Why are virtual currency criminal cases often classified as pyramid schemes?

Author: Liu Zhengyao, Senior Lawyer at Shanghai Mankun Law Firm

In recent years, criminal cases involving virtual currencies have been frequent, and one pattern is that many cases related to cryptocurrencies are often filed by public security organs as organizing and leading pyramid schemes. As the saying goes, "there must be a reason for unusual occurrences." Are cryptocurrency practitioners fond of engaging in pyramid schemes, or is there another underlying issue? In this article, Lawyer Liu will discuss this topic.

Based on our team's years of practical experience, the reason why criminal cases involving virtual currencies are often classified as pyramid schemes can generally be attributed to the following two aspects:

Criminal Cases Involving Cryptocurrencies Are Somewhat Difficult to Handle

The distinction between criminal cases involving cryptocurrencies and traditional criminal cases lies in their "simple" and "complex" attributes:

"Simple" refers to the period before the "9.24 Notice" (the "Notice on Further Preventing and Dealing with Risks of Virtual Currency Trading and Speculation"), when regulators had not imposed strict oversight on the cryptocurrency sector. There were earnest entrepreneurs as well as speculative traders chasing quick profits, creating a bustling cryptocurrency market. At that time, cases involving cryptocurrencies, especially criminal cases, had not yet exploded; even if there were cases constituting crimes, they were typically very clear-cut (such as theft, fraud, etc.), and the prosecution, defense, and court generally still used traditional criminal case thinking models to handle these cases.

"Complex" refers to the period after the "9.24 Notice," when the state launched a comprehensive crackdown from various angles, including market/financial/insurance/foreign exchange regulation, cybersecurity, and judicial policy. It was as if the singer threw a "two-way foil" or "snow wave paper" into the cryptocurrency sector, and the noise of the cryptocurrency market was immediately silenced, leading to a surge in civil disputes and criminal prosecutions. At this time, the behavioral structures and business models in virtual currency-related cases had evolved and iterated over several years, resulting in complex trading models that are difficult to classify directly and clearly under criminal law (such as NFTs, DAOs, etc.).

Civil litigation involving cryptocurrency-related disputes is relatively easier to resolve; however, for criminal cases involving cryptocurrencies, there is considerable controversy over how to apply current criminal laws and regulations. The main disputes lie in the following areas:

First, the value of cryptocurrencies involved in criminal cases is difficult to determine. Many criminal cases require a specific amount involved for conviction and sentencing, but cryptocurrencies are recognized by Chinese regulators as having no monetary attributes, only those of virtual goods. The value of virtual goods is crucial in distinguishing between crimes and non-crimes, and between different crimes. In traditional criminal cases, judicial authorities can fix evidence and amounts involved through price determinations by competent authorities, judicial audits, and appraisals. However, in criminal cases involving cryptocurrencies, none of these methods can be used. In practice, judicial authorities often require suspects/defendants to entrust third-party disposal companies (usually recommended by judicial authorities) to handle cryptocurrencies, which poses significant legal risks. At the very least, this indicates that judicial authorities allow or even participate in the behavior of suspects/defendants engaging in the mass trading of cryptocurrencies, which is explicitly prohibited by ten ministries of the state.

Second, criminal cases involving cryptocurrencies tend to be complex. Most criminal cases involving virtual currencies involve numerous participants, especially for cases where project parties are implicated due to issuing tokens. From the perspective of judicial authorities, