure, and open source protocols managed by the community of users. This is the promise of the new cryptocurrency platforms, such as Bitcoin and Ripple. These platforms may enable the creation of a host of new players that will not be content just to rival banks, but in fact will seek to displace banks altogether.