Uniform Commercial Code and Bitcoin

Miles CowanNew York Attorney Miles Cowan, a partner at Bailey Duquette and CEO of Tillit, discusses Bitcoin and Uniform Commercial Code (UCC).

His experience includes:

  • a private equity fund in connection with the restructuring of one of its portfolio company’s debt structure
  • a private equity fund in acquiring a controlling interest in a privately computer-based certification firm
  • a cloud computing provider in connection with its acquisition by a public company
  • several technology companies in multiple series of debt and equity financings
  • assisting a large insurance company in financing the acquisition and servicing of multiple portfolios of viatical settlements
  • a privately held regional cellular telephone company in the acquisition of multiple cellular telephone markets from a national carrier
  • a private investment fund in obtaining financing to fund loans to individual franchisees of a national franchise


Interview with Miles Cowan on the Uniform Commercial Code (UCC) and Bitcoin

  Trace Mayer:  Okay.  Welcome back to the Bitcoin Knowledge Podcast.  We have an excellent guest today, Miles Cowan.  He is CEO and Founder of Tillit and also partner at, what is it, Bailey Market?

Miles Cowan:  Bailey Duquette.

Trace Mayer:  Bailey Duquette.  Go ahead and give us a little of your background.

Miles Cowan:  So first of all, thanks for having me, Trace.  It’s a nice honor to have been followed up on so quickly after the conference earlier this week in New York Law School, of which I am overwhelmed and that sort of explains the first piece of my story.

I’m an attorney and practiced for a number of years at a firm that eventually ended up being called Dentons.  I joined a firm called Seiden & Schein that then went through a number of acquisitions and mergers and brought on other attorneys and went from 600 attorneys to around 3,000 by the time I left at the beginning of this year.

My focus there was a split between a fair bit of commercial lending and private equity group, doing lot of mergers and acquisitions deals, and lot for private company, securities-related transaction one way or the other.

I also, many years ago, actually before law school, was a professional musician.  And during those days, moonlighted as a programmer and had a little bit of a tech inclination.  And, you know, those forces sort of collided when at the middle of last year I started looking at what’s going on Bitcoin and only seeing it peripherally.

That picked up pace right in the end of last year when I went on a vacation, had some time to read Satoshi's paper.  So it really poked around the Bitcoin top forums and was just completely floored by what's going on.  And it all, sort of, came rushing into me then and I said it’s time for a change.  So I left the big law firm.

Joined Bailey Duquette and simultaneously formed Tillit.  We have been exploring a couple of -- I think they are all loosely related one way or the other.  Some of it derives from smart contract concept whatever that may or may not mean.  I know, there’s lot of definitions about what constitutes smart contracts and particularly what it means to an attorney.

You know, corporate attorneys have a lot of ideas about well, it'd be nice if this contract always be assured to be executed exactly the way it was written.  What would that mean, benefits, and how could we make a reality for the types of the applications that I’ve became familiar with as an attorney.

Smart contract and Decentralized ledger

Trace Mayer:  Adam Back, he’s actually cited in Satoshi's paper and he’s talked about this concept of programmable trust.  And with the way the Bitcoin protocol works, we're going to be able to build out these smart contracts.  Now that’s what you're doing over at Tillit or at least wanting to do?

Miles Cowan:   It is, and it’s funny like I alluded to.  I think the definition of smart contract is somewhat malleable to use a potentially unpopular term in align with bitcoin and as we kick the tires on some use case ideas that sort of what we’re finding.

The concept of programmable trust, I think, was very apt.  The name Tillit actually is a Norwegian word for trust and that it was deliberate because one of the things that I feel and felt strongly since I first started learning about this space is that, what’s actually going on here with the decentralized ledger technology is effectively just the reallocation of trust from parties, you know, traditionally held that trusted role to somewhere else.

You're fundamentally the idea of a decentralized ledger is you don't have to trust that I kept my books right, you just have to trust the miners have done the right job.

Trust didn't go away and I know there’s a lot of strong, and I happen to agree with it, suggestions that because the way the incentives work we should trust the miners.  I think that's probably right.  It’s probably a good idea to just once in a while at least acknowledge that trust is still there.  It's just now somewhere else.

This is particularly interesting in light of the side chains -- just came out this week and it’s actually explicitly acknowledged in there that incentives issues might get a little more complex as the miners participate both with multiple side chain and validation roles.  But in any event, we view that, with this new tool available whether trust was completely away or simply reallocated somewhere else by moving it around we can be revaluate a good number of traditional trust relationships.

Trace Mayer:  And distributing that trust.   Miles Cowan:  That's right.

Trace Mayer:  As supposed to centralizing it, like, with our current system.

