Blockchain Technology in an Electronic Chattel Paper World, Reducing Transaction Costs and Limiting Fraud

• Publication year: 2022

54 Creighton L. Rev. 411. BLOCKCHAIN TECHNOLOGY IN AN ELECTRONIC CHATTEL PAPER WORLD, REDUCING TRANSACTION COSTS AND LIMITING FRAUD

BLOCKCHAIN TECHNOLOGY IN AN ELECTRONIC CHATTEL PAPER WORLD, REDUCING TRANSACTION COSTS AND LIMITING FRAUD

JESSICA J. PATACH ^[D1]

I. INTRODUCTION ................................... 412

II. BACKGROUND .................................... 414

A. U.C.C. ARTICLE 9 ................................ 414

1. History and General Application of U.C.C. § 9-105 ...................................... 414

2. Control of Electronic Chattel Paper ........... 416

3. U.C.C. § 9-105 Requirements to Meet the Safe-Harbor of Control ....................... 417

B. THIRD-PARTY CUSTODIANS' ROLE IN THE ELECTRONIC CHATTEL PAPER WORLD ............. 419

1. How Third-Party Custodian Systems Operate and the Role of the Electronic Vault ........................................ 419

2. Use of Third-Party Custodians and Electronic Vaults Continues to Grow ......... 420

C. WHAT BLOCKCHAIN IS AND HOW IT WAS IMPLEMENTED IN BITCOIN ........................ 422

1. Emergence of Blockchain ..................... 422

2. Private ("Permissioned") Versus Public ("Permissionless") Blockchains ............... 425

3. Costs Associated with Blockchain ............. 427

III. ARGUMENT ....................................... 428

A. BLOCKCHAIN USE IN ELECTRONIC CHATTEL PAPER MEETS THE CONTROL REQUIREMENTS OF U.C.C. § 9-105 ................................... 429

1. Control of Electronic Chattel Paper Is Established When a System Is in Place That Evidences the Transfer of Interests in the Electronic Chattel Paper to the Secured Party It Was Assigned to, Which Can Be Done Through the Safe-Harbor Provision Under U.C.C. § 9-105(b) ..................... 429

2. Blockchain Technology Satisfies the Safe-Harbor of U.C.C. § 9-105 ..................... 430

3. Blockchain Technology Used with Electronic Chattel Paper Establishes Control Under U.C.C. § 9-105 ................ 435

B. FRAUD WILL NOT BE A WIDESPREAD OCCURRENCE WHICH WOULD PROHIBIT OR INHIBIT THE MANNER IN WHICH BLOCKCHAIN IS USED IN ELECTRONIC CHATTEL PAPER TRANSACTIONS ................................... 436

IV. CONCLUSION ..................................... 438

I. INTRODUCTION

The 2019 novel coronavirus ("COVID-19") not only impacted the health, safety, and security of people across the world, but also forced a technologically-dependent business sector to increase its volume of online transactions. ^[1] With the role internet performs in commerce, reliance is placed on financial institutions which act as third parties and facilitate transactions; such transactions have a possibility of being reversed due to fraud, creating an environment where fraud is viewed as acceptable and unavoidable to some extent. ^[2] A popular form of fraud in cryptocurrencies occurs through the notion of double-spending because digital data can be easily replicated. Double-spending occurs when a person owning a crypto-coin of sorts spends that same coin more than one time. ^[3] Double-spending is a unique roadblock to cryptocurrencies that cash does not face. ^[4] For example, Bitcoin can be equated to a digital file that can be copied and replicated however many times the owner chooses. When this occurs, that same coin can be spent multiple times even if that coin has previously been given to another. Discrepancies are created between spending records and how much of the cryptocurrency is still available due to double-spending. ^[5] The same is true for other forms of digital currency, including electronic chattel paper, which can easily be replicated and the same sold to multiple parties unknowingly. Blockchain was created in an effort to address this double-spending issue with little to no costs associated with its implementation.

