With the widespread dissemination and application of blockchain, an emerging technology, cases have frequently emerged worldwide that use buzzwords such as “blockchain,” “Web3,” and “virtual currencies” as a pretext for schemes that exploit participants (commonly referred to as “harvesting leeks”). The most common offenses include organizing and leading pyramid schemes, operating casinos, and engaging in illegal business operations. However, in the course of providing legal advice and handling cases, Mankun lawyers have observed that, in many instances, even project promoters themselves do not understand why they are deemed to have committed these offenses, nor do they know which of their actions may give rise to criminal liability, resulting in losses to both themselves and their users.

Accordingly, Mankun lawyers are launching this series of articles, beginning with a review of multiple cases involving the same charges in recent years, to provide Web3 entrepreneurs and investors with guidance on avoiding pitfalls. In this installment, Mankun lawyers will discuss the offense of “organizing and leading pyramid scheme activities” (hereinafter referred to as “pyramid scheme crimes”).

Overview of Pyramid Scheme Cases

In judicial practice in recent years, the number of pyramid scheme cases involving virtual currencies has continued to increase. Let us examine the following representative cases:

Case A

Chen and others used so-called blockchain technology to establish the “Certain Token” online platform to conduct pyramid scheme activities. Participants were required to obtain membership accounts on the platform through referrals by uplines and to pay virtual currencies as an entry fee. They engaged in arbitrage trading through “smart dog brick-moving” technology to generate platform profits. A hierarchical structure of uplines and downlines was formed among platform members, and rebates were distributed by the platform based on the number of downline members recruited and the amount invested, using three methods: smart brick-moving profits, referral-link profits, and executive-level profits. According to statistics, the “Certain Token” platform registered more than 2.6 million member accounts, with hierarchies reaching 3,293 levels, and collected more than 9 million units of various virtual currencies from members, including Bitcoin, Tether (USDT), and EOS. The court held that Chen had committed the crime of organizing and leading pyramid scheme activities, sentencing him to eleven years’ imprisonment and imposing a fine of RMB 6 million.

Case B

Yang designed and issued Taixi Coin and established the Taixi Platform. Without any actual business operations, Yang fabricated profit prospects and carried out various forms of offline and online promotional campaigns. Participants were required to purchase Taixi Coin and lock it up in order to qualify to refer and recruit downlines. The platform offered rebate mechanisms such as static rewards, dynamic rewards, and performance-based rewards, inducing participants to continue recruiting others. According to expert appraisal: from the year the Taixi Platform was established until the date the case was uncovered, it registered a total of 200,989 members, of whom 111,852 actually held Taixi Coin, with member hierarchies spanning 44 levels. The court convicted Yang and others of organizing and leading pyramid scheme activities, sentencing them to fixed-term imprisonment ranging from seven years to one year, and imposing fines totaling slightly over RMB 2 million.

Case C

Mu and others developed the “Boer World” app, using game projects such as “Million Crocodiles” and “Digging for Dinosaurs Together” as a pretext, and luring individuals to register as members by promising high returns. Participants were required to join via invitation codes and to purchase and exchange digital currencies in order to participate in the games and benefit from the appreciation of digital currencies. “Boer World” provided rebates through three main revenue-sharing methods: static returns, dynamic returns, and team bonuses. According to expert appraisal, the total number of member hierarchy levels in “Boer World” exceeded three, with more than 10,000 participants. The court convicted Mu of organizing and leading pyramid scheme activities, sentencing him to six years and six months’ imprisonment and imposing a fine of RMB 250,000.

Summary:As can be seen, scenarios involving pyramid schemes related to virtual currencies typically occur in the investment sector. Compared with pyramid schemes in traditional investment activities, these crypto-related criminal activities leverage the powerful dissemination capacity of the internet to accumulate funds more rapidly and expand their scope of influence. Meanwhile, strong investment demand, the allure of high returns, as well as excessive enthusiasm for and superficial understanding of virtual assets, have facilitated such criminal activities, further exacerbating their social harm.

How is a pyramid scheme determined?

