Security Interests in Digital Assets under Korean Law

Security Interests in Digital Assets under Korean Law Security Interests in Digital Assets under Korean Law - - Possibility, Limitations and Legal Protection Gaps Possibility, Limitations and Legal Protection Gaps Korea Advanced Institute of Science and Technology (KAIST) WooJung Jon

Civil Law Definition of Property Traditional Definition of thing Virtual Assets Ownership Ambiguity In civil-law systems, "property" usually covers tangible objects. E.g.Korea's Civil Code Article 98 defines "things" as corporeal objects or controllable natural forces such as electricity. Virtual assets are intangible data entries on a ledger, not physical things or natural forces." They do not neatly fit the Article 98 definition of a transferable thing. Because they fall outside classical definitions, it is unclear if one's hold over digital assets is a property right under civil law. This ambiguity undermines legal protection and transactions involving digital assets.

Issues in Legal Classification of Digital Assets Neither Tangible nor Claim Excluded from Property 1 2 Virtual assets have no physical form and are not a right against another party, challenging the binary of chose-in- possession (tangible property) vs. chose-in-action (claim). Korean courts refuse to treat digital assets as "property." Japanese courts ruled that Bitcoin is not "a thing" under the Japanese Civil Code, since only corporeal objects qualify as property. Legal Gap 3 This strict classification means holders of digital assets may lack full property-rights protection (e.g. in theft or bankruptcy) because the law doesn't recognize digital assets as property.

Challenges in Security Rights (Collateral) Pledging Difficulties No Clear Framework Traditional pledge law assumes a transfer of possession of a thing to the creditor. With digital assets, there is no physical possession. Many secured transactions laws (e.g. civil codes, UCC Article 9 ) did not envision digital assets. It is uncertain how to "perfect" a security interest in digital assets by registration, control, or possession under existing laws. Risk for Creditors Without legal clarity, creditors face risk in accepting digital assets as collateral. A debtor could secretly transfer the digital asset, or courts might later rule the security interest invalid if the digital asset is not recognized as property.

Methods of Securing Digital Assets Possessory Pledge (Control) Title Transfer for Security Security Trust (Escrow) Smart Contract Collateral (DeFi) The asset is placed with a third- party trustee or custodian who holds it for the benefit of the creditor until the obligation is fulfilled. The trustee arrangement secures the asset and can act impartially, ensuring the debtor can't unilaterally misappropriate it. Creditor takes control of the asset (e.g. moving coins to a wallet controlled by the creditor or handing over a hardware wallet). This mimics possession and might perfect a pledge by control of the private key. Debtor transfers ownership of the digital asset to the creditor (or an agent) as collateral, under an agreement that it will be returned upon debt repayment. This outright transfer secures the debt but blurs legal ownership during the loan. Debtor locks the asset in a smart contract that automatically enforces the loan terms. The code will hold the digital asset, trigger liquidation if default occurs, and release collateral when the loan is repaid. (This provides technical security without relying on a central party, though legal recognition of such arrangements is still evolving.)

General Security Right Registry Approach (UNCITRAL Model Law) Digital Asset Collateral Registration: One possible method is to register security rights over digital assets in a general registry (akin to the UNCITRAL Model Law framework), indexed by the debtor. Current Korean Law Constraints: Act on Security Over Movable Property and Claims (DongSan-Chaegwon-Dambodeunggi Act) primarily allows security registrations only when the debtor is a corporation or a business registered individual. In South Korea, corporate ownership of digital assets is not permitted, so corporations do not hold digital assets under the company s name. Consequently, no security interest registration can be made. Potential for Individual Debtors: A business registered individual could, in theory, register a security interest over digital assets under the Act on Security Over Movable Property and Claims. However, it remains legally unclear whether digital assets qualify as (movable asset) under Korean law, which casts serious doubt on whether the registry would accept such filings.

