By Keith Barnett
Companies can use blockchain technology to execute contracts, make and accept payments, and help confirm a chain of title when title is challenged by debtors in litigation. Blockchain technology can also be used to help debt management companies when they receive subpoenas from the federal and state regulators related to investigations and enforcement actions. Simply put, blockchain has the potential to be both the present and future of the debt management industry, as this technology will make companies that purchase, or support the purchase, of receivables on the secondary credit market more efficient, save money, and increase profitability.
The most easily achievable application of blockchain in the debt management market is the ability to establish clear chains of ownership when buying and selling portfolios of debt, in addition to tracking the value of a particular portfolio for any subsequent sales. As the blockchain can be used to establish secure virtual audit trails and protect records, buyers of debt portfolios can be protected from accounts being sold to multiple buyers, or from having a less valuable portfolio than initially thought; this effectively increases peace of mind and lowers transaction costs. How? Although blockchain was initially created to serve as a public ledger for cryptocurrency transactions, namely bitcoin, the scope of blockchain technology goes well beyond cryptocurrency and provides a sense of security for the debt management industry described above.
Boiling the concept down past the technological jargon and buzzwords, each block of the chain is “mined” by confirming that a set of transactions have occurred. This allows the creation of unique digital items, tagged to a specific user, with the creation of the transfer and its competition confirmed by a purely unbiased set of users known as “miners.” These miners run complex hash equations and puzzles and, put simply, are double checking to confirm that the transaction actually occurred and should be added to the public ledger as confirmed—much like an escrow company. These confirmations cannot be modified or deleted without the knowledge of the users. As a result, companies that purchase or support the purchase of receivables on the secondary credit market have a clear chain of title, know what they are buying, and know that legitimate debts will be collected sufficient to survive scrutiny from debtors and regulators.
It is also important to understand the role that tokenization plays. While the buzz in the mainstream media has focused on individuals paying millions of dollars for a digital piece of artwork, tokenization plays an important role. Tokenization is not a new idea. Conceptually similar to derivatives of securities, tokenization adds a form of creating a blockchain token that represents a physical asset in virtual space, allowing information and value to be transferred, stored, and subsequently verified in a secure manner on the blockchain. In short, tokens permit the ownership of a tangible valuable asset to be known to the public. Nearly any asset of value can be tokenized. Tokens standing alone have no real value beyond the underlying asset. Further, tokens can take different forms of being either fungible or non-fungible. This is the underlying technology that allowed for the creation of NFTs – which was the virtual trading of virtual art which were “minted” tokens on an exchange. Those tokens had images attached to them and their value was based on the desires of the market to “own” that image. Do not let the term NFT steer you away; the underlying asset of a token does not need to be virtual, nor image based. With many new forms of technology that can become invaluable, first must come the clunky iterations that resonate heavily with early adopters but would be frustrating for many later and mainstream users. By keeping the core benefit of tokenization in mind, however, blockchains can be used to verify the value, the transfer, and the ownership of valuable assets in rapid and efficient means.
Other industries have used blockchain technology and the results have been fulfilling. For example, the real estate market has been playing with the concept of integrating the blockchain into the industry through tokenization of real properties. Real estate firms are using digital exchanges to buy, trade, and invest in properties on the blockchain. Real property essentially becomes as tradable as shares on the stock market, allowing for vastly increased liquidity, more transparency, and a reduction in intermediaries in the broader process.
Understandably, there will be concerns about the costs associated with using tokenization and blockchain. Pragmatically, the long-term benefits of tokenization and the blockchain will likely outstrip the costs in utilizing the technology. That threshold is exceptionally broad in moving from the current debt portfolio sales to tokenized debt portfolios. While there are likely systems already in existence which are capable of supporting complex tokenization, market-based movement will ensure that such a change is not a futile effort. To that end, the debt management industry will need to overcome any skepticism of cryptocurrency and “crypto-related” mechanisms. Tokenization tends to avoid some of these concerns simply by the value being attached to an underlying tangible asset the token is digitizing for the sake of transfer, transparency, and value.
From a legal standpoint, cryptocurrency and the blockchain are in a state of flux because of the several federal agencies attempting to wrangle some form of control over the domain. As innovation moves forward, the legal frameworks are attempting to keep up. Not only have the United States Treasury Department, SEC and CFTC weighed in on the circumstances under which they will regulate blockchain, the Consumer Financial Protection Bureau (CFPB) has weighed in on the issue with respect to consumer financial services, and the Federal Trade Commission has historically investigated debt management companies for possible violations of the FTC Act and Telemarketing Sales Rule.
States are also stepping into the arena to regulate blockchain innovation, with nearly 40 states introducing some form of legislation, mainly to foster the expansion of the technology’s usage. A number of states, for example, have established that contracts and signatures “signed” through the blockchain, via computer, or confirmed on the blockchain are effective signing of contracts, opening the door for judicial weight to uphold a virtual blockchain based contract or transfer.
In addition to promoting efficiency, blockchain technology can be used to effect payments. For example, using blockchain technology, a debt management company can pay another debt management company for a portfolio through fiat currency or a cryptocurrency that is unique to the industry that will eventually be converted to fiat. The use of blockchain in payments does not end with business-to-business transactions. Debtors can also pay down or pay off their debts through a cryptocurrency operating as a stablecoin that carries the same value as a U.S. dollar. The advantage for the industry will be payments that are not subject to returns like we see with ACH payments.
While the world of tokenization and blockchain may seem to be exceptionally complicated, the contractual and payments solutions that they provide will allow for efficiency in the industry when someone takes the lead to address the potential roadblocks. Other industries, such as real estate, are already seeing initial success in using blockchain. And considering the issues that plague the debt management exchanges of debt portfolios and payments, these innovations could go a long way of streamlining the transfer of debt on secondary markets and the bottom line.
Keith J. Barnett is a Partner at Troutman Pepper representing clients in the financial services industry as a litigation, compliance, regulatory, investigations (internal and regulatory), and enforcement attorney spans 20 years.