Attorney Shao Shiwei | Event Recap | What Are the Legal Risks of Investing in Blockchain and Virtual Currency Projects? How to Avoid Pitfalls?

 

On September 14, at the invitation of the Conflux Chinese Community, Attorney Shao Shiwei of Mankun Law Firm delivered a specialized presentation on preventing legal risks associated with individual investments in blockchain and virtual currency projects. This article is a transcript of the event.
 

 

Theme: Treasure Hunting in the Crypto Circle: A Safety Guide to Avoiding “Crocodiles”

 

In the world of crypto assets, investors are like a group of brave explorers who, carrying their wallets and dreams, jump into this treasure island full of unknowns and possibilities. However, as in all adventure stories, there are always “crocodiles” lurking beside the treasure, waiting for careless explorers. This article serves as an expedition manual to help you find treasure in the jungle of the crypto circle while avoiding those dangerous “crocodiles.”

 

 

 

01

Project Legality: Treasure or Trap?

 

 

In the crypto circle, some projects appear like shining gold coins, but they may merely be gilded stones. Before investing, you must investigate these projects like a detective to ensure they are not legal “traps.” Before you begin digging, ensure that your actions comply with local laws; otherwise, you may find that your treasure turns into a fine.

 

 

 

For individual investors, the greatest risk in investing in crypto circle projects lies not in “losing money” (financial loss), but in “losing freedom” (being arrested). Of course, the worst-case scenario is losing both money and freedom. Such situations are relatively common when projects involve pyramid schemes or gambling. Two cases are shared below:

 

♦ Case: In a Virtual Currency Pyramid Scheme, the Complainant Became a Criminal Suspect

 

 

 

The complainant, Mr. Xie, joined an organization called “Hua [Redacted] Club” through a friend’s introduction and invested by purchasing virtual currencies. After making small initial investments and observing favorable returns, Mr. Xie invested his entire savings of RMB 2 million, only to become trapped. Due to being trapped, Mr. Xie sought new ways to generate profits: following instructions from superiors to “recruit heads” and develop downlines, Mr. Xie developed downlines across 9 levels, totaling more than 300 people. Subsequently, the platform collapsed, and downstream investors demanded repayment from Mr. Xie, prompting him to file a police report. After filing the report, Mr. Xie was criminally detained by the public security authorities.

 

#More Content ➡️ “Virtual Currency Pyramid Scheme: Why Did the Complainant Become a Criminal Suspect?”

 

 

 

❓ How to Determine Whether a Platform Is Suspected of Operating a Pyramid Scheme?

First, the platform requires payment of an entry fee.

Second, compensation is based on recruiting members (“pulling heads”), and the hierarchy exceeds three levels.

Third, commissions are received based on profits generated by downlines.

 

#Related Reading ➡️ “Case Analysis: How Can Web3 Games Avoid Pyramid Scheme Risks? Insights from a RMB 40 Billion Crypto Circle Pyramid Scheme Case”

 

 

 

♦ Case: Receiving Commissions for Recruiting New Users to an Exchange Led to Being Charged as an Accomplice in Operating a Casino

 

In April this year, a blogger published an article stating that the high-leverage perpetual contract trading offered by the BKEX exchange was defined as online gambling. If exchange users act as agents for the platform and receive commissions on platform fees, they may be deemed accomplices in the crime of operating a casino. As a financial instrument, contract trading shares similarities with other financial products such as futures, stocks, and options, and involves the possibility of gaining profits through luck. It is precisely due to the widespread “gambling mindset” among investors that contract trading appears quite similar to probability-based gambling activities.

 

 

 

 

❓ How to Determine Whether a Project Involves Gambling?

1. Purchasing props/game coins within the platform for a fee.

2. The ability to withdraw funds directly or indirectly to obtain fiat currency.

3. Gameplay mechanics: chance-based, seeking large gains with small stakes, and involving the possibility of loss.

 

#Related Reading ➡️ “Play-to-Earn Blockchain Games: How to Avoid Becoming Gambling?”

 

 

Therefore, when selecting investment projects, we must remain vigilant and thoroughly understand the nature of the project. As discussed above, if a project involves gambling or pyramid schemes, investors may not only lose funds but also face potential criminal risks. Next, let us explore more common scenarios where, although no criminal liability arises from the project itself, “explorers” in the crypto circle who suffer financial losses may face challenges in protecting their rights.

 

 

 

 

02

Fraud and Scams: Beware of Those “Crocodiles”

 

In the jungle of the crypto circle, some “crocodiles” (projects) disguise themselves as friendly animals, promising unrealistic high returns. These are usually signs of fraud. Before investing, remain as cautious as you would with strangers, and verify the background of the project team and the feasibility of the project through reliable channels.

 

 

 

Many projects in the crypto circle, such as ICOs, blockchain games, and DeFi, have no space for compliant development within China. Even for projects operated by Chinese nationals, servers are generally located overseas, and project personnel often physically reside abroad. Therefore, as an investor, if a crypto circle project absconds (“rug pull”), the prospects for protecting your rights are very slim.

 

 

 

♦ Case: The “Soft Rug Pull” of the Web3 Gambling Platform ZKasino

 

 

 

ZKasino is a decentralized gambling-style gaming platform. On March 16, 2024, ZKasino announced that the ZKasino Bridge was about to go live, and participants in the fund bridging activity would receive ZKAS token rewards. Subsequently, ZKasino repeatedly issued notices indicating that users who deposited funds earlier would receive more token rewards, and introduced a commission mechanism to encourage users to invite new users to join.

In April, users discovered they were unable to withdraw funds. Meanwhile, the project’s whitepaper document not only secretly changed the status of user-staked assets to a donation mode but also enforced an “IDO,” converting all ETH staked by users with real money into the platform’s own token, ZKAS.

In May, Binance’s Financial Crime Compliance and Investigation Team, in cooperation with the Dutch Fiscal Information and Investigation Service, froze millions of euros related to the ZKasino scam. The project opened a refund registration channel on May 28 for a period of three days. It later stated that “registration data will be collected over the next few days. A new announcement providing data for public verification will be released as soon as possible.”

 

However, according to the latest news on August 14, 2024, the funds raised from investors remain in two addresses: ·0x42dc91caa486a1cbf921a8009404a590414285a3 (5,271 ETH); ·0x0ab4a19ab20bd1dde51a5d302721fcc30f34094d (5,266 ETH).

 

Related Reading ➡️ “Did ZKasino, the Web3 Gambling Platform Valued at $350 Million, Abscond with Funds? Can Domestic Investors Protect Their Rights?”)

 

 

 

❓ If a Crypto Circle Project Absconds, Can Domestic Investors Protect Their Rights?
Protecting rights in such cases is by no means easy.

 

Participants in the crypto circle should be familiar with the “September 24 Notice.” In September 2021, ten ministries and commissions issued the “Notice on Further Preventing and Disposing of Risks Related to Virtual Currency Trading and Speculation,” which stated that “participating in virtual currency investment and trading activities carries legal risks. Any legal person, unincorporated organization, or natural person investing in virtual currencies and related derivatives, if violating public order and good morals, shall have the relevant civil juridical acts deemed invalid, and any losses arising therefrom shall be borne by themselves,” and that “illegal business operations, financial fraud, and other criminal activities in virtual currency-related business activities, as well as money laundering, gambling, illegal fundraising, and pyramid schemes using virtual currencies as a pretext, shall be severely cracked down upon.”

Combining the principles of personal jurisdiction and territorial jurisdiction under China’s criminal law provisions, since virtual currency-related business activities are defined as illegal financial activities in China: (1) If Chinese citizens engage in such businesses, or if relevant illegal or criminal acts or results occur within China, Chinese judicial authorities have jurisdiction. (2) If individuals suffer losses due to investing in virtual currencies, the relevant civil juridical acts are invalid, and they bear the risks themselves.

Therefore, to protect one’s rights, the following issues must be addressed: (1) Prerequisite for Rights Protection: Since individual investments in virtual currency transactions are not protected by law and civil juridical acts are invalid, the premise under which personal property rights and interests might be protected is that the matter must constitute a criminal case. (2) Difficulties in Cross-Border Cases: Although there have been precedents where the actual controller of a pyramid scheme claiming to involve virtual currency mining investments, which caused billions in losses to Chinese citizens, was captured with the assistance of international criminal justice and subsequently extradited back to China, domestic judicial authorities do not intervene in every foreign project that absconds. Although China has jurisdiction, it lacks enforcement power abroad. Handling cross-border cases requires comprehensive consideration of complex factors such as the amount of funds involved, social harm, legal consequences, whether extradition treaties exist between China and other countries, and international police cooperation and communication. This constitutes diplomatic communication and negotiation between states.

 

The above introduces the various legal risks that explorers may face during their journey in the crypto circle. So, if one chooses to cooperate with others, such as entrusting others to conduct investment and financial management on their behalf, what matters should explorers pay attention to?

 

 

 

 

03

Guides in the Crypto Jungle: The Leaders

 

 

 

 

 

 

A qualified guide in the crypto circle should, like a seasoned hunter, track the traces of projects, verify the background of the project team and the feasibility of the project through reliable channels, and ensure that investors do not fall into fraud traps. However, investors should also note that there are no absolutely safe projects. Remain wary of projects promising unrealistic high returns, as these are often bait set by “crocodiles.” Sometimes, even the guides themselves may stumble.

 

 

 

❓ How Should Explorers Protect Themselves When Cooperating with Guides?
Entering the crypto circle has a certain threshold. Not everyone can quickly start investing in crypto circle projects or trading cryptocurrencies on their own after understanding basic concepts such as fiat on/off ramps, crypto wallets, mining, and exchanges. At this point, entrusting others to manage investments and finances has become a shortcut for investors seeking to earn their “first pot of gold” in the crypto circle.

 

For investors who only provide capital and do not participate in the project itself, potential risks include: What if the project loses money and the capital is lost? Can the funds be recovered from the party managing the investment? If rights are protected through litigation, will the court support the claim? If the court supports the return of virtual currencies, can the judgment be enforced?

 

Regarding disputes involving crypto assets, China currently lacks clear legal provisions. While acknowledging Bitcoin and other virtual currencies as virtual commodities and affirming their value, the legal stance towards cryptocurrency traders remains subtly negative. In judicial practice, courts in different regions handle such disputes differently. Overall, the main viewpoints of the courts are as follows:

 

 

 

#Related Reading ➡️

“Recruiting People to Trade Cryptocurrencies and Play Contracts on Exchanges and Receiving Trading Commissions: Are There Legal Risks?”

“Contract Trading Signal Services That Make You Soar: Angel or Devil?”

“Crypto Circle Key Opinion Leaders (KOLs) Providing Signal Services for Commissions: Is This Business Legal?”

“Court Viewpoint: Transferring Virtual Currencies to Another Party Constitutes an Illegal Debt! Do Not Expect to Get It Back If Lent! — Lawyer’s Advice: How to Recover the Money?”

“What Are the Legal Risks of Overseas Agency Investment in ICO Projects?”

“Practical Discussion: Review of Key Issues in Virtual Currency Investment and Mining”

 

 

❗ Guides May Also Stumble
In the eyes of legal professionals, one type of crypto circle project—blockchain games—is actually very close to gambling. However, as ordinary investors, whether explorers or guides, it may be difficult to accurately identify and distinguish whether the projects they invest in are gambling-related games.

 

 

♦ Case: Player Reported Losses in Blockchain Game Investment, Resulting in Police Raiding the Entire Group

 

 

 

Player A learned about a blockchain game platform with investment value through an introduction. Not only did A invest RMB 400,000–500,000 of their own money, but also encouraged friends around them to invest. Player B, a long-time friend of Player A, saw that A had indeed made significant profits. Based on trust, B transferred approximately RMB 200,000 to A, asking A to help make money together. Unexpectedly, A later lost both their own money and B’s money. After B repeatedly demanded repayment from A, A refused to repay, claiming that A had previously informed B that investment carries risks and that B should bear the investment risks independently. Consequently, B filed a report at the local police station.

 

The outcome of the case was that B was administratively detained for 15 days, and A was sentenced by the court to one year in prison for the crime of operating a casino.

 

#Related Reading ➡️

“A Crime That Crypto Entrepreneurs Must Pay Extra Attention To—The Crime of Illegally Utilizing Information Networks”

“What Legal Risks Should Be Noted for Virtual Currency Paid Communities?”

“What Legal Risks Should Be Considered When Establishing a Web3 ‘Airdrop Hunting’ Studio?”

“What Are the Legal Risks for Crypto Circle KOLs Promoting Projects?”

“Is It Legal for Internet Celebrity KOLs to Issue Tokens for Fans to Share Dividends? See How Friend.tech and Time Store Leverage Fan Economics”

 

 

 

 

04

Conclusion

 

In the exploration of the crypto circle, treasures and “crocodiles” coexist. Through the map provided in this article, you can better understand the boundaries of legal risks, thereby protecting your personal assets while pursuing wealth growth. Remember, the smartest explorers are those who know how to avoid traps. Good luck in your crypto circle adventures, but never forget that safety always comes first!