Miles Cowan:  Exactly whether it was once centralized and now will be moved to either with periphery or to multiple actors.  I think, it’s going to be worthwhile effort to systematically evaluate existing trust relationships.  Many of them were are to identify.  They're explicit.  I mean, escrow arrangement.  I pay an escrow agent to hold on the money where there are two parties paying escrow agent to hold on my money until some condition occurs, both agree or some period of time lapses or whatever it is.

Trace Mayer:  And that condition could even be determined autonomously through an oracle?

Miles Cowan:  Oh, you’re right.   Trace Mayer:  Like, it cited in the white paper.

Miles Cowan:  If you're using a smart contract, yes.  But before you even get there just like find the trust relationship.  The classic case, I pay a bank to act as an escrow agent and there are some rules about where the money comes out and goes to.

Many trust relationships are implicit and these also can be very significant and show up in lot of places.  One example, relates to something we've looked at the beginning of the year which would come into play putting equities on block chain.  But again, coming from the private company security space, my first thought was well, use already available exemption from the SEC's registration rules.

And you've got people who have regulation, the rules propagated there under which was the common way that private companies stock is sold today.  We're all waiting.  Not for sure, how much longer.  We’ll get crowd funding regulations at the SEC at some point in the future which will have some new exemptions that make it available to sell securities to people, non-public securities.  This is that we can contrast just registering the securities and doing an IPO, listing shares in NASDAQ.

In that context you’re very likely to find a whole bunch of transfer restrictions on the stock, which are very unlike you and I shouldn't have any restrictions from buying and selling Apple stock, right?

Just wake up one day and decide it's time to sell and put an order.  You have people to buy.  There it's done, it's executed.  You got the whole clearing settlement system that also has some potential intact, you know, uses of the smart contract space but, you know, there's no restriction.

Private company stock is frequently, you know, the initial investors were all tied up in various ways with the other rights of first refusal, drag along rights and tag along rights that impose all sorts of restrictions and rules on how the stock can move among us or among new actors.  And they're all enforced by contract, stockholder agreement or shareholder's agreement or something, get on the implicit trust issues that we all have to sort of trust each other not to violate these rules.

Because there’s a cost to police people to make sure they aren't violated and then if you do discover we got to haul them into court and even if you wind up where you ought to be it’s expensive and time assuming, risky and that cost comes out somewhere and it's implicit and the discounted cost to security, there is some danger.

And smart contract capabilities where we put equities on a block chain and it fused within the block chain or whatever ledger you’re using.  These types of restrictions and rules, suddenly risk of violation is gone.  You know there's an example, again, the trust that I had to put stockholders are reallocated perhaps to the miner or whatever system it is that’s --

Trace Mayer:  It’s verifying.

Miles Cowan:  That’s right.

Trace Mayer:  That’s coming up with the distributed consensus of block chain.

Miles Cowan:  Exactly.  I have to trust.  They validate the rules correctly as I read, but for reasons we mentioned earlier, I think that’s pretty safe to do at least in the first instance and by doing it we should make the whole system more and more efficient.  I know, that people were trying to bring to light completely public markets with equities on the block chains that we may get there.  I think the regulatory hurdles are --

Trace Mayer:   Yeah, that’s a big mess.

Miles Cowan:  People they have issues with money transmitter license, but those paled by comparison.

Trace Mayer:  To the security issues?

Miles Cowan:  Yeah.

Trace Mayer:  I mean, you’ve got both state and federal law. You got all types of --

Miles Cowan:  Yeah.

Trace Mayer:  I think a lot of people very much underestimate both the civil and criminal implications of all state and federal securities laws and they're very broad like under the Howey test.   Miles Cowan:  Oh, absolutely.  Howey test which answers the question, what is a security, was broad that comes out of the Supreme Court.

Trace Mayer:  And then the other Supreme Court decision that the 33 Securities Act that substituted caveat emptor for full and complete disclosure.

Miles Cowan:  Correct.

Trace Mayer:  So I mean between Howey and no longer having caveat emptor, I mean this puts a lot of burden on these "issuers of securities."

Miles Cowan:  This is something that cannot be overstated in this space.  I know, it’s extremely exciting time and it should be.  The ability to create these markets and issue these -- they might be secured and I know people are trying not to issue securities, but as we've alluded to things with Howey tests are broad like intent and it’s a very easy hole to step in if you are not careful.

That said, the promise of this is large, you know.  I’m glad that people are pushing the envelope there.  I guess my first biggest feeling about it is that the tech probably isn’t the hard part, and building a platform that enables this to happen, a company or somebody issues a token that eventually ends up being the security, whether intentionally or just because that's everyone use it, and if it were to be traded it's not that earth shattering, which sort of goes to another part of what I've been trying to do internally with Tillit is I look at the space which is ask the question just because this is possible to do on a decentralized ledger, is it something that really make sense to do.  And I don't think the answer will always be yes.

