Attorney Shao Shiwei | The PlusToken RMB 40 Billion Pyramid Scheme Case: How Can Web3 Games Avoid Pyramid Scheme Risks?

According to the official characterization, "this is the first major transnational online pyramid scheme criminal case solved by China's public security authorities that uses blockchain technology and digital currency as the medium of transaction."

1. What is PlusToken?

In 2018, PlusToken launched a digital currency wallet, billed as the world's second-largest digital currency wallet, and the platform spread in China as well as in South Korea, Japan, and other countries.

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Under the name of providing digital currency value-added services, the platform required participants to pay in digital currency worth more than USD 500 and to activate a "Smart Dog" (which simultaneously conducted arbitrage trading on different exchanges to earn the price difference), upon which they could obtain platform returns. Members formed upper and lower tiers according to the order of referral and development, and the platform established three main methods of return, by which it paid rebates.

According to the appraisal, the number of participating users in this case reached more than 2.69 million, with approximately 3,200 tiers. The market value of the virtual currencies collected by the platform, such as Bitcoin and Ethereum, was equivalent to RMB 40 billion.

The court of first instance ruled that Chen and others were guilty of the crime of organizing and leading pyramid schemes, and the persons involved were sentenced to terms of imprisonment ranging from 2 to 11 years.

On November 19, 2020, the Yancheng Intermediate People's Court of Jiangsu Province issued a final ruling on appeal, upholding the original first-instance judgment against Chen and others.

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According to the platform's description of its system, the ways in which users could profit can be briefly divided into two main categories: user acquisition and dividend returns, and Smart Dog arbitrage returns.

First,user acquisitionand dividend returns.

Members were divided into five levels: ordinary member, major holder, big shot, master, and genesis. A member could receive 100% of the arbitrage returns of the first tier of downline members they developed, and 10% of those of the second to tenth tiers. Members could stack commissions: major holders stacked a 5% commission, big shots 10%, and masters 15%; genesis required directly referring more than 10 members including three at the master level, and the platform would grant monthly and annual dividends.

Second is Smart Dog arbitrage.

The specific mechanism was as follows: a user transferred Plus coins worth USD 500 or equivalent digital assets into a PlusToken wallet on a designated online platform and thereby obtained a "arbitrage robot" Smart Dog; once activated, the Smart Dog could earn price differences for the user on virtual currency exchanges. There was a static return of more than 10% per month, and returns could reach as high as 60%. The platform stated that the returns from arbitrage consisted of integrating the trading prices of all virtual currency exchanges, buying a certain virtual currency on the exchange where it was at a low price, and then selling the virtual currency on the exchange where it was at a high price, and that this conduct of earning price differences was "not affected by rises and falls in the coin market".

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1. Criteria for Determining Pyramid Scheme Conduct

Pyramid scheme conduct must first be distinguished as administrative illegality or criminal punishment. Under Article 7 of the Regulations on Prohibition of Pyramid Schemes, pyramid scheme conduct can be divided into three major categories: the headcount-recruitment type, the entry-fee type, and the team-compensation type. However,the headcount-recruitment type and the entry-fee type of pyramid scheme conduct are also referred to as fraudulent pyramid schemes,，while the team-compensation type of pyramid scheme is regarded as an operating pyramid scheme. Fraudulent pyramid schemes are regulated by criminal law, whereas team-compensation pyramid schemes that merely pursue performance are generally not treated as criminal offenses. This article discusses only the crime of organizing and leading pyramid scheme activities as it relates to pyramid scheme conduct.

Taking the Plustoken platform for analysis,how can it be determined whether a platform is suspected of being a pyramid scheme?

First, the platform requires payment of an entry fee.Users must pay digital currency worth more than USD 500 as a threshold fee and activate the "Smart Dog" in order to obtain platform returns.

Second, the compensation method is based on recruiting people, and it exceeds three tiers.Developing downline users can generate commission income. Members are divided into five levels: ordinary member, large account, big shot, great master, and genesis. Members can receive 100% of the "brick-moving" returns of the first tier of downline they develop, and 10% of the returns of the second to tenth tiers. Plustoken's maximum tier reached more than 3,200 levels. Genesis-level members could collect RMB 10 million per year solely from downline dividends.

Third, profits are obtained based on downlines, and rebates can be earned.Under the Plustoken arbitrage bonus system, the platform could take 10% of downline earnings.

2. Deceptiveness is an essential element of a fraudulent pyramid scheme.

Beyond the three points above, an important feature of the crime of pyramid selling is the act of defrauding others of their property.

If the operator provides users with genuine products or services, this crime is not constituted. If users' returns derive from the "entry fees" of other downline users, then it constitutes the crime of pyramid selling, which, under the guise of marketing goods or providing services, in fact defrauds others of their property.

The types of user returns set up on the Plustoken platform can be divided into static returns and dynamic returns.

Static returns are the Smart Dog arbitrage returns. Having paid the US$500 threshold fee to activate Smart Dog, could it really bring users a static return of 10% per month? Through arbitrage—buying low and selling high to capture price differences across major exchanges—if such high returns were truly possible, why is it that since the birth of Bitcoin in 2008, none of the many crypto-industry experts has known of it?

Dynamic returns are recruitment and dividend returns. Based on the number of downline members recruited and the profits they generate, participants receive commission from members at different tiers according to prescribed ratios. Upper-tier income derives from downlines; under the Criminal Law, where the personnel participating in pyramid-selling activities within an organization number 30 or more and the hierarchy comprises three or more tiers, the organizers and leaders constitute a criminal offense.

1. Genuine products or services must be provided to users.

The platform itself needs a reasonable economic model, in which the generation and consumption of tokens or items can form a scientifically complete internal economic circulation. In terms of game content design, the platform should be able to ensure that players participate in the game for the sake of playing the game itself and for a better gaming experience, rather than purely "play to earn." If the game is merely used as a vehicle for a pure head-count money-grabbing scheme, then the goods or services advertised and marketed by the project are merely a pretext for recruiting people in order to obtain entry fees. In such a case, neither the platform operator nor the users will care about the actual value of the products or services provided by the platform, and this is then no different from a Ponzi-style blockchain game.

2. Design of the recruitment commission mechanism.

Not only blockchain game projects, but many commercial projects in their initial user-acquisition stage have a recruitment commission mechanism, giving certain rewards to existing users who refer new users. Subject to satisfaction of point 1 above, this business model is not unlawful. In other words, a hierarchical structure does not equate to suspected pyramid-selling crime.

However, a more compliant approach is, of course, to limit the referral commission mechanism to no more than three tiers (such three tiers should be determined by rebate tier rather than organizational tier; given space constraints, this is not elaborated further here).

3. Sources of user returns

On the Plustoken platform, in addition to per-head referral commissions, users were also marketed high static returns from arbitrage, but in fact the so-called returns were merely a Ponzi scheme to induce users to invest more principal. In blockchain games, if in-game NFTs can be traded on the secondary market, market rules must be followed and their value determined by the market; and when operators promote game projects, they must also remember not to make promissory statements that violate national policies, such as that playing blockchain games can make money or that principal and interest are guaranteed.

The entirely new gaming experience and distribution model of Web3 games present opportunities for developers who constantly pursue innovation, while also bringing many challenges. How Web3 games can safely establish a presence in China and achieve long-term and healthy development is a protracted battle. But we believe thatthe games of the future will certainly be decentralized.