On March 31, Idaho Governor Brad Little signed HB 583, the Digital Asset Act. The bill amends Title 28 of the Idaho Code, which governs commercial transactions generally, to include a new chapter dedicated to regulation of digital assets. The bill goes into effect on July 1. Idaho’s bill is multifaceted:
(1) It distinguishes digital securities and virtual currencies, the latter of which do not constitute securities under Idaho law;
(2) It defines “control,” or custody of digital assets, to encompass automated transactions facilitated by “smart contracts” and circumstances where a party has possession of the cryptographic private key associated with a particular digital asset; and
(3) It incentivizes a secured party to perfect its security interest in digital assets by control instead of through filing a financing statement.
Money Principles and Idaho’s Definition of Virtual Currency. Historically, money has possessed three functional qualities: It has served as a medium of exchange, a store of value, and a unit of account.
The first of those qualities is widely considered to be the most important determinant of whether an asset constitutes money. If in exchange for provision of goods or services, many merchants begin to accept virtual currency as a form of payment, such currency may eventually operate in practice like the paper money and coins we use today. Although the bill categorizes both digital securities and virtual currencies as digital assets (specifically, intangible personal property), it notably describes virtual currencies as digital assets that are used as either a medium of exchange, a unit of account, or a store of value.
Critically, the bill expressly excludes virtual currencies from the reach of Idaho’s Uniform Securities Act, which regulates the sale and purchase of securities. The bill’s definition of virtual currencies arguably could fence in several existing cryptocurrencies, including but not limited to stablecoins and bitcoin, which act as mediums of exchange and a store of value respectively.
Secured Transactions, Smart Contracts, and Cryptography. Traces of Idaho’s intent to subject digital assets to its existing commercial law is widespread throughout the bill. For example, the bill notes Idaho law relating to perfection and priority of security interests apply to digital assets. Nevertheless, due to the intangibility of digital assets, the bill exempts digital asset priority disputes from Idaho’s “first-to-file” rule (the functional equivalent of Section 322(d) of Article 9 of the UCC), which usually would grant a creditor a first-position lien in a borrower’s collateral upon the filing of a financing statement.
Under the bill, a secured party that has “control” over a digital asset subject to a security interest has priority over a secured party who does not. The bill defines “control” as the “ability to exclude others from the use of [digital assets]” by means of a “private key.” As we previously explained here, digital asset transactions are facilitated through public key cryptography, and only the party in possession of the private key that corresponds to the public key associated with the digital wallet at issue can truly exercise control over digital assets linked to the digital wallet. On the other hand, the bill asserts that a secured party may also exert “control” over a digital asset by utilizing a “smart contract,” which is a self-executing line of computer code that automates finality of a transaction when certain predetermined conditions are met.
For example, Secured Party 1 lends money to Borrower A, and in exchange, Borrower A agrees to transfer a digital asset as collateral to Secured Party 1. Next, Secured Party 1 and Borrower A agree to certain terms: “When Borrower A repays to Secured Party 1 the full value of the loan plus interest, Secured Party 1 must transfer ownership of the collateral back to Borrower A.” These terms may be written into a smart contract, and once the code is deployed on blockchain, it usually cannot be modified. Therefore, if Borrower A repays the full value of the loan plus interest, the smart contract will automatically place the collateral back in her possession. Smart contracts are traceable and verifiable on blockchain and effectuate agreements to be carried out among anonymous parties without the need for an enforcement intermediary (i.e., escrow agent).
Our Take. Like Wyoming’s recent legislation, Idaho’s digital asset legislation distinguishes a virtual currency from a digital security. Although this approach conflicts with the SEC’s (current) perception of digital assets generally, until the SEC is provided with definitive guidance about how the agency should regulate digital assets, under the Howey test or otherwise, state legislators may continue to take matters into their own hands in an attempt to provide their constituents with clarification concerning how their digital assets will be viewed in the eyes of the law.