UCC and bitcoin

Trace Mayer:  Now, you mentioned there the tech might be the easy part of all this, but we were having a discussion about the UCC and like lien attachments before the interview.  I think that might actually be a very difficult problem to solve from the tech standpoint.  Can you perhaps go into a little bit of the background about UCC and we're talking about this chain of title on bitcoins?

But one is like whether somebody can even own a bitcoin and what the bitcoin is.  Because, I mean, it’s governed under the MIT license and everybody's got a copy of the block chain so you could assert that everybody owns all the bitcoins.  And there's no way to really prove that you don't have a private key which is another potential problem under the 521 Contempt Power with bankruptcy.

So perhaps you can go over a little bit about the UCC, how that applies with attachment assets, securities, how we're tracing our bundle of rights when we log into our e-trade or interactive broker's accounts and says we have a 100 shares of Apple?  What do we really own and how do we figure that out?  Can you perhaps give a little, like, flesh out that skeleton a little bit for us?

Miles Cowan:  So I'll do my best.  It actually is that that covers a rather wide numbers of discrete rules and sources of the rules, different acts of laws.  I guess we can start with the first instance with just bitcoin itself.  You ask the question if it's possible to own a bitcoin.  The MIT license covers a source code.  The fact that we have really by convention agree to treat the entries on this ledger as bitcoin and use them as currency.

If you sort of back up from that, all it is, is just the result of some math.  You know, it's deterministic and we can prove that satisfy all sort of conditions, but it's only when you and decide that the result of that proof is going to be called bitcoin and used as currency that it actually becomes a bitcoin.

Trace Mayer:  Which would be subjective value theory.  It only has value because we as individuals are actually valuing it as such.

Miles Cowan:  Precisely.  I mean, you can support it with arguments as well because it's scares and it has --

Trace Mayer:  Well, that might be why we decide the value.

Miles Cowan:  Exactly.

Trace Mayer:  But it’s not like anything has intrinsic value even gold or weed.  I mean, we as individuals have to value it.

Miles Cowan:  So the question of whether you can own a thing.  The MIT license I don't think you could argue says that it's own collectively by anyone who's ever - everyone, anyone who ever downloads the code.  I'm not sure.

Another view on that is like imagine that you've got some bitcoin deposited in an exchange and the exchange fails, you show up.  I don't think you would for a second feel that you're doing something weird if you asserted a claim of bankruptcy as a creditor.  You would feel fully that you own that.

Trace Mayer:  And we got other theories like unjust enrichment or detrimental reliance.

Miles Cowan:  Sure. All these would still turn on the question that you own in the first instance, right?  Like are you unjustly enriched because, you know, you ended up with his asset that I believe that I own you know, whatever that may mean.  I think that's one of the easier questions here is that someone owns and I know people try to say well, I only control the address, you know.

Trace Mayer:  Or, I hold the bitcoins.

Miles Cowan:  Yeah.

Trace Mayer:  Like the BitLicense even uses phrases like hold.

Miles Cowan:  I think that the terminology hold is not challenging to, you know, the legal system today.  That, you know, there is plenty of abstract definition or you know, implications of holding.  Most things we own, we don't hold physically and pick up or could we?

Trace Mayer:  But we're usually able to prove that we don't hold it.

Miles Cowan:  Not so much.  We rely on someone else to tell us.  Like how can I prove that I don't own a share of Apple stock?

Trace Mayer:  Well, the share of the Apple stock would be titled in your name or it would be in your e-trade account that's with your name or things like that.

Miles Cowan:  You eventually will be able to trace somewhere.

Trace Mayer:  Like for example, Mr. Myles Cowan, he has on good authority 100,000 bitcoins.  You cannot prove that you don't have those 100,000 bitcoins.

Miles Cowan:  This is true.  I'll give you that.  And, you know, I guess you're getting the point where your concern is easier for someone to sort of make a false accusation and I'm sort of stuck on the back.

Trace Mayer:  Well, I mean.

Miles Cowan:  I guess it's slightly hold.

Trace Mayer:  Well, I mean, there is that, but I guess it gets to a different and maybe it's just the completely disruptive nature of bitcoin that the private keys to that asset or the wealth are literally controlled by an individual as opposed to controlled under a governmental legal regime.  Because the title to the table is controlled under our property right's legal scheme, whereas the bitcoin network doesn't care what the law might say.

You either are able to solve the math problem or you can't to move those bitcoins.  If a judge were to issue an order and it said that these bitcoins have to move from address A to address B.  Well, if he doesn't have the private key and whoever does have the private key is not cooperative, those bitcoins aren't going to move.

