Numerous companies currently offer digital asset interest accounts in the United States, but they have begun to attract significant regulatory scrutiny which may change the terms or availability of these accounts going forward.  The Securities and Exchange Commission’s (“SEC’s”) interactions over the past year with two companies providing these accounts, BlockFi and Coinbase, including the SEC’s not widely publicized interactions with the former, provide some insight into the SEC’s view of these products.  While it seems clear that the SEC is intent on taking an active role in their regulation there are some indications that offerors may have a path forward for these products with the SEC. 

Coinbase Lend:

On June 29, 2021, Coinbase, a cryptocurrency exchange platform, introduced Coinbase Lend, a digital assets interest account.[1]  Lend was designed to allow investors to earn interest on their USD Coin (“USDC”), a stablecoin pegged to the US dollar and offered by a consortium of companies of which Coinbase is a member.  Under the announced terms of the Lend product, investors would lend their USDC to Coinbase in exchange for a 4% Annual Percentage Yield interest on the underlying USDC.[2]

Coinbase described in its blog the company’s discussions with various U.S. regulators, including the SEC, before announcing the launch of Lend.  When Coinbase announced the launch of Lend Coinbase, it did not register it as a security with the SEC because the company believed that the Lend product was not a security under the law (as Coinbase understood it).[3]

However, on September 1, 2021, Coinbase announced that it had received a Wells notice from the SEC relating to the Lend product.  According to Coinbase the Wells notice informed Coinbase that if it proceeded with offering Lend to the public the SEC staff would recommend an enforcement action against Coinbase based on the company’s offer and sale of an unregistered security.  According to Coinbase the SEC staff stated in the Wells notice that they believed Lend was both a “note,” as defined in Reves v. Ernst & Young, 494 U.S. 56 (1990), and an “investment contract,” as defined in SEC v. W.J. Howey Co., 328 U.S. 293 (1946).  According to Coinbase the SEC did not provide additional clarity as to why it believed Lend was a “note” or “investment contract” beyond citing these cases.[4]

Coinbase reacted strongly and publicly to the Wells notice from the SEC staff, claiming the SEC was creating “mystery and ambiguity [that will] only serve to unnecessarily stifle new products that customers want and that Coinbase and others can safely deliver.”[5]  Coinbase also noted that numerous companies had already created digital asset interest account products without registering them as securities with the SEC and that Coinbase had met with the SEC and other regulators for months to ensure compliance before launching Lend.[6]  However, despite its vehement protestations, Coinbase announced that it would delay the launch of Coinbase Lend.  Soon after, on September 17, 2021, Coinbase publicly cancelled Coinbase Lend entirely.[7]

BlockFi Interest Accounts:

One of the already existing digital assets interest account products referenced by Coinbase was BlockFi’s BlockFi Interest Account (“BIA”) product.  Launched on March 4, 2019, by the end of 2021 BlockFi held over $10 billion in investor assets, and there were close to 400,000 BIA investors in the United States.[8]

On February 14, 2022, the SEC announced a settled administrative proceeding which charged BlockFi, wherein the SEC found (though BlockFi did not admit) that BlockFi failed to register the offers and sales of its BIAs, operated as an unregistered investment company and negligently made false and misleading statements concerning the level of risk associated with its BIAs.  The SEC ordered BlockFi to cease-and-desist offering its BIA product and imposed on BlockFi a $100 million penalty, half of which was payable to 32 participating state governments.[9]  In its order, the SEC provided commentary on its use of the Reves and Howey cases and its position on digital asset interest accounts generally.

Specifically, the SEC found that the BIA product offered by BlockFi was both a “note” (under Reves)[10] and an “investment contract” (under Howey),[11] the same theories Coinbase explained were contained in the Wells notice it had received in September 2021.  Therefore, because BlockFi offered and sold unregistered securities the SEC found it had violated the registration provisions of the Securities Act of 1933 (the “Securities Act”).

While the SEC has invoked Howey with respect to digital asset offerings on several subsequent occasions since releasing its report on “The DAO” in 2017, the SEC’s reliance on Reves is of very recent vintage.  The BlockFi settlement reflects the first non-fraud invocation of the Reves theory regarding digital asset offerings by the SEC.[12]  It is important to note that no federal courts in any district have endorsed the SEC’s Reves-based theory.

