Attorney Shao Shiwei | The Presence of Referral Rewards in Virtual Currency Projects Does Not Equate to the Crime of Pyramid Selling—The Key Lies in the Source of Funds

Let us first look at a case

Machael and others established a virtual currency platform and issued X virtual currency. The project model was as follows: For every transaction of X tokens by downstream members, the platform collected a certain percentage as a service fee and rewarded 20% of this service fee to the upstream member who recruited the downstream member, as a referral reward.

In this scenario, do Machael and others constitute the crime of organizing and leading pyramid selling activities?

Formally speaking, the platform pays referral rewards to upstream members based on the trading activities of downstream members, which seems to meet the formal requirement of “using the number of developed personnel as the basis for remuneration.” It might seem uncontroversial to characterize this as a pyramid selling crime?

However, this judgment is obviously too hasty.

Distinguishing Pyramid Selling Crimes from Administrative Violations of Team-Based Remuneration: The Key Lies in the Source of Upstream Profits

According to the 2013 “Opinions of the Supreme People's Court, the Supreme People's Procuratorate, and the Ministry of Public Security on Several Issues Concerning the Application of Law in Handling Criminal Cases of Organizing and Leading Pyramid Selling Activities,” pure “team-based remuneration” pyramid selling activities aimed at selling commodities and using sales performance as the basis for remuneration shall not be treated as crimes.

This provision establishes the core distinction in practice between pyramid selling crimes and administrative violations:the source of profits for upstream members, specifically whether it isthe principal contributions of downstream members, orthe genuine operating revenue of the platform？

If it derives from the principal contributions of downstream members—essentially “robbing Peter to pay Paul,” using the money of later-entering users to fill the returns of earlier participants—it is a typical Ponzi structure and suspected of constituting a pyramid selling crime. However, if it derives from profits generated through the platform’s genuine business operations, it can be argued as an administrative violation of team-based remuneration, not constituting a crime.

Therefore, the starting point for lawyers handling such cases is to determine the specific source and nature of the funds for upstream rewards within the specific model of the involved project.

For Virtual Currency Projects Involved in Pyramid Selling, How to Determine Whether the Platform Has Genuine Operating Revenue

Returning to Machael’s case mentioned at the beginning. To argue that the platform does not constitute a pyramid selling crime, it is necessary to combine the specific circumstances of the project to find a plausible business logic—proving that the reward funds given to upstream members were earned by the platform itself, not extracted from downstream members. Here, we must consider two scenarios.

Test 1: What can tokens do besides being resold?

If the only use of tokens within the platform is to resell them to the next participant, or to exchange them for USDT in a “fake DEX” built by the project developers (where the USDT comes from the principal of later entrants), then the tokens have no independent utility value. The project developers have no genuine operating revenue, and the funds for upstream rewards can only come from the principal of new users, making the Ponzi structure difficult to deny.

Conversely, if tokens can be used within the application to purchase goods or services with independent value—such as NFT equipment, membership rights, data services, game items, etc.—and the consumption payments can be traced into the project developers’ treasury, then the project developers have a factual basis to claim “genuine operating revenue.”

Test 2: Can one participate without buying tokens?

This is the key to determining whether the act of purchasing tokens constitutes an “entry fee” for pyramid selling. In Web3 platforms, users often need to first convert RMB into USDT, and then into platform tokens. Whether this token purchase acts as an entry fee mainly depends on this factor:

If one cannot activate an account or generate a promotion link without buying tokens, meaning the purchase is mandatorily linked to participation eligibility, there is a risk of it being recognized as an entry fee.

Conversely, if users can register for free and obtain initial tokens by completing tasks, merely earning more slowly without buying tokens, then the compulsoriness of the purchase is insufficient, and it should not be recognized as an entry fee.

Take Move-to-Earn Projects as an Example: Three Characterization Outcomes

Taking “Move-to-Earn” projects as an example, and combining the above two test standards,the same type of project may fall into three completely different legal categories.