Miles Cowan:  Fair enough.  I think I can draw some maybe not really promising or helpful analogy, but from bearer instruments of all sorts.  It’s always impossible to prove that you don't hold their instrument.

Trace Mayer:  Right.  Like a gold coin or a bearer treasury loan or something.

Miles Cowan:  Yeah.  To the extent that there is threats of contempt or what not, I mean this aren't new problems.  Maybe the magnitude is more dangerous here because you can argue that it's got huge pile of bitcoins.  Currently it's some address that we say we own.  I don't know.  I don't have a good answer to that.  My suspicion is those sorts of problem are likely to be few and far in between.

Trace Mayer:  And they'll probably be easily folded in under our very flexible common law.

Miles Cowan:  Yeah.  Well, I think we will do just look at when did this come up before, how often is it someone going to order to transfer ownership of some bearer instrument or asset.  I said I don't have it and someone's going to say they did.  You know, I think those are corner cases which are just not likely to come up very often.

Trace Mayer:  But it could strike at constitutional issues.  We've got 5th Amendment Right against self-incrimination.  For the most part in criminal procedure with the key disclosure cases, I mean, you don't have to disclose you're private keys.  Yet in England, for example, you can go to jail if you don't disclose a private key for inscription.  And in this case like disclosing the private key is I mean, it amounts to a seizure and then we've got civil forfeiture.

Miles Cowan:  Of course.

Trace Mayer:  So I mean, we might say they're corner issues, but it also strikes at the root of some of these elemental principles of due process, warrants, reasonable searches and seizures.  All of these matters.  And then particularly applying it, it looked like we zoom out but, you know, zooming back in like applying it to this chain of law that attaches to securities and UCC and like how that's important for lubricating the gears of commerce.

Miles Cowan:  Well, I think it is related and this is something that we looked at, thought about a lot and leaving aside the possible issues.  Well, you own it and you're saying you don't.  More significantly is trying to prevent I'm not quite sure you want to describe it as a black box of bitcoin disappears and no one can actually --.

Trace Mayer:  Like Mt. Gox?

Miles Cowan:  Yeah, for example.  Although I think -- no, Mt. Gox.  Most people would claim that is mine.  Nobody is ready to disclaim or pretend that it's not theirs.

Trace Mayer:  Well, yeah.  But there is no way for Mr. Karpeles to prove that he was either hacked or he stole the bitcoins himself or absconded with them.

Miles Cowan:  Fair enough.

Trace Mayer:  We lost them, I mean.

Miles Cowan:  Fair enough.  But at some level that may not matter much.  Really, at the end of the day he's trying to make the creditors hold at least pro rata hold [unintelligible] assets left.  The UCC, to get back on that topic, is an important issue here and the basic idea and this comes in to a couple of context.  If you're just to take any asset it could be a bitcoin before you even get into specifics.  If you we're to borrow money from a bank, one from your company, small business line or in any other types of financings frequently gave a lien on your assets.  It's not uncommon.  There's a lien on all of your assets.  There blanket all asset lien.  It is quite customary as many forms of financing.

Trace Mayer:  Yeah.  Personal guarantee.

Miles Cowan:  Yeah.  It goes above and beyond on the assets.  Now, you're personally liable even if you're separated, should be separated as a stockholder, but the consequence for that are basically you're the default on a loan.  Actually, more significantly just a default on a loan, but if you were to declare bankruptcy you become insolvent. So only does your loan not get paid back, none of your creditors get paid back.

And there's a fight for your assets in the bankruptcy.  A properly perfected lien holder and perfection is another related issued to granting a lien.  You need both of these thing together to prevail in the system.  If you're a senior, secure and perfected lien holder in the bankruptcy, you will prevail over, you know, who gets the assets.  Technically you prevail over the bankruptcy trustee.  Because trustee is supposed to get control of the assets to use it to distribute to creditors.  You actually sort of prime them.

There's a few exceptions and it's a little bit complicated, but the basic goal is that I lend you money, you gave me lien on your assets.  Everything went wrong.  You are now in bankruptcy.  I at least get the assets that you have.  Now, if it happens to be enough that I'm fully repaid on my loan and there's something left over then it goes to the other frequently called unsecured creditors.

Now, the rules for the way these liens are created or attached is the word and then eventually perfected have a number of variations that depend directly on what the collateral is under the UCC there's several categories of collateral descriptions.  Some of them are very specific and weird like commercial tort claims to more easily identifiable things like equipments, accounts which simply means that accounts are seizeable deposit accounts. Your money on deposit with the bank as another example.