In addition to charging BlockFi with selling unregistered securities, the SEC also charged BlockFi with acting as an unregistered investment company in violation of the Investment Company Act of 1940 (the “Investment Company Act”).  Specifically, the SEC found that BlockFi operated as an investment company because it “it issued securities and also held more than 40 percent of its total assets, excluding cash, in investment securities, including loans of crypto assets to institutional borrowers.”[13]  Lastly, the SEC also found that BlockFi negligently made false and misleading statements “concerning the level of risk in its loan portfolio and lending activity.”[14]

Interestingly, however, the SEC and BlockFi agreed on a possible path forward whereby BlockFi could resume its BIA product.  The SEC gave BlockFi 60 days (with potential for a 30 day extension) to register its business pursuant to the Investment Company Act or to provide the SEC with “sufficient credible evidence” that it qualified for an exception to the registration requirement.  The SEC and BlockFi further agreed that BlockFi would attempt to register its digital asset interest account program(s) with the SEC on a Form S-1 in compliance with the Securities Act.  The SEC stated that these two registrations would go hand-in-hand, and that the SEC would not declare any registration on Form S-1 effective until the SEC deemed BlockFi’s business in compliance with the Investment Company Act.[15]  Most interestingly, as discussed further below, the SEC’s order did not specifically address BlockFi’s ability to maintain and service the extant BIA accounts it already offered in the United States.

Commissioner Peirce Reaction:

SEC Commissioner Hester M. Peirce issued a dissent from and criticism of the settlement, raising numerous issues and doubts about whether the SEC would ever allow digital asset interest accounts to be registered at all.

Commissioner Peirce questioned whether or not making digital asset interest accounts and those who offer them subject to securities regulation, through the Securities Act and Investment Company Act, would actually protect customers and retail investors.  Commissioner Peirce also stated that subjecting BlockFi to the existing provisions of the Investment Company Act and making compliance with it a condition of registering digital asset interest account product(s) only forces BlockFi into making redundant disclosures.[16]

Commissioner Peirce further noted that applying the “securities regulatory framework” might have the unintended consequences: “Rather than forcing transparency around retail crypto lending products, today’s settlement may stop them from being offered to retail customers in the United States.  BlockFi will not be allowed to take in any additional crypto from retail investors until the company has registered a new crypto lending product on Form S-1.  Getting an S-1 to the point where staff will declare it effective is often a months-long, iterative process.  When crypto is at issue, the timeframe is likely to be longer than it would be for more traditional filings.”[17]

Subsequent BlockFi SEC Filings:

The SEC’s actions subsequent to its settlement with BlockFi indicate, however, there is reason to believe the SEC may be open to BlockFi registering a digital asset interest account product despite Commissioner Peirce’s skepticism.  First, while notably absent from the settlement document, the SEC has allowed BlockFi to continue servicing its existing BIAs in the months subsequent to the settlement, apparently only preventing BlockFi from offering new accounts[18]  Second, several recent SEC filings made by two different BlockFi entities, along with the SEC’s responses, indicate that the SEC may ultimately permit such accounts, albeit by assuming a more active role in regulating their operations.

On April 4, 2022, BlockFi, Inc. filed a Form T-3 regarding the BIAs, assuming the BIAs from its subsidiary BlockFi Lending LLC, the entity specifically named in the SEC settlement order.[19]  The SEC declared the Form T-3 effective without comment on April 14, 2022.  This filing, and its immediate acceptance by the SEC, could be a significant marker of the impending registration of BlockFi’s new digital asset interest product.  In its settlement with the SEC, BlockFi agreed that its new product would be offered by BlockFi Inc.  Moving the existing BIAs to BlockFi Inc. through a Form T-3 would allow BlockFi to exchange the existing BIAs for equivalent accounts in BlockFi’s new product, which may be a precursor to the registration of the new product.

In addition, BlockFi entities have filed three other Form T-3s since the announcement of the settlement.  On February 14, 2022, the same day the settlement was announced, BlockFi Lending LLC filed a Form T-3 requesting to amend the interest rates on the existing BIAs (which are variable interest accounts).  This Form T-3 acknowledged the existing BIAs as securities but claimed they were products that do not require SEC registration (under Section 3(a)(9) of the Securities Act).

The SEC responded to the Form T-3 eight days later but did not raise any fundamental questions, such as why BlockFi contended the product was exempt from registration under Section 3(a)(9).  Following a couple of amendments and responses from BlockFi the SEC declared the Form T-3 effective.  The SEC also declared effective subsequent Form T-3s, filed for the same purpose in March by BlockFi Lending LLC and in April by BlockFi, Inc., permitting BlockFi to adjust the interest rates offered on its existing BIAs.

The timing of BlockFi Lending LLC’s first Form T-3 filing and the timing and content of the SEC’s response suggest that this course of action may have been known to or expected by the SEC’s Division of Corporation Finance at the time of the settlement.  It remains to be seen, however, whether BlockFi will ultimately succeed in registering its new digital asset interest account product with SEC, and, if it does succeed, whether the SEC will similarly require filings by each provider of a digital asset interest account product whenever they vary their interest rates.