In virtual asset projects, what conduct will be deemed as the crime of organizing or leading a pyramid scheme? Let us first examine the definitions and constituent elements of pyramid schemes under administrative law and of the crime of organizing or leading a pyramid scheme under criminal law.

Pyramid scheme conduct specifically refers to operators setting certain fee thresholds for new members to join, binding members through hierarchical agency structures in a specified order, and calculating remuneration based on the number of downline recruits developed, thereby forming a continuously expanding closed loop.

According to the definitions of pyramid schemes set forth in the Regulations on Prohibiting Pyramid Schemes promulgated by the State Council and the Risk Warning Notice on New Types of Pyramid Scheme Activities issued by the State Administration for Industry and Commerce, generally speaking, if the following elements are simultaneously present in business operations, the conduct constitutes a pyramid scheme.

• Payment of entry fees:Paying entry fees, either directly or in disguised form, meaning that one must pay money to join in order to obtain the "qualification" to calculate remuneration and recruit downlines;
• Recruitment of downlines:Directly or indirectly recruiting downlines, i.e., inducing others to join and organizing them into hierarchical levels in a specified order;
• Hierarchical remuneration:Uplines derive remuneration from the sales performance of downlines they have directly or indirectly recruited, or calculate remuneration or rebates based on the number of persons directly or indirectly recruited.

On this basis, pursuant to Article 224-1 of the Criminal Law of the People's Republic of China, if there is also conduct involving inducing or coercing others to participate, or defrauding them of property, the offense of organizing or leading a pyramid scheme is constituted.

Meanwhile, pursuant to Article 70 of the Provisions (II) on the Standards for Filing and Prosecuting Criminal Cases under the Jurisdiction of Public Security Organs, jointly issued by the Supreme People's Procuratorate and the Ministry of Public Security, individuals who play a key role in carrying out pyramid scheme activities or in establishing or expanding pyramid scheme organizations shall be subject to filing and prosecution if they recruit more than thirty downlines across more than three levels.

Based on the cases discussed above, it is not difficult to observe that pyramid scheme activities in the virtual currency market exhibit certain commonalities, typically occurring in the following scenarios.

• Entry Threshold:To access the functionalities, value-added services, or returns provided by the project operator, participants are generally required to purchase the operator’s products or pay a specified amount to qualify. The fraudulent collection of entry fees constitutes the direct source of revenue for pyramid schemes; all other elements revolve around this core feature. Whether through tiered compensation or headcount-based recruitment, the ultimate objective is to derive illegal profits from an expanding base of participants.

• Headcount-Based Recruitment Model:Because the revenue of such pyramid-scheme-related projects relies on continuous recruitment to sustain the capital chain, rather than generating returns through genuine investment. Under this model, project operators, seeking rapid revenue growth, often employ deceptive practices, gaining trust and promoting the scheme with promises of high returns to induce others to join. Headcount-based recruitment utilizes various operational and promotional methods. Online, operators conduct broad-scale publicity via major social media platforms to attract investors, while also using private messages and emotional manipulation to build trust and lure investors. Offline, operators organize meetings for face-to-face promotion, continuing to make false promises to further reinforce investor trust.

• Multi-Level Profit-Sharing Structure:Project operators establish diverse commission or rebate mechanisms; however, in substance, participants’ returns are directly tied to the number of downlines they recruit and the hierarchical levels involved. Participants’ primary income derives from recruiting downlines rather than from the project’s actual profitability. The understanding of tiered compensation comprises two aspects. First, the determination of levels: according to the Measures for the Administration of Pyramid Selling promulgated by the State Administration for Industry and Commerce, and the 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, the levels in pyramid scheme cases should be calculated as follows: 1. In criminal pyramid scheme cases handled by public security organs, the top level counts as Level 1; 2. In administrative pyramid selling cases handled by industry and commerce administration authorities, the top level is not counted; 3. All intermediate levels are calculated based on the upline-downline relationship; 4. The lowest level is not counted as a tier. Second, the understanding of the compensation mechanism: regardless of the compensation method provided by the project operator, if its essence is to encourage the recruitment of downlines, it will constitute pyramid selling under administrative law.