We have a couple of close to catch-all type categories where it gets interesting.  General intangible is a sort of a large category to captures a lot of things.  There's also a definitions of money under the UCC.  Going back to the example, you're holding some bitcoin, you're holding some other assets as well and you've given me as a lender an all-asset lien attached to all of your assets, including the bitcoins and I perfect correctly and perfection, again, depends on the types of collateral you have.

Some collateral you need to take possession of, some you have assert control over.  Control is a very defined concept.  Some, perhaps majority, if I imperfect my filings of financing statement in a public record and the goal is that future creditors, people who do business with you can protect themselves by searching in the right place if they search the financing records, statement records to see if there is a lien reported or if it's other types of collateral certificate of securities, for example, and they ask to see it and you can't show it to them, they're now on notice that maybe someone else has an interest I, me as your lender.

So what happens is I create the lien. I properly perfect.  And now you spend your bitcoin one way or the other.  You sent them to someone in payment for something, you traded for something, whatever it is, they are now out of your control and in someone else's control.  Let's just say held for ignoring the potential issue of the term.  But now, say, you do go bankrupt today after you transferred this bitcoin.  And I, as a lender, am sort of savvy, have some good guys in my legal team, technology types people who understand the block chain.  Let's also assume that you haven't gone through sort of any deliberate effort to --

Trace Mayer:  Fraudulent convey.

Miles Cowan:  Well, not that.  Things like coin joiner.  It's in mixing service or other wise --

Trace Mayer:  Okay.  So I can.

Miles Cowan:  Obstructed the record.

Trace Mayer:  So, you're able to track the bitcoins.

Miles Cowan:  Let assumes that it's been very clean thing.  You held a pile of bitcoin today and then you send it to Party B over here and now you're bankrupt.  I'm able to trace it down to him.

Under the current rules, I would almost assuredly have valid claim of the bitcoin in the transfer of his hands and if I can find out who they are and identify who is on the other side of [unintelligible] the block chain, subpoena them and they would be force to turn those coin over back into the bankruptcy estate and they would then be turned over to me as a secured lender.

Trace Mayer:  So why are they going to have to turn these bitcoins back into the bankruptcy estate?

Miles Cowan:  Because the rules are, and there's some exception, we'll talk about quickly, but generally the lien follows the asset. Unless I as a secured lender authorized its transfer free of the lien.  This happens all the time.  Company sell assets and say, yeah, you got to a lien on my assets.  I'm selling some and they go to their lender and asked I need you to get me explicit release of this lien.  And the buyer will demand it.  The buyer will want to protect themselves by searching in advance and discover the lien.  Then says okay, I'll buy them but you get the lien off of it first.  So that the lender probably the borrower is going to have to pay down some portion of the loan or otherwise make the lender comfortable for releasing this collateral that remember it's the lender's collateral.

So, makes sense.  The borrower should not be able to unilaterally divest the lender of his interest.  Otherwise what's the use of that collateral.

Trace Mayer:  Yeah.  I mean, otherwise the lender's going to require a lot more capital or a lot higher interest rate or whatever.

Miles Cowan:  Correct.  Now because that's sort of what people expect in the lender-borrower relationship.  The UCC was drafted to accommodate that and deal with those rules.  So if you didn't ask my permission as a lender when you send those bitcoins, the lien didn't come off of them and they stayed on.  It stayed attached.  Your transferee could have protected themselves by searching the financial statement records and discovered this lien.

Which again is what happens today, but it's not customary when people are trading money, for example.  Let's just say that you take change back from a merchant, you know, small stores.

Trace Mayer:  From the hotdog stand, I mean.  Should that change be encumbered?

Miles Cowan:  And the answer is you wouldn't expect it to be and it's much too burdensome for you to be searching financial statement records, so to accommodate this sort of economic reality that UCC has specific rules to restrict liens from money as defined in the UCC for precisely that reason.  Because taking the money as change, it doesn't make any sense to have you trying to search or otherwise protect yourself from that sale.  Provided that you and the hotdog guy you're acting in collusion to try to defraud me as the lender, you take that money, the change free of the lien.  And this is codified in explicit in UCC.  But bitcoin under almost any, you know, that way we do definition will not be money.  And as a consequence these liens certain rules are inapplicable.

Trace Mayer:  And is that largely because money usually refers to legal tender?

Miles Cowan:  If you just open up.  I should have actually brought one here.  If you open up the UCC and read the definition of money it's, to paraphrase, basically the exchange on account that's in the term of authorized or adopted by a government.  I'm forgetting the terms exactly.

But one interesting potential thing that I actually wrote about on our blog a little while ago was Isle of Man having put out this RFP to say, hey, guys you can cross this bitcoin payments for us to pay taxes.  In which case you might be able to argue the Isle of Man by having excepted bitcoin as tax payment shoehorned it in under the definition of money to do business.