Through implementing the concept of irreversible transactions, Blockchain curbs fraudulent activities associated with online commerce and double-spending problems. ^[6] Blockchain addresses these issues through its harmonization of four concepts: (1) encryption, (2) decentralization, (3) distribution, and (4) self-proving characteristics of Blockchain. ^[7] Beyond financial applications, Blockchain is found in numerous areas such as real estate and intellectual property tracking. ^[8] Blockchain is now making its debut in private securities transactions. ^[9] Blockchain usage has made its most recent appearance in a $69 million purchase of artwork that exists only in digital format. ^[10]

This Article addresses the use of Blockchain technology as applied to electronic chattel paper in efforts to reduce third-party custodian involvement. ^[11] First, this Article addresses the evolution of Article 9 of the Uniform Commercial Code ("U.C.C.") which subdivides chattel paper into both tangible chattel paper and electronic chattel paper and adds control as a manner to perfect a security interest in electronic chattel paper. ^[12] Subsequently, this Article discusses the involvement of third-party custodians and their role relative to electronic chattel paper. ^[13] This Article then describes the use of Blockchain and its implementation in Bitcoin, as well as costs associated with Blockchain. ^[14] This Article argues how Blockchain technology will establish control under the U.C.C. creating a perfected first-priority security interest in the electronic chattel paper. ^[15] In conclusion, this Article establishes Blockchain as the preferred method of establishing control per the U.C.C., as compared to the use of third-party custodians. ^[16]

II. BACKGROUND

A. U.C.C. Article 9

1. History and General Application of U.C.C. § 9-105

Article 9 applies to chattel paper in two scenarios: (1) the creation of a security interest in such paper to secure an obligation; and (2) the sale of such paper. ^[17] Tangible chattel paper is considered quasi-negotiable and, prior to 2001, was the only form of chattel paper in existence. ^[18] According to the Uniform Commercial Code ("U.C.C."), chattel paper consists of a record, or records, that show there is both a monetary obligation along with a security interest in specific goods or a lease of specific goods. ^[19] This indicates that, at least in regard to tangible chattel paper, multiple pieces of paper, such as a note accompanied by a security agreement, could make up a single item of chattel paper. ^[20] The first reference to electronic chattel paper appeared in 1998 in a draft of Revised Article 9. ^[21] Compared to chattel paper as traditionally understood, electronic chattel paper differs only slightly in that the U.C.C. states that the record, or records of electronic chattel paper, consist of electronically stored information. ^[22]

There are two ways Article 9 of the U.C.C. provides for perfecting a security interest in tangible chattel paper. ^[23] A security interest in chattel paper can be perfected through either filing a financing statement or by taking physical possession of such paper. ^[24] A possessory security interest in chattel paper, pending satisfaction of U.C.C. conditions, will take priority over a financing statement filed prior to the possession of the chattel paper. ^[25] For instance, this is a classic example: an automobile dealer typically comes into possession of tangible chattel paper as part of the financing for an automobile; the dealer then transfers this perfected security interest in the chattel paper to another, typically the financial institution who approved the loan, for value. ^[26] The purchaser of that chattel paper-defined by U.C.C. § 9-330-who subsequently takes possession of such chattel paper and meets the requisite conditions, would have a security interest that is superior to the rights of secured creditors who filed financing statements prior to the transfer of possession in the chattel paper. ^[27] Because there are often copies of the same chattel paper, to obtain such superior rights the possessor of the chattel paper must be in possession of the chattel paper marked as the original. ^[28]

Revised Article 9, with the addition of electronic chattel paper, is considered an improved version of earlier versions of Article 9 ("Former Article 9"). ^[29] Drafters of Revised Article 9 used forward-looking provisions that considered the future of transactions and their incorporation of modern technology and its evolutions, including how such technology might be applied to the concept of control. ^[30] The concept of control for electronic chattel paper replicates the same ideas underlying perfection by possession for tangible chattel paper. ^[31]

2. Control of Electronic Chattel Paper

In 1998, the National Conference of Commissioners on Uniform State Laws adopted Revised Article 9, which first implemented the notion of control (as opposed to possession) for electronic chattel paper. ^[32] When comparing possession and control, control is to electronic chattel paper what possession is to tangible chattel paper. ^[33] The need for control as a method of perfection over that of possession is evidenced by the fact that possession of electronic chattel paper is neither feasible nor practical. ^[34] The concept of control allows electronic chattel paper to have the same quasi-negotiable characteristics as tangible chattel paper. ^[35] To facilitate a parallel manner of perfection for electronic chattel paper, U.C.C. § 9-105 requires a single...