Founder of cryptocurrency bitClout (BTCLT) Nader Al-Naji has been arrested in New York and charged with one count of wire fraud. Investigators say he defrauded an investor by spending money reserved for platform development on personal expenditures, and made misleading claims that the project was “decentralized.” He faces 20 years in jail if convicted.

In a parallel civil complaint, the SEC claimed that Al-Naji fraudulently informed investors that BTCLT was a decentralized cryptocurrency “with no company behind it, just coins and code,” ­when in reality, he controlled the project from behind the pseudonym “Diamondhands.” The platform, also called BitClout, integrated social media functions and claimed that the value of its cryptocurrency would be tied to the reputation of certain account holders.

Profiles were often opened under the names of people who had no relationship to the company, leading to a cease-and-desist letter for violating California Civil Code section 3344, which prohibits commercial misappropriations of identity.

Al-Naji analogized to BTCLT to a stock, but never registered its offers and sales with the SEC, as he was required to by law. He even told an investor that the asset was “fake decentralized” in a bid to confuse regulators.

Regulators claim that Al-Naji’s statements were made to conceal to investors BTCLT’s likelihood of being regulated as a security.

Al-Naji also misled a prominent law firm into producing a statement that BTCLT would be unlikely to be regulated as a security due to its decentralized nature.

Investment in BTCLT totaled $257m, $7m of which Al-Naji used on personal expenditures.

Regulators claim that Al-Naji’s statements were made to conceal to investors BTCLT’s likelihood of being regulated as a security by the SEC, which has long advocated for stringent cryptocurrency regulation.

The agency tends to brings enforcement actions against companies that produce “centralized” coins whose value is tied to promotion and management. However, this is far from an ironclad policy, and the SEC has even investigated decentralized cryptocurrencies like ether.

According to the SEC, Al-Naji’s misleading statements about BTCLT violated the following provisions of the Securities Act:

• Section 5, which requires registration statements and ensures potential investors only have access to information that the SEC approves during a public securities offering;
• the anti-fraud provisions of Section 17(a);
• the anti-fraud provisions of Section 10(b) and Rule 10b-5.

Decentralized or not?

Some forms of cryptocurrency such as bitcoin and ether are decentralized: anyone can produce tokens through “mining” operations, and its value reflects natural supply and demand on the marketplace.

However, most forms of cryptocurrency are centralized, where circulation and value are tied to the concerted efforts of those connected to the platform. As seen in high-profile crypto collapses such as Terraform Labs’ Terra-LUNA, these promotional efforts are can be fraudulently misleading or conceal structural elements with how the asset is minted and generates value.

In Terra-Luna’s situation, Terraform insinuated that its “stablecoin” terra (UST) would remain pegged to the value of a US dollar. In reality, the claim was misleading. The token became worthless when its flimsy stabilization algorithm, which was tied to sister coin LUNA, failed among faltering crypto prices in May 2022.

In both cases, fraud allegations were brought in part over false claims that the projects were fully decentralized. In Terra’s case, this was connected to promises that the value of the “stable” token could actually generate profits through a staking protocol called Anchor.

Due to their similarity to securities under the Howey test, “centralized” cryptocurrencies are typically regulated by the SEC, which has long advocated for strict enforcement due to the possibility of fraud. But some have criticized the SEC for expanding the definition of centralization beyond usefulness.

New legislation would grant the SEC jurisdiction over centralized crypto and the CFTC jurisdiction over decentralized crypto, ending ambiguity over how the digital assets should be classified.