Trace Mayer:  Or Judge Mazzant in the Trendon Shavers case.  Federal Judge saying it was money and --.

Miles Cowan:  Yeah.  But that's not a government accepting.  That's very different.

Trace Mayer:  Yeah.  Well, and then we've also got the Albert Case.  Where the --

Miles Cowan:  Same thing.

Trace Mayer:  Where the judge held --

Miles Cowan:  Just because they define as money for the purposes of the statue, right because sort of, does mean the government is accepting it as payment for its own obligations or liabilities.  So, I don't think either one of those gets you very far down.  Again, I wish I had brought it for me but it's easy to look up in UCC.

I don't want this like some [unintelligible] very scary thing.  What it does is creates a certain amount of legal uncertainty.  As a practical, matter we made a couple of assumption in this example, right.  That there's no conjoin, no mixing, no whatever.  It was one transfer.  It was all in one block.  It is very easy to identify. There is some very serious practical --

Trace Mayer:  It makes it a lot easier and hypothetical to actual trace down the bitcoins than force it.

Miles Cowan:  And in real life it could be very difficult to do this.  But, you know, and not to be pedantic and wear the lawyer hat too much, but it should be a problem to people and particularly when you start talking about large institutional financial actors.

Trace Mayer:  Like, an ETF.  This should be a risk factor.

Miles Cowan:  Should be.  My opinion would be disclose it as a risk factor.  It boils down to this. If I have some bitcoin right now in my wallet or whatever I can't say unequivocally that it's not liened up in someone else's favor.  I don't have the ability to make that statement.

Trace Mayer:  Now could regulated exchanges or larger institutional money that's coming in, could they perhaps have some types of indemnity agreements that help clear ups some of this uncertainty on title?

Miles Cowan:  I guess, who is the indemnity for?  Favor whom?

Trace Mayer:  So I think itBit, for example, they want to make it so that you're basically like buying virgin coin.  Kind of, like mine coins.  They was them to be clien.  They want to know that there are no ALM/KYC issues with them.  Let's say that they wanted to go to another level and provide an indemnity agreement on coins that are sold on their exchange.  Then that could be perhaps a potential business model for someone in the space.

Miles Cowan:  It is a form of insurance one way or the other.  Mine coins are very good example.  Those being virgin coins perhaps only one's that you can completely make an unqualified assertion that these --.

Trace Mayer:  They're coming from a miner.

Miles Cowan:  Right.  Provided that miners don't attach the lien themselves.

Trace Mayer:  Or that there wasn't a lien on the mining equipment.

Miles Cowan:  Well, correct.  And this is actually interesting because if there was a lien that would be the equivalent of them attaching a lien, because liens also apply to 'proceeds of collateral.'  It is a very interesting question if mining equipment, if the coins that are mined by liened up mining equipment constitute proceeds of the lien collateral then there would be lien attached to them as well.

But again you could at least know it, right.  They can know either, yes, they have a lien in or no, they don't.  Once it's now filtered through many steps it becomes very difficult to say I never knew who was holding it and again overtime these get fragmented into de minimis pieces.

Trace Mayer:  De minimis amounts.

Miles Cowan:  And for practical reasons, it's not a huge issue.  Now, let's shift gears very quickly.  So this is bitcoin, you got a number of related types of assets.  Many of them pure, non-counterparty and I mean that in a legal sense not to project counterparty.  There is no counterparty to a bitcoin.  It exists as a consequence of the math.

Trace Mayer:  Yeah, we're discussing earlier, it's equity based.  Like gold as opposed to debt based.

Miles Cowan:  Yeah.  Right, I mean, it's not an IOU, right?  Or it's not representive of anything, it just is.  And there's many of these cryptocurrencies satisfy that definition.  And XRP on Ripple and all these other alt coins, whatever.  There's no one on either side, they just are.  But there are many types of assets which aren't counterparty assets and again, this sort of has a double meaning in the light of counterparty project as well as just legal sense.  There's someone standing behind this thing.

There's some potentially and this a lot of what we been looking at Tillit, very interesting ways to handle these assets under the UCC.  And there's a definition of security under the UCC that is broader than the SEC definitions of security.  This makes it a little bit scary and confusing sometimes, but it is conceivable, at least, that certain of these IOU type assets.

Basically, you know, take a Ripple IOU for example. [Unintelligible] issue a balance on the ledger.  That ledger balance to potentially be treated as a security under the UCC not when it's SEC-type security.  And there are a whole different set of rules about how liens attached, gets stripped from securities in place suddenly.  One of the more significant ones relates to what's called the protected purchaser provision for securities.

Similar to the way money works.  But as you're not trying to defraud and secure -- don't have notice of an adverse claim has called you as a transferee of the security take it free of any other interests.  This is basically why you don't have to worry when you buy a share of Apple stock on the open market that a lien follows it.

