Special Disclaimer: This article is an original work by Attorney Shao Shiwei. It represents only the personal views of the author and does not constitute legal consultation or legal advice on any specific matters. For article reprints, legal consultations, or business exchanges, please add: sswls66
Introduction:
According to an official statement issued by STFIL Protocol, on April 9, 2024, its core technical team was being detained by Chinese police.
This marks another instance where a Filecoin project developer has been investigated by domestic police, following the earlier investigations into Filecoin miners.
According to the STFIL Protocol website, as a promoter of the Filecoin DeFi ecosystem, the STFIL Protocol is the first liquid staking protocol for Filecoin launched on the Filecoin Virtual Machine (FVM). It enables $FIL token holders to earn stable returns without lock-up periods and provides collateral for storage providers engaged in leveraged mining.
As one of the applications in the DeFi sector, what are the legal risks associated with liquid staking projects within China?
01
What Is Liquid Staking Mining?
The core of liquid staking mining lies in injecting cryptocurrency funds into liquidity pools to support the normal operation of decentralized exchanges (DEXs) or other blockchain protocols. In return, participants receive rewards in corresponding tokens. This mechanism injects necessary liquidity into the blockchain ecosystem and facilitates users' trading of digital assets. As an innovative form of staking, liquid staking allows users to maintain liquidity while staking their tokens. Users are not subject to any lock-up periods. In short, liquid staking is the tokenization of staked assets; this method allows users to deposit funds into DeFi custody accounts while retaining access to those funds, thereby rendering the entire protocol highly "liquid."
02
Legal Analysis of Liquid Staking Mining
1. Can Civil Remedies Be Sought for Entrusted Investment Contracts Involving Staking and Mining?
Although many individuals are aware that virtual currency transactions are not protected by law in China, they often find it difficult to resist the temptation of high returns. In practice, there are numerous disputes involving entrusted financial management of virtual currencies. For example, Party A tells Party B that they can transfer virtual currencies from their wallet to a contract mining pool for mining, claiming that this method of earning interest on deposited coins yields high returns. Consequently, Party A signs an entrusted financial management contract with Party B and transfers the virtual currencies from their wallet to Party B as requested. However, Party B later informs Party A that due to market volatility risks, not only were no profits made, but Party A's principal was also lost. In such a scenario, can Party A sue Party B for the return of the "principal"?
To provide a direct and straightforward conclusion: It is highly likely that the court will either refuse to accept the case or dismiss Party A's claims. There are two reasons for this. First, the contract is invalid due to the nature of virtual currency transactions themselves. Second, investment projects such as liquid staking mining do not constitute pledged property as prescribed under China's Civil Code. Virtual currencies neither fall under "pledge of rights" (such as checks, bonds, equity interests, etc.) nor under "pledge of movables" as defined by Chinese law.
Therefore, property losses arising from the signing of such staking agreements are unlikely to be supported by the courts due to the lack of a basis for claim.
2. Liquid Staking Projects May Pose Risks of Involvement in Pyramid Schemes
In liquid staking, users profit by staking their held tokens on a platform to earn staking rewards. This process itself is unrelated to pyramid schemes. Whether the platform operator is suspected of criminal offenses related to pyramid schemes usually depends on the promotion model. At the initial launch of a project, certain reward mechanisms are often established to attract more users, encouraging existing users to refer new participants.
The Regulations on Prohibiting Pyramid Schemes prescribe three types of pyramid scheme activities: recruiting members based on headcount, charging entry fees, and calculating remuneration based on team performance. Under the crime of organizing and leading pyramid scheme activities as stipulated in Amendment (VII) to the Criminal Law, pyramid scheme activities include only two operational forms: "recruiting members based on headcount" and "charging entry fees." In other words, team-based remuneration pyramid schemes (involving the sale of goods) constitute only administrative violations, whereas criminal liability for pyramid schemes applies solely to "recruiting members based on headcount" and "charging entry fees."
First, from a formal perspective, the token staking involved in staking-and-mining projects carries the legal risk of being characterized by judicial authorities as an "entry fee." Second, if users' earnings in a staking-and-mining project consist solely of interest earned on deposited coins, the platform would naturally not be involved in pyramid schemes. However, if users additionally receive token rewards for recruiting other users, then whether the project itself is suspected of constituting a pyramid scheme crime must be assessed based on factors such as the users' profit model, hierarchical structure, and scale of personnel.
3. Liquid Staking Projects May Pose Legal Risks Related to Illegal Fundraising
What risks might liquid staking projects pose to users, potentially leading to user losses? Referring to the STFIL Protocol website1, regarding risks to stakers, two points are highlighted: First, concerning the timing of asset return, "in the event of a run on the pool, there may be certain delays in retrieving staked assets." Second, smart contracts may contain vulnerabilities.
Therefore, theoretically speaking,if unforeseeable risks arise in a DeFi staking project, user assets could be completely lost.
According to policy provisions such as China's "September 24 Notice," virtual currency-related businesses are classified as illegal financial activities. Therefore, even if project risks result from force majeure, and even if industry insiders believe that the project developers have fulfilled their relevant duty of care and bear no liability, once domestic users report cases alleging damage to their property rights and interests, it poses significant danger to project developers physically located within China.
From the perspective of judicial authorities: Virtual currency-related investment and trading activities are prohibited in China, yet your party continues to engage in them; after users invest substantial sums, their rights and interests are impaired; therefore, your party is suspected ofillegally absorbing public deposits and engaging in illegal financial activities.
03
Concluding Remarks
From the platform operator's perspective, pursuant to the principles of territorial jurisdiction and personal jurisdiction under China's criminal judicial jurisdiction, even if a project is operated overseas, Chinese judicial authorities have jurisdiction if the victims are located within China or if the perpetrators hold Chinese nationality. Given that virtual currency-related projects are classified as illegal financial activities, employing personnel within China to engage in DeFi-related entrepreneurial ventures indeed entails significant legal risks.
From the user's perspective, since virtual currency transactions are not protected by law, any investment losses may result in difficulties in seeking legal remedies. Therefore,users should approach such staking-and-mining projects rationally, exercise caution in investing, and remain vigilant against fraud.
[1] https://docs.stfil.io/v/cn/liquid-staking/risks
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