How legally protected are you against NFT collateral as loans?

Jamal Molla
Written By Jamal Molla
I write about cryptocurrency, with a special interest in NFT and metaverse in particular.

Notwithstanding anyone’s perspective, it is hard not to have heard about the widespread popularity of non-fungible tokens (NFT). Despite current slowdowns within the industry, the entire NFT sales are projected to reach $90 billion before 2022. Previously, in 2021, its total volume was $40 billion, with everything moving gradually to reach a higher volume.

Leveraging on its previous success, there seems to be a different focus on NFTs. The attention from these newcomers is shaking the industry, also known as lenders. Remarkably, we’ve seen the introduction of a new term or label coined within the industry – NFT collateral.

Borrowers and lenders have similar goals, whether they are involved in a house loan, an NFT-secured loan, or multimillion-dollar leveraged funding of a business. The lender is compelled to lend the borrower short-term cash by taxing interest on the capital. Since they don’t need to offer the asset, the borrower is prepared to pay such an interest rate since they require an instant supply of liquid dollars.

In a used automobile market, the lender takes possession of the car if the borrower fails to fulfill their part. How the lender is safeguarded from a borrower’s non-payment of the loan, or “default,” differs depending on the asset.

According to Article 9 of the Uniform Commercial Code (UCC), lenders have the essential assurance that this automobile ownership transfer will occur with or without the assistance of the defaulting borrower because of the secured lending laws.

So, what are the guaranteed lending regulations that apply to NFTs?

While using an NFT as collateral is theoretically unpretentious and even in smart contract execution, the constitutional protections of using an NFT as assets is a complex question of “perfection” of the lender’s security interest.

An NFT differs from an automobile and doesn’t represent an “art” under existing UCC regulations. It is most likely a “generic intangible,” which is the UCC’s overflow bucket for difficult-to-categorize collateral, or an “investment property,” which is a word that encompasses securities.

Consequently, tagging NFT as an investment property might be suitable for cryptocurrency borrowers and lenders. For an investment property, control is what perfects the security interest. Therefore, you only have to take ownership under these conditions.

  • The NFT is sent to the lender’s wallet, notwithstanding how awkward the situation might be.
  • The NFT is handed over to a third party with an agreement signed between all parties (lender, borrower, and the third party.)

The borrower provides a lender a security interest in the NFT under this threefold agreement, but the NFT is held in a particular account (or wallet) with the third party. That third party, in turn, promises to exclusively execute the lender’s instructions, granting the lender “ownership” of the NFT and finalizing their security interest.

What more?

There is every probability that, like in different marketplaces, there won’t be any drive for more stringent legal regulations unless there is an issue worth dealing with. Crypto and bonded lending lawyers must be prepared to use the UCC laws when confronted with such a situation.

Leave a Comment