Can cryptocurrencies serve as collateral for a loan agreement in Germany? This question is often asked by wealthy crypto investors who, in order to finance their commercial blockchain projects or their private asset investments (real estate, company shareholdings, etc.), wish to take out loans and, for logical reasons, “deposit” their crypto portfolio as collateral. Is this legally possible?
What are cryptocurrencies?
The manner in which cryptocurrencies can become collateral depends first on how cryptocurrencies are to be handled under German civil law. They could be classified as a article, a right or something else entirely.
The difficulty of the legal classification of cryptocurrencies becomes evident when one realizes that off-chain and on-chain transactions can diverge: The transactions that are mapped on the blockchain do not necessarily match the legal positions supporting them. For example, it is conceivable that Ether do not change their “owners” on the blockchain, but that they have already changed “owners” (possibly several times) by transferring a wallet including a “seed phrase.”
Cryptocurrencies as an article?
For cryptocurrencies to be classified as articles, they would have to be tangible objects. Even though the hardware that enables and represents cryptocurrencies is real, the physicality of cryptocurrencies per se is overwhelmingly rejected. Quite simply, there is no self-contained software or parts of it that can be embodied conclusively. Even wallets, contrary to their figurative representation, do not contain the cryptocurrency itself, but only the access to the blockchain.
Cryptocurrencies as rights?
The situation is similar with regard to the qualification of cryptocurrencies as rights. In itself, there is something to be said for the comparability of cryptocurrencies and rights. A right within the meaning of the law does, however, convey a claim. And cryptocurrencies are not doing that right now: They do not convey any claims against third parties.
Transfer of cryptocurrencies as a real act
Ultimately, the question of whether cryptocurrencies can be used as collateral for a loan does not depend on how exactly cryptocurrencies are to be classified. After all, the transfer of cryptocurrencies, which is what is at issue in the case of the provision of collateral, can be treated as a real act. Thus, the transfer then does not follow the usual property law regulations of the legislation, but cryptocurrencies are simply transferred “purely real”: from wallet to wallet by arranging the necessary technical steps. Contractually, the parties agree on how exactly this should be done and cloak this process in a suitable legal construct.
Handling of cryptosecurity
So how exactly can lenders and borrowers proceed if cryptocurrencies are to serve as collateral for a loan? It is conceivable, for example, that the borrower grants the lender the right to receive the corresponding amount of cryptocurrencies in the event that the loan is not serviced.
On-chain, the borrower would still be the “owner” of the Bitcoin. Off-chain, however, the borrower would commit to transfer to the lender.
To avoid the lender relying on the voluntariness of the borrower to transfer the cryptocurrencies, it is nevertheless a good idea to engage a trustee to ensure the settlement of what has been agreed. Alternatively, it is of course also possible to draft a smart contract that automatically initiates the transfer if the agreed conditions are met.
Advice on all legal issues in the context of cryptocurrencies
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Blockchain/Bitcoin Business & Trading in Germany