Assisting Others in Investing in Virtual Currencies: What to Do If Losses Are Incurred?

A Painful Area of Practice

Special Disclaimer:

This article is an original work by Mankun Law Firm. It reflects solely the personal views of the author and does not constitute legal consultation or legal advice on any specific matter. For permission to reprint, please contact Mankun Law Firm staff at: MankunLawFirm

Introduction

You want to trade crypto assets, but the crypto market is fraught with risks and you lack expertise. What should you do? Seek assistance from someone knowledgeable in crypto assets.

Bitcoin has surged again. Upon hearing this news, Xiao Li also wished to invest in virtual assets. However, constrained by limited funds and lacking any knowledge of virtual assets, Xiao Li was introduced through a friend to Xiao Zhang, a prominent figure in the crypto circle. Through their interactions, Xiao Li was deeply impressed by Xiao Zhang’s purported prowess in the crypto market and decided to entrust Xiao Zhang with trading on his behalf. Although Xiao Li was unfamiliar with the crypto market, he possessed strong risk awareness. To mitigate potential losses, Xiao Li required Xiao Zhang to issue a promissory note stating: “Xiao Zhang borrows RMB 300,000 from Xiao Li for house renovation purposes, with agreed-upon interest and repayment date.” Furthermore, Xiao Zhang promised guaranteed profits. With all arrangements in place, Xiao Li transferred RMB 300,000 to Xiao Zhang’s account for the purpose of crypto trading. Xiao Li then waited at home for the value of the virtual assets to rise substantially, anticipating significant gains. However, unforeseen events occurred. One day, Xiao Zhang informed Xiao Li that the trading platform used to purchase the virtual assets had been forcibly shut down due to suspected involvement in criminal activities such as pyramid schemes, money laundering, and fraud, rendering trading impossible (resulting in a total loss). Xiao Li subsequently demanded repayment from Xiao Zhang in accordance with the promissory note, but Xiao Zhang refused to repay.

At the suggestion of a friend, Xiao Li approached Mankun Law Firm with the promissory note.

Are virtual assets protected by law?

First, let us examine the relevant legal provisions in China concerning virtual assets. Article 127 of the Civil Code of the People’s Republic of China provides that where laws contain provisions on the protection of data and online virtual property, such provisions shall apply. According to the Notice on Further Preventing and Disposing of the Risks of Hype in Virtual Currency Transactions (Yin Fa [2021] No. 237), virtual currencies do not have legal tender status and shall not be used or circulated as currency in the market. Domestic and foreign institutions are prohibited from engaging in business activities related to virtual currencies and their derivatives. Where any legal person, unincorporated organization, or natural person invests in virtual currencies and related derivatives in violation of public order and good customs, the relevant civil juristic acts shall be null and void.

In other words, while the Civil Code provides protection for virtual assets, the definition of “virtual property” is governed by other legal provisions. Relevant policies in China maintain a cautious stance toward virtual currencies, prohibiting business activities related to virtual currencies and their derivatives through departmental rules.

How would a court rule on the act of entrusting another person to invest in virtual currencies?

How do courts adjudicate cases involving investments in virtual currencies?

Case 1: Dismissal of Claims

Mr. Li assisted Mr. Lü in investing in the virtual asset “Ethereum.” Mr. Li issued a promissory note to Mr. Lü, stating that Mr. Li had borrowed RMB 290,000 from Mr. Lü under the pretext of home renovation, and specifying the loan date, ID number, and telephone number. The note further indicated that the “payee” was Ge’s account at the Agricultural Bank of China. On the same day, Mr. Lü transferred RMB 5,000 to Mr. Li via online banking and RMB 170,250 to Ge via mobile banking. Subsequently, Mr. Li invested in virtual assets in Mr. Lü’s name. Due to irregularities on the trading platform, transactions in “Ethereum” became impossible, and the platform was shut down. Ultimately, Mr. Lü filed suit in court, requesting Mr. Li to repay the principal plus interest.