Open Issues and Next Steps:

The SEC’s settlement with BlockFi, their use of the Reves and Howey cases and their subsequent interactions with BlockFi regarding the Form T-3 filings align with the maximalist approach towards regulating digital assets which SEC Chair Gary Gensler has taken since assuming his position.  Chair Gensler noted that the settlement “makes clear that crypto markets must comply with time-tested securities laws, such as the Securities Act of 1933 and the Investment Company Act of 1940.”[20]

Despite the recent developments discussed above it remains to be seen whether BlockFi will succeed in reaching an agreement with the SEC regarding Investment Company Act compliance, and whether BlockFi will be able to successfully register its digital asset interest account product(s) with the SEC on a Form S-1.  No digital asset interest account product has ever been registered with the SEC before.

More regulatory developments may be on their way soon.  The initial 60-day deadline for BlockFi to comply with the Investment Company Act was Friday, April 15 and the 30-day extension is up on Sunday, May 15.  Companies which currently provide digital interest accounts should continue to monitor developments as the SEC has indicated that they expect other, similar, companies or products to follow what the SEC and BlockFi eventually work out.  Companies offering similar products should be prepared to face demands from the SEC to register with the SEC both the offering entity itself and the digital asset interest account products.  Companies should also anticipate that the SEC expect periodic filings, similar to the Forms T-3 filed by BlockFi since the settlement, in order to maintain and upkeep their digital asset interest accounts.  It bares noting again though that the SEC’s interpretations of the Securities Act, Investment Companies Act, Reves and Howey, as utilized in the settlement, have not been tested in court.

[1]    The Coinbase Blog, June 29, 2021, https://blog.coinbase.com/sign-up-to-earn-4-apy-on-usd-coin-with-coinbase-cdad79e5f5eb.

[2]      Id.

[3]      The Coinbase Blog, Sept. 7, 2021, https://blog.coinbase.com/the-sec-has-told-us-it-wants-to-sue-us-over-lend-we-have-no-idea-why-a3a1b6507009.

[4]      Id.

[5]      Id.

[6]      Id.

[7]      The Coinbase Blog, Sept. 17, 2021, https://blog.coinbase.com/sign-up-to-earn-4-apy-on-usd-coin-with-coinbase-cdad79e5f5eb.

[8]      SEC Order, BlockFi Lending LLC, File No. 3-20758, at 2 (SEC Feb. 14, 2022).

[9]      SEC Press Release, BlockFi Agrees to Pay $100 Million in Penalties and Pursue Registration of its Crypto Lending Product, Feb. 14, 2022, https://www.sec.gov/news/press-release/2022-26.

[10]    The SEC’s position is based on its analysis of the below “four factor” test implemented by Reves:

(1) The “seller’s purpose is to raise money for the general use of a business enterprise;”
(2) The instrument is distributed so “there is ‘common trading for speculation or investment;’”
(3) The instruments are securities within “the reasonable expectations of the investing public;” and
(4) There is not “another regulatory scheme” which governs the instruments in question.

Reves at 66-67; SEC Order at 8.

[11]    The SEC’s position is based on its analysis of the below factors described in Howey:

(1) There is “a contract, transaction or scheme whereby a person invests his money;”
(2) The investment of money is “in a common enterprise;”
(3) The investor “is led to expect profits;” and
(4) These profits are derived “solely from the efforts of the promoter or a third party.”

Howey at 298-299; SEC Order at 8.

[12]    The SEC has previously settled a fraud case relating to digital assets using the Reves theory. See SEC Order, Blockchain Credit Partners d/b/a DeFi Money Market, Gregory Keough, and Derek Acree, File No. 3-20453 (SEC Aug. 6, 2021).

[13]    SEC Order at 3.

[14]    SEC Order at 6.

[15]    SEC Order at 12.

[16]    Peirce, Hester M., Statement on Settlement with BlockFi Lending LLC, Feb. 14, 2022, https://www.sec.gov/news/statement/peirce-blockfi-20220214.

[17]    Id.

[18]    BlockFi Blog Post,  BlockFi Enters Landmark Resolution with Federal and State Regulators Providing Clarity on Pathway for Crypto Interest Securities, Feb. 14, 2022, https://blockfi.com/resolution-announcement.

[19]    A Form T-3 is filed with the SEC in order to change the terms of an indenture governing a class of debt securities issued in an unregistered offering.  This is in contrast to Forms T-1 and T-2, which are used to file indentures governing a class of debt securities registered through a Securities Act registrations statement (such as a S-1). 

[20]    SEC Press Release.