Attorney Shao Shiwei | Entrusted Investment in Virtual Currencies: How to Mitigate Legal Risks?

In his daily practice, Attorney Shao encounters various legal inquiries from entrusted investment providers:

Where the entrusted investment provider is an individual,common legal issues include:

Investing in virtual currencies on behalf of others (who may be relatives or friends) and receiving a certain service fee (or in some cases, providing assistance gratuitously without charging any fee), but subsequently suffering losses on the invested assets. The relatives or friends demand the return of the invested funds, while the entrusted investment provider argues that investment carries risks, that the investor should have been aware of the principle of assuming their own risks, and that they should not bear any liability for compensation. A dispute arises between the parties, leading the entrusting party to report the matter to the public security authorities or file a lawsuit in court. The entrusted investment provider is now uncertain about how to respond;

Where the entrusted investment provider is an institution,common legal issues include:

A fund company primarily engaged in stock options and cryptocurrency investment and trading in global markets, employing investment researchers, programmers, traders, and other personnel within China, conducting arbitrage and quantitative trading through cryptocurrency exchange APIs, with funds sourced from investors; or a blockchain gaming team (with its entity located overseas but actually operated by Chinese nationals) raising funds from multiple venture capital firms and individual investors by selling tokens;

Due to various factors, the investments incur losses, causing the entrusted investment provider to face pressure from numerous investors seeking to enforce their rights, thereby placing the provider in a difficult situation.

The legal risks faced by the entrusted investment provider can be broadly categorized into criminal and civil liabilities. Consequently, the corresponding adverse legal consequences also fall into two main categories: either monetary compensation or criminal sentencing. Therefore, when consulting with lawyers,the primary concern for the entrusted investment provider is usually to understand the legal nature of the case—specifically, whether it constitutes a civil dispute or involves suspected criminal offenses.If it is a civil dispute, preparations should be made in advance for potential future litigation, including the collection of relevant evidence. If it involves suspected criminal offenses, measures for criminal legal risk prevention and control must be implemented to minimize potential legal risks.

Given that each case is unique and to protect client privacy, this article will not discuss specific cases previously handled by our team. Instead, it will analyze currently publicly available cases and legal provisions.

In judicial practice, courts across different regions handle civil litigation cases involving entrusted investments in virtual currencies differently, with varying adjudication standards. Overall, these approaches can be categorized as follows:

• The court holds that disputes arising from investments in virtual currencies violate policy regulations and do not fall within the scope of civil litigation, thus refusing to accept the case;

• The court holds thatsuch disputes may involve suspected criminal offenses, therefore ruling to dismiss the lawsuit and transferring the case to the public security authorities; 

• The court holds that because the investment behavior violates policy regulations, the investor should bear the risks themselves, and thus does not support the investor’s claims;

• The court holds that although the investment behavior violates policy regulations, the fault liability of both parties should be reasonably apportioned, thereby determining the proportion of compensation to be borne by the entrusted investment provider;

Due to space limitations, civil disputes (interested readers may scroll to the end of the article to view related articles) are not the focus of this discussion. We primarily explorethe primary concern of the entrusted investment provider:—In the face of civil lawsuits or criminal complaints filed by investors to enforce their rights, what criminal risks might the entrusted investment provider face?

First, the court determines that the civil case involves suspected criminal offenses and transfers it to the public security authorities.

For example, the Hongkou Court in Shanghai previously adjudicated a dispute concerning entrusted investment in virtual currencies. The plaintiff, Mr. Zhao, invested 700 Ethereum tokens through Mr. Xu, an employee of Shanghai Distributed Investment Management Co., Ltd., in 2017 to participate in Polkadot (DOT) token investments, but subsequently did not receive the corresponding DOT tokens. The company stated that Mr. Xu had resigned in 2018 and that his entrusted investment activities were related to BLOCKASSET Company. The third party, Mr. Sun, stated that Mr. Xu had reached an agreement with BLOCKASSET, treating Mr. Zhao’s 700 Ethereum tokens as a loan, which had been repaid.The Hongkou Court determined that the case involved suspicions of criminal activity, ruled to dismiss the lawsuit, and transferred the relevant materials to the public security authorities or the procuratorial organs,with the amount involved exceeding RMB 90 million.

Second, investors file reports with the public security authorities, and the potential criminal charges against the entrusted investment provider.

In practice, it is relatively rare for the nature of a case to shift from civil to criminal during civil litigation. More commonly, investors directly file reports with the public security authorities. Based on a simplistic understanding, complainants often allege that the entrusted investment provider is suspected of fraud due to their investment losses. However, regarding the specific characterization of the case, the following charges appear with high frequency:Fraud, Illegal Business Operations, Illegally Absorbing Public Deposits, and Organizing and Leading Pyramid Schemes.These charges are among the most frequently encountered.

Therefore, at this stage, the entrusted investment provider should familiarize themselves with these criminal charges and immediately screen their own conduct for any related activities to proactively implement legal risk prevention measures. For example:

• Fraud:Does the entrusted investment provider have knowledge of the projects in which they invest? Do the projects genuinely exist? What were the content and methods of promotion when introducing the projects to investors? What was the investor’s own level of understanding regarding the invested projects?

• Illegal Business Operations:For instance, in current quantitative trading investments in virtual currencies, the entrusted investment provider attracts investors to contribute virtual currencies and generates profit by charging fees. If the operational activities of the entrusted investment provider are conducted within mainland China, could judicial authorities deem this a violation of national laws and regulations, constituting illegal business operations?

   

• Illegally Absorbing Public Deposits:The characteristics of this offense are “illegality, publicity, inducement of interest, and social nature.” The entrusted investment provider needs to screen their conduct against these four characteristics one by one.

   

• Organizing and Leading Pyramid Schemes:Do the projects or products in which the entrusted investment provider invests exhibit the characteristics of pyramid schemes as defined under criminal law, as illustrated in the figure below?

Preventive measures are often more meaningful than reactive responses.

Under the red lines set by policy, entrusted investment providers conducting entrusted investment businesses within China will inevitably face legal risks. For institutional entrusted investment providers, such risks do not cease to exist simply because “we can guarantee that investors will not suffer losses.” Since policy regulations stipulate that “virtual currency-related businesses constitute illegal financial activities,” criminal risks may arise from reports filed by clients or from whistleblowing by competitors or relatives and friends. Therefore, we do not recommend conducting such businesses within China.

Compared to institutional investors, individual entrusted investment providers generally face lower legal risks because their relationship with investors is one-on-one, and in practice, these relationships are predominantly with relatives and friends. Nevertheless, it is advisable to sign clear agreements with the entrusting party, detailing the rights and responsibilities of both parties, and to explicitly explain the relevant risks to the entrusting party. Ensure that they have a clear understanding of the high-risk nature of the investment, and properly preserve communication records with the entrusting party and documents related to the investment, as these will serve as important evidence in the event of a dispute.

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