After trial, the court held that although Mr. Li had issued a promissory note to Mr. Lü, evidence such as WeChat chat records between the parties sufficiently established that Lü Hengjin had delivered funds to Li Juan for the purpose of investing in virtual assets, and that Li Juan had paid Lü Hengjin the proceeds from trading “Ethereum.” No private lending relationship was formed between the parties; therefore, the plaintiff Mr. Lü’s claims were dismissed. Dissatisfied, Mr. Lü appealed to the Lianyungang Intermediate People’s Court of Jiangsu Province. The second-instance court found that the conduct of the parties was inconsistent with that typical of parties to ordinary private lending arrangements, giving rise to reasonable suspicion that the arrangement was nominally a loan but in substance an entrustment for virtual asset trading. The existing evidence was insufficient to confirm that the lending relationship evidenced by the promissory note reflected the parties’ true intent. Accordingly, the original judgment was upheld in accordance with law. [(2021) Su 07 Min Zhong No. 4842]

Case 2: Each Party Bears 50% Liability

Cheng assisted Li in investing in virtual assets. Under Cheng’s guidance, Li conducted virtual asset investments in his own name. Later, Li logged into his personal account using a dynamic SMS verification code but was unable to view the status of his principal or operate withdrawals of the principal, which raised investment concerns. Li demanded that Cheng refund the investment amount, leading to a dispute between them. Moreover, WeChat records between Cheng and Li showed that Cheng had promised to refund Li’s investment principal of RMB 90,000.

Li first filed suit in court on the basis of private lending. His claims were dismissed at first instance, and the dismissal was upheld on appeal. Li then filed suit again at first instance, alleging a dispute over a private entrusted financial management contract. After trial, the court held that an entrustment contract dispute existed between the parties. However, pursuant to theNotice on Further Preventing and Disposing of Risks Related to Virtual Asset Trading and Speculation(Yin Fa [2021] No. 237), their conduct violated mandatory provisions and was therefore void. Having determined that the entrustment was void, the court assessed the parties’ respective faults and held that Cheng was at fault for impairing Li’s reliance interests, while Li was also at fault for failing to exercise rational consideration of investment risks. Accordingly, the court ruled that each party shall bear 50% of the liability. [(2022) Qing 01 Min Zhong No. 1133]

Analysis by Mankun Lawyers

Returning to the case presented at the beginning of this article, the relationship between Xiao Li and Xiao Zhang constitutes an arrangement that is nominally a loan but in substance an entrustment contract for virtual asset investment. There was no true intent to create a lending relationship between Xiao Li and Xiao Zhang, and no private lending relationship was formed. Furthermore,the entrustment for virtual asset investment is void due to violation of mandatory provisions.

The entrustment contract between Xiao Li and Xiao Zhang is void. Xiao Li entrusted the investment based on absolute reliance on Xiao Zhang personally. Given the substantial risks inherent in virtual asset investments, Xiao Zhang was obligated to fulfill the duty of risk disclosure; however, his promise of profits and issuance of a promissory note demonstrate that he failed to fulfill this duty, constituting significant fault. As an investor, Xiao Li lacked in-depth understanding of the intended investment sector and product information, failed to exercise due diligence regarding the trustee’s qualifications and capabilities, placed blind trust in the trustee, and lacked rational consideration and judgment in the face of the high risks associated with virtual asset investments. These factors were important causes of the loss of principal, and Xiao Li is also at fault.

Article 157 of the Civil Code: After a civil juristic act is determined to be void, revoked, or legally ineffective, any property acquired by the actor as a result of such act shall be returned; if return is impossible or unnecessary, compensation shall be made based on the value thereof. The party at fault shall compensate the other party for the losses incurred thereby;If all parties are at fault, each shall bear corresponding liability. Where the law provides otherwise, such provisions shall prevail.

Recommendations from Mankun Lawyers

Although the Civil Code affirms the nature of rights in virtual assets, relevant policies remain cautious toward virtual currencies and prohibit the trading of virtual currencies and their derivatives. In light of legal and policy requirements, Mankun lawyers provide the following reminders:

1. Investment in virtual currencies carries significant risks. Investors who lack sufficient understanding of virtual currencies should exercise extreme caution when investing.

2. Individuals considering investment in virtual currencies should first gain an in-depth understanding of market trends and undertake necessary preparatory work. Those intending to entrust others with investment should carefully evaluate the trustee’s qualifications, capabilities, and professional integrity.

3. Any potential risks encountered during the investment process should be addressed promptly. For issues that are difficult to resolve independently, timely consultation with professional lawyers is advised to avoid asset losses.