The Traveling Wilburys famously noted “In Jersey, anything's legal as long as you don't get caught.”[1] Apparently the New Jersey Bureau of Securities (“Bureau”) disagrees. The Bureau issued a Summary Cease and Desist Order to BlockFi Inc. (“BlockFi”) on July 20, 2021, ordering the company to stop offering interest-bearing cryptocurrency[2] accounts to new customers in New Jersey. According to the Order, BlockFi, through its affiliates, has been facilitating its cryptocurrency lending and proprietary trading operations through the sale of unregistered securities in violation of New Jersey’s securities laws.

“Our rules are simple: if you sell securities in New Jersey, you need to comply with New Jersey’s securities laws,” said New Jersey’s Acting Attorney General Andrew Bruck.[3] “No one gets a free pass simply because they’re operating in the fast-evolving cryptocurrency market. Our Bureau of Securities will be monitoring this issue closely as we work to protect investors.” Just ask Tweeter and the Monkey Man . . .

Since its inception in 2017, BlockFi has raised over $500 million in private funding and has a valuation of approximately $5 billion. The firm offers interest-bearing cryptocurrency accounts that enable customers to deposit certain digital assets — including Bitcoin and Ethereum — into these accounts. According to the New Jersey Bureau of Securities (the “Bureau”) , BlockFi pools these deposits together to facilitate its digital asset lending and proprietary trading operations. In exchange for depositing their eligible cryptocurrencies with BlockFi, a customer would earn a variable yield depending on how much and which digital assets are deposited.

The Bureau’s action comes amid increased state and federal regulatory concern over the proliferation and activities of decentralized digital asset lending platforms. Positioned as disruptors to the financial system, firms like BlockFi have reinvented traditional financial products, such as interest-bearing accounts, with promises of providing attractive returns for digital asset consumers, particularly when compared to traditional financial products such as a savings account at a bank. Unlike traditional, regulated banks, however, losses incurred through these entity’s platforms are not insured against or protected by the Federal Deposit Insurance Corporation (or the Securities Investor Protection Corporation). Whether the offering of these cryptocurrency interest-bearing accounts are deemed securities likely hinges on the application of the seminal Howey, Reves and Gary Plastics cases that established tests for determining whether a product should be deemed a security.

Also worth noting is the issuance to BlockFi of a Show Cause Order on July 21, 2021, by the Alabama Securities Commission (“ASC”). The ASC claims BlockFi sold unregistered securities without an exemption from registration of the securities. In the press release for the order, the ASC noted the “action comes amid rising concerns over the proliferation of decentralized finance platforms like BlockFi that seek to reinvent traditional financial systems such as banks and brokerages for digital asset investors.”[4]

Not to be outdone by their fellow regulators, the Texas State Securities Board filed for a cease and desist order against BlockFi on July 22, 2021. Like the actions brought by the regulators in the other states, the Texas Securities Board claims BlockFi sold unregistered securities. But unlike the actions by the other state regulators, Texas claims BlockFi also violated the securities laws of that state by offering and selling securities in Texas without first being registered as a dealer or agent. This claim is similar to enforcement actions brought by the SEC against unlicensed brokers.

These cases are not just a harbinger of concern for BlockFi, but for the entire digital asset lending industry. The timing of the New Jersey action is of note because of the recent appointment of former New Jersey Attorney General, Gurbir Grewal, as Director of the SEC Division of Enforcement.[5] Specifically, it is worth noting each of the orders by state regulators likely comes after months or even years of investigations, inquiries and discussions. Director Grewal was likely involved in the New Jersey investigation that ultimately led to the issuance of the Order and that the digital asset lending space is on his radar. The authors believe the SEC and other state regulators will likely bring enforcement actions against digital asset lending platforms based on claims the operators sold unregistered securities without a registration or an exemption from registration and that the firms acted as unregistered brokers-dealers.