Trace Mayer:  Yeah, that the broker-dealer might be a malefactor or something.

Miles Cowan:  Right.  Or with even someone further up the chain, at the other side of your trade.  And again it's to accommodate just the reality otherwise the market wouldn't have functioned.

Trace Mayer:  Well, we would just have too many pieces of gravel.

Miles Cowan:  Yeah.

Trace Mayer:  Inside of it.  And they would just grind to a halt.

Miles Cowan:  So because of that it's possible, you know in a way to move this counterparty assets one way or the other, whether the Ripples balances on things with just equity, you know, potential equities recorded on ledgers or debt instruments.  Counterparty IOU-type assets, if you treat them correctly and sometimes it actually is going to require the terms of the way they're issued because you can opt in to this treatment under Article 8 of the UCC.

But again it's an explicit opt-in prevision in certain circumstances and everyone who is involved has to agree to treat in this way.  Provided you do, you have some potentially more favorable set of existing legal rules to allow these things to be transferred and used.  You know, it covers more widely without this overhang of concern about liens following the stuff around.

Another related piece to that, very much what we're looking into at Tillit is now, let's assume that you do want to put liens on these assets.  Because you want to use them the way other assets were used today.  People pledge their assets in support of loans for various reasons. Assets move into and through structured finance product where you have very significant concerns about where titles is, what security interests are and concepts of bankruptcy remoteness and all this.

They'll turn, at the end of the day, on what these things are with the UCC and how they'll behave legally.  Almost always the big concern is how do these things behave in a bankruptcy.  That's the sort of the end scenario everybody wants to avoid.  They want certainty or if something went wrong, someone fail, some actor in the structure is now in bankruptcy, who did these assets belong to when the dust settles?

Trace Mayer:  And you have to be able to unilaterally bring those assets back.

Miles Cowan:  Well, if that's the deal, right.

Trace Mayer:  Right.

Miles Cowan:  Right, in this structure.  You either bring them back or not bring them back.  Very frequently what you're looking for in many structured finance product is assurance that assets won't be clawed back.

Trace Mayer:  Right.  That they aren't liens against, but like in some cases you want to unilaterally bring those assets back.

Miles Cowan:  Yep.

Trace Mayer:  But in bitcoin's case you're going to actually have to have the private key to bring those back, right?

Miles Cowan:  And this is where from again to the lawyers ears in terms of smart contract, these started implicating some of these type of considerations.  And many assets under the UCC require concepts of control in order to properly perfect in the liens.  And remember, perfection is a necessary component to prevailing the bankruptcy.  Just have a lien that have a perfected lien.  And control, depending on the type of collateral involved sometimes means things unsurprisedly control agreements or account control agreements.

And usually, you have to enter the three party contract, lender, borrower and the bank where a deposit account is held, for example.  And these concepts look very strange when you're talking about decentralized ledger, because these assets aren't held anywhere except as ledger entries.  The ledger isn't going to show up with a pen and sign a contract.  So we got to program the rules, shifting control agreements that are required in UCC and to be a perfected creditor.

The only party around the contract is the block chain itself.  And this would have been distraction but at the end of the day when you program in the same rules into the code, smart contract style.  And is a related number of use cases here that we are look into.  Gold have been able to provide assurance to how these assets would behave and how they would move through admittedly what are existing products and structures, whether it's lending or structured finance products, whatever they maybe, I want to start from there.

Now, at the same time, of course, this new technology potentially enables all sorts of new products that haven't been envisioned yet because it's possible to manipulate these assets in ways that weren't possible before.  But at least today, I think we could draw from what the finance world knows it works and we could argue a fair bit about whether it works and whether it's a good idea.  But to the extent that these products exist and are utilized today, if we can figure out how to take out this uncertainty that's related to title, liens, type of issues, potentially we could start seeing these technologies expand into broader uses in the current economic system and credit markets in particular.

Trace Mayer:  And another thing we're able to do is with this programmable trust, we're able to almost with laser-like precision cut out the different rights or obligations, to ownership.  Because that's another problem we've got with our current system is we don't necessarily know who owns what, where it's held, how it's encumbered.

I mean, you could say hypothecation nation, we've got a run on the good collateral.  Everybody wants to know that they've got the asset themselves.  The whole $700-billion bailouts was all about people running out of particular assets so quickly.

So how can bitcoin be a solution to some of these problems that we've got in our current financial and monetary system in our credit and lending markets?  That's a huge question I know but --

Miles Cowan:  It is.

