Between July 20-22, 2021, state securities regulators in New Jersey, Texas, and Alabama took aim at BlockFi — a cryptocurrency-based platform that has raised $14.7 billion from investors — related to the company’s interest-bearing crypto accounts. This regulatory scrutiny, brought by a bipartisan group of state securities regulators, may prove significant given that state and federal legislation has failed to enact comprehensive legislation regarding digital assets.

About BlockFi

BlockFi is a financial services company that provides “credit services to markets with limited access to simple [banking] products, like a savings account.” BlockFi allows investors to “use cryptocurrency to earn interest at up to 7.5% [Annual Percentage Yield], borrow cash, and buy or sell crypto” with “no hidden fees” or “minimum balances.” The company generates revenue by allowing investors to deposit cryptocurrencies into interest-bearing accounts, called BlockFi Interest Accounts (BIAs). BlockFi then uses the BIAs to fund its lending operations. These operations include offering trading accounts and crypto-backed loans. BlockFi also uses BIA deposits to engage in proprietary trading.

While the company’s model may seem to resemble that of a traditional bank or brokerage firm, there is one key difference: BlockFi’s BIAs are not registered with any federal or state securities regulator. Nor are the accounts protected or insured by the Securities Investor Protection Corporation or the Federal Deposit Insurance Corporation. As a result, the company’s operations leave investors vulnerable to increased risk, which presumably caught the attention of New Jersey regulators (BlockFi’s state of domicile).

New Jersey’s Bureau of Securities Cease and Desist Order

On July 20, 2021, the New Jersey Bureau of Securities (part of the New Jersey attorney general’s office) ordered BlockFi to stop selling BIAs because BIAs are unregistered securities. The bureau’s press release noted that the order was issued “amid rising concerns over the proliferation of … financial platforms [seeking] to reinvent traditional financial systems.” However, BlockFi disputes that its BIAs are unregistered securities, calling them “lawful and appropriate to [the] crypto market.”

The order also alleged that BlockFi has failed to disclose its unregistered status to investors, despite claiming to be a “U.S. regulated” entity on its website. Acting Attorney General Andrew Bruck stated: ” Our rules are simple, if you sell securities in New Jersey, you need to comply with New Jersey’s securities laws … . No one gets a free pass simply because they’re operating in the fast-evolving cryptocurrency market.”

The bureau’s order, however, falls short of ordering BlockFi to return existing account holder principal. Nor does the order prevent BlockFi from paying interest on existing accounts.

Alabama’s Securities Commission Issues Show-Cause Order

Also on July 20, 2021, the Alabama Securities Commission issued an order providing BlockFi with 28 days to justify why the company should “not be directed to cease and desist from selling unregistered securities in Alabama.” Consistent with New Jersey’s action, the show-cause order also asserts that BlockFi is innapropriately advertisting that it is a “U.S. regulated entity” despite not being registered with the Alabama Securities Commission.

Texas Files Its Own Show-Cause Order

Two days later on July 22, 2021, the State Securities Board in the Lone Star state filed its own show-cause order against BlockFi, giving the company an opportunity to respond to the same allegations and present evidence at an administrative hearing scheduled for October 13. Specifically, the order asserts that BlockFi is not licensed to sell securities in Texas and subjects Texas investors to undisclosed risks related to the purchase and sale of securities.

Comments from BlockFi CEO

In a series of tweets, CEO Zac Prince admitted that the company received the order in New Jersey but pledged continued support to BlockFi’s existing clients within the state. BlockFi then doubled down on its position in response to the actions by Texas and Alabama declaring: “Our stance hasn’t changed — the Blockfi Interest Account is not a security.”

A Sign of Future Enforcement

This year, according to Google Trends, search terms for “bitcoin,” the largest cryptocurrency by market capitalization, went from a value of just six in December 2020 to a whopping 91 by May 2021. Simultaneously, bitcoin’s price rose 209.7%. With crypto’s rise, however, came an associated rise in crypto-related scams, which, according to the Federal Trade Commission, have bilked investors of $80 million — a record-setting amount. As a result, these enforcement action against BlockFi will likely be the first of many state-driven enforcement actions targeting crypto-based investment products.

Implications and Conclusion

BlockFi is the latest digital asset company to face regulatory scrutiny. It is also an example of the issues that arise when states and the federal government fail to comprehensively regulate a new product. While bitcoin and ethereum are believed to be commodities based on comments from the SEC and CFTC, these actions by a bipartisan group of states could set precedent for how states deal with cryptocurrency-backed products. Thus, in the absence of comprehensive regulation, companies offering digital asset-related products are at an increased risk of enforcement actions interrupting their product offerings, which could ultimately harm investors.