I've been digging around further and here is what I found. Something is definitely off.
So it seems like the user roles are being assigned from the group to the groupblog - however it's assigning the wrong roles. In short - it seems that the mapping of group roles to the blog roles is completely off.
I have these settings defined in the Group:
Group Administrator: Blog Admin
Group Moderator: Blog Editor
Group Member: Blog Contributor
When a person becomes a group member, they are assigned the blog contributor role - so far, so good.
When a person is promoted from member to group moderator, their blog role is not promoted, it says at blog contributor. Wrong.
When a person is promoted from group moderator to group administrator, their role changes to blog editor. Wrong.
When a person is demoted from group administrator to group member, their role changes to blog administrator. Also wrong.
So this is what I've been able to find out.
I'm using the latest version of wordpress, buddypress, and the groupblog plugin. I have very very few other plugins added - basically testing in my sandbox area.