UK Law Commission Calls for Special Legal Framework for Crypto as Collateral
The Law Commission of England and Wales has recommended a national legal framework tailored to dealing with digital assets that addresses collateral arrangements using crypto to back loans.
The commission, funded by the Ministry of Justice, noted that such collateral arrangements offer “various benefits” such as improving market liquidity and allowing investors to “extract” the value of otherwise “underutilized” assets. However, risks exist for borrowers providing such collateral if the lender they operate with goes bankrupt, in which case they may not have a claim on all of their funds.
“If a collateral taker enters insolvency proceedings, a collateral provider would have only an unsecured claim for the amount constituting surplus proceeds, rather than a proprietary claim to the assets,” wrote the commission in a 304-page report published on Wednesday.
Crypto-backed loans are used to unlock large resources for HODLers who keep much of their value stored in digital assets already. They’re often used as a form of leverage – borrowing against one’s Bitcoin in order to buy more Bitcoin, for example.
There are some major risks, however: if crypto held as collateral by the lender drops below a certain value relative to the loan size, it will liquidate and keep all of the borrower’s funds to remain profitable.
What’s more, borrowers may not be protected if lending firms rehypothecate their collateral and lose it all, like Celsius and BlockFi did last year, before going bankrupt.
While the commission – funded by the United Kingdom’s Ministry of Justice – acknowledged that existing UK law has proven sufficient to accommodate digital assets, it said there remains “residual legal uncertainty” as the market continues to grow and evolve.
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