Trace Mayer:  But you're working on solutions is what we're getting at.   Miles Cowan:  Yes, in some ways.  One of the, I guess, my first observations with this, it might actually sound like a little bit of a naysayer here but is that it goes to what I said before, just because you can't decentralized something doesn't mean you shouldn't.  Not because of that idea, but what do you really gain from doing it?  And many of the examples we're just talking about were concerns during the bailout or [unintelligible] when Lehman failed and there was just a massive panic about who was exposed and where.   Trace Mayer:  Trillion-dollar bankruptcy.   Miles Cowan:  Right.  A lot of the problems weren't because we didn't have tools to identify who was holding what; it was just that they won't required to use the tools.  As a consequence a lot of [unintelligible] now with mandatory clearing concepts, where directly step from the concern that we can't have all this unknown liability, who owes what, where in this huge complex web of chains of obligations.

Trace Mayer:  Yeah.  Warren Buffett calls it a daisy-chain.   Miles Cowan:  Yeah.

Trace Mayer:  Financial weapons of mass destruction.   Miles Cowan:  Yeah, absolutely.  But that didn't happen because there was no way to record it.  Just because there was no requirement that it be recorded it all.  This wasn't a consequence of a ledger that failed, or that was manipulated. Just these things weren't recorded on a ledger.  So something like bitcoin or any other decentralized ledger being available doesn't immediately have anything to do with that until some other rule or law comes into play requiring the use of the ledger.

So by itself, in isolation, bitcoin can't affect this. But what we have though is an environment where whole experience is fresh in a lot of people's minds and if bitcoin uses these ledgers generally can be advocated in advance that once can basically help reconcile the ownership to these things, once people were forced to put them on ledgers one way or the other.  That's when it does get extremely powerful.

We'll need the regulators so we go hand-in-hand because right now quite frankly, there's been a couple of years where the mandatory clearing requirements were now on Fed.  They were all being forced on this swap execution facilities or other places bitcoin has not addressed any of those now required recording regimes yet.  We would have to disrupt what spread since the financial meltdown to take the place and help address admittedly very real problems.

But there's now already quasi solutions with some of those problems.  And so the question is, what bitcoin and other ledger technology, what it's capable of doing now, is it better or enough, is it going to improve on what's already in place.  It's very recent some of these clearing processes.

I don't know the answer to that.  I think you an articulate a case where actually it should better, right, if you really have one common ledger where all of this is happening, the audibility that entails, transparency and what-not.  You can certainly imagine how this is superior to almost any another approach.

But it's going to require so many simultaneous moving parts and I'll go back to what I said before, the tech isn't going to be the hard part here.

We'll make the ledger available, we'll make the tools and particularly some of the things, like, the two-way [unintelligible] side chains are becoming very interesting potential tools in this model where it's possible to lock up assets and have other representations of them being manipulated in different waves.

And you can easily imagine assembling very elegant solutions here.  But it's very early in that respect.  I don't even think the example and use cases for many of these technologies are still rather small in scope.  Sometimes, a little bit like science experiments and what-not but they are very important predecessors to the more complex and nuanced system that it could be for, again, maybe I sound a little bit like a  naysayer, I don't want to do that because, you know what, I quit my job to start a crypto currency start-up.

I clearly believe there is enormous potential here.  But to tackle the really, really big problems that are frequently advocated or advanced as potential uses for this is a long process and probably going to be incremental.  That's the question speaking of which increments first.  What piece to write and chew how to solve that make it better, make it faster, make it safer, whatever you're doing, which point is easier to plugin other actors because the financial system for better or for worse is just extremely complex.  It's getting very hard to just turn off one model and turn on another one overnight.

Trace Mayer:  Well, not to have this go too long.  I think we're about over time but we have the Gutenberg Press.  It took 150 years before we got the scientific journal.  They made romance novels, like 10 years after the Gutenberg Press.  So we see where humanity's priorities are as we journey from the swamps to the stars.

Mark Andreasen, one of the central core figures in Silicon Valley.  It's the personal computer, the internet and bitcoin.  Ike you said, we're just at the very beginning of applying financial cryptography to build out solutions to the problems that we have in our current worldwide monetary and financial systems.

And you're right there at the center of it.  CEO, co-founder of Tillit, partner at Bailey Duquette.  How do people listening to the podcast find you?

Miles Cowan:  So, well, part of this may depend on how you post the podcast and if there is any links in the bottom.  But --

Trace Mayer:  Oh, yeah.  We'll include those for sure.

Miles Cowan:  Right now, I'm at [email protected] and [email protected] are the two most direct ways and depends on what you want to talk [unintelligible] applications, or you got a law problem in space.  But, either way is a good way to reach me.  Be happy to hear from you.

Trace Mayer:  Okay, sounds good.  Thanks for being on the podcast.   Miles Cowan:  Absolutely.  Thanks a lot for having me.

Written by Miles Cowan on November 27, 2014.