Mankun Lawyers’ Recommendations

Therefore, on the basis of understanding pyramid scheme activities, we must adopt a rigorous and prudent approach to minimize the risk of involvement in pyramid schemes. Mankun Lawyers offer the following recommendations:

For Entrepreneurs

When structuring a project, attention should be paid to the following points to avoid being characterized as a pyramid scheme:

• Operate in compliance with laws and regulations.Project sponsors shall understand and comply with relevant national laws and regulations, ensure that the project’s operating model is lawful, and avoid using pyramid scheme structures for promotion and marketing. In terms of organizational structure, they shall avoid establishing multi-tier agency arrangements; specifically, they shall avoid scenarios involving two or more tiers of intermediaries between the project sponsor and end users (e.g., project sponsor + agent + agent + end user). At the same time, it is necessary to clearly identify the red lines for criminal risk: conduct suspected of constituting a pyramid scheme generally involves three or more tiers and the recruitment of 30 or more participants; circumstances deemed “serious” (punishable by imprisonment of five years or more) are typically characterized by the recruitment of 120 or more participants or investment amounts exceeding RMB 2.5 million.

• Transparent operations.Maintain transparency in project operations and clarify the sources of revenue and the distribution mechanism. Project sponsors shall avoid any direct or indirect rebate models in which lower-tier participants pay rebates to upper-tier participants, and ensure that compensation is based primarily on actual performance from the sale of goods or services. At the same time, project sponsors shall regularly disclose the project’s financial status and operational conditions to investors to enhance investor trust.

• Reasonable return structures.Establish reasonable return mechanisms and avoid attracting investors with excessively high returns. Project sponsors should consider the project’s actual profitability and the ultimate purpose of its business model when setting reasonable investment returns, avoiding excessive promises. At the same time, project sponsors need to assess whether their business model may directly or indirectly cause others to suffer illegal losses to their property, so as to avoid defrauding others of their property.

For entrepreneurs

When participating in investments, pay attention to the following points to identify pyramid-scheme-type projects:

• Exercise caution in project selection.Select projects with lawful qualifications and good reputations, and avoid blind investment. Investors should fully understand and investigate the actual circumstances of the project, avoid placing undue reliance on promotional materials and promises, and be alert to projects with high entry thresholds or requirements to recruit new participants, so as to avoid becoming trapped in a pyramid scheme loop.

• Make rational judgments about returns.Remain rational and do not be tempted by high returns; carefully review the actual circumstances of the project. Investors should, based on their own risk tolerance, make rational judgments about the project’s investment returns, remain vigilant against pitches such as “guaranteed profits with no loss” or “quick gains,” do not believe that windfalls will fall from the sky, and avoid falling into traps that could result in both financial loss and personal harm. At the same time, promptly understand the project’s distribution mechanism, be alert to the essence of tiered compensation, and take steps to mitigate your own risks.

• Seek professional advice.Before investing, consult a qualified lawyer or financial advisor to understand the legality and risks of the project. Investors should seek advice and assistance from professionals to avoid making erroneous judgments due to a lack of specialized knowledge.

Conclusion

While advancements in internet technology bring convenience to daily life, they also foster illicit activities. With the popularity of concepts such as Bitcoin and blockchain, individuals who engage with these emerging technologies and attempt to understand them often encounter various potential issues that expose them to certain risks. For instance, in pyramid scheme activities, organizers or participants may not realize that they are involved in a pyramid scheme; however, the inherent characteristics of such conduct—including the payment of entry fees, recruitment-based development through “pulling in heads,” the formation of hierarchical structures, and compensation conditions tied to such recruitment—already define potential compliance issues.

If you are already involved, please withdraw promptly and seek assistance from a professional legal team to address any ensuing issues. Mankun Law Firm will continue to publish insights on common compliance issues in the blockchain sector, helping more entrepreneurs and investors pave a safe and compliant path forward. Stay tuned!

Special Disclaimer:

This article is an original work of Mankun Law Firm. It reflects only the personal views of the author and does not constitute legal consultation or legal advice on any specific matter.

 

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