Challenges of Private Key-Based Control vs. Benefits of Exchange-Based Security Interest Registry Enforcement Difficulties with Private Keys Private Key Duplication Debtor s Double Sale Security Risks Difficult to be Exclusive No Security Interest Registry in Current Crypto Exchanges Lack of Standardized Recording Absence of Public Notice Korea Stock Exchange Has Pledge Registries System Established Mechanism Public Notice Prevention of Double Collateralization Proven Enforceability Digital Assets Security Interest Registration System Registry Implementation Locked from Transfer Public Notice Reliable and Transparent Framework for Digital Asset Collateral

Challenges in Enforcing Security Interests in Digital Assets Need for Debtor Cooperation Creditors cannot seize digital assets collateral on their own. Digital assets transfer require wallet access and the private key. If the debtor refuses to share the key, the creditor has no direct means to retrieve the digital asset. Access Requires Private Keys Digital assets are managed by private keys linked to wallet addresses. Creditors lacking the debtor s private key cannot move or sell the digital asset, even in the debtor s default. Without those credentials, the creditor s legal entitlements remain unenforceable. Necessity of Legal Proceedings Judicial Relief: Creditors must obtain a court order compelling the debtor to transfer or surrender the digital asset. Self-Help Limitations: Unlike tangible goods, repossession is futile without court oversight. Freezing Assets on Exchanges Court Orders: The court may freeze the account or instruct the exchange to transfer the digital asset to the creditor s account. Prevents Debtor Transfers: Such injunctions secure the debtor s digital asset for eventual satisfaction of the debt. Limits of Creditor Self-Help vs. Exchanges Exchanges owe duties to their customers and cannot freeze or release digital assets at a creditor s mere request. Formal legal process (injunction or attachment) is essential for the exchange to cooperate.

Attachment of Debtors Contractual Claims against the Exchange Civil Enforcement of Unsecured Creditor via Claim Attachment Due to the absence of a clear perfection mechanism, there is no established practice for secured creditors enforcing their rights against digital assets. In practice, if the debtor s digital assets are on an exchange, the unsecured creditor garnishes the debtor s right to withdraw from that exchange. Attachment Order: Under the Korean Civil Execution Act, once the court issues an attachment order, the exchange (as a third-party obligor) must not release the digital asset to the debtor. Attachment of Claim vs. Asset Contractual Arrangement: Korean courts view the relationship between the exchange and a user as akin to a deposit or custody agreement. Legal Distinction: Seizing the contractual right to claim return of a digital asset is different from directly seizing the digital asset itself. Exchange as Garnishee: The digital asset remains under the exchange s custody and is frozen by the attachment order. Cooperative Intermediary: This system relies on the exchange s cooperation to preserve the digital asset.

Attachment of Digital Assets Under the Korean National Tax Collection Act Legal Framework of Korean National Tax Collection Act Empowers Tax Authorities Order the debtor or a third party (exchange/custodian) to transfer the digital asset Direct the digital asset s transfer to a government wallet Attachment Procedure by Tax Authorities Transfer Request Domestic Exchange must move the digital asset to the tax office s account. Freezing Assets prevents the taxpayer from moving or liquidating the digital asset. If personally held in Private Wallets, the tax authority needs to find out the private key, which is not simple. Post-Attachment Disposal Liquidation Option: Once attached, the Act allows selling the digital asset to satisfy tax arrears. Seized digital assets are sold at market price via an exchange.

Need for Reform Update Legal Definitions There is a growing consensus that legislatures must update legal definitions and frameworks to integrate digital assets. Expand Property Notion Scholars and law commissions urge expanding the notion of property to encompass digital assets or creating a new category fo r them. Adopt Control Concept Security transaction laws should adopt the concept of control (similar to UCC Article 12) to allow effective security interests in digital assets. Exchanges might want to install security interest registration system The law should acknowledge such security interest registration in the exchange account as exclusive control .

Policy Recommendations Draw on Emerging Models Harmonize Internationally Ensure Legal Clarity 1 2 3 Harmonizing these rules internationally would reduce uncertainty. Legal clarity and certainty in this area will support innovation in the digital assets finance while protecting rights and maintaining legal stability ensuring that digital assets can be integrated into the legal system rather than exist in a regulatory gray area. Policymakers should draw on emerging models (UCC Article 12's approach, UNIDROIT principles) to craft clear rules defining control of digital assets and mechanisms for using them as collateral.

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