Category 1: Does Not Constitute Any Pyramid Selling Violation

Users can use basic functions for free; purchasing NFT running shoes is merely an optional upgrade, not a mandatory entry threshold; referral rewards are based on the actual consumption amount of the referred person (such as NFT royalty shares), not on the number of recruits; tokens can be used for in-app consumption, purchasing items, and paying for services, having genuine usage scenarios; the project developers have genuine operating revenue from NFT royalties, advertising collaborations, etc., and upstream rewards derive from this, not from the principal of new users

—Such a model has neither mandatory entry fees nor a multi-level rebate structure, and does not constitute any form of pyramid selling violation.

Category 2: Constitutes Administrative Violation of Team-Based Remuneration, But Not Recognized as a Crime

There exists a multi-level rebate structure where upstream members can receive rewards from the consumption purchases of downstream members; however, the rebates are calculated based on the sales performance of downstream members (the amount or quantity of NFT purchases), not based on the number of developed personnel; the project aims to sell NFTs/tokens, involving genuine commodity circulation; there is no subjective intent to defraud property

—Satisfying Article 7, Item (3) of the Regulations on Prohibiting Pyramid Selling, this belongs to team-based remuneration pyramid selling and is not recognized as a crime.

Category 3: Constitutes Pyramid Selling Crime

Mandatory purchase of high-priced NFTs/tokens as an entry threshold; rebates are calculated directly based on the number of downstream members developed, unrelated to consumption behavior; there are promises of high static returns, with funds sourced from the principal of later entrants; tokens have no genuine consumption scenarios and serve only as accounting tools for pyramid selling; there is a subjective intent to defraud property

—Simultaneously satisfying the four elements of “entry fee + hierarchy + remuneration based on recruiting + defrauding property,” this constitutes the crime of organizing and leading pyramid selling activities.

An Additional Point: What Does It Mean If the Project Developers Lack Genuine Consumption Scenarios?

This is precisely the key issue in most virtual currency pyramid selling cases.

If platform tokens have no genuine consumption scenarios other than being resold to the next participant within the platform—the sole purpose for users buying tokens is to wait for appreciation or receive static returns

—then the project developers have no genuine operating revenue, and the funds for upstream rewards can only come from the principal of new users.

Regardless of how the internal reward rules of the platform are designed, the underlying structure of the entire model is a “robbing Peter to pay Paul” Ponzi scheme, making it difficult to change the characterization of the project itself as a pyramid selling crime.

Defense Points: The Following Four Points Must Be Simultaneously Supported by Evidence

If the project developers intend to argue that they do not constitute a pyramid selling crime, or constitute only an administrative violation, the following four points must be simultaneously supported by evidence:

1. Tokens have genuine consumption scenarios and can be used within the application to purchase goods or services with independent value;

2. Consumption payments indeed enter the project developers’ treasury, and on-chain fund flows are traceable;

3. Upstream rewards derive from the project developers’ revenue, rather than being directly deducted from the principal of downstream members;

4. The trigger point for rewards is upon completion of consumption, not upon the purchase or staking of tokens.

If evidence for any of the above links is missing or broken, the risk of characterizing the activity as a pyramid selling crime will significantly increase.

Conclusion

Such cases involve the tokenomics design of the project developers, on-chain fund flows, and the verification of the authenticity of consumption scenarios. If judicial organs are unfamiliar with Web3 business models, it may lead to deviations in the characterization of related cases.

Furthermore, the Web3 field itself iterates extremely rapidly, and when each new model emerges, the corresponding judicial cognition is often still blank.

However, this also means that such cases offer significant scope for defense. As defense counsel, it is necessary to find effective entry points based on a familiarity with the business models and operational logic of such projects.

Special Declaration: This article is an original work by Attorney Shao Shiwei, representing only the personal views of the author, and does not constitute legal consultation or legal advice on specific matters. For article reposting, legal consultation, or peer exchange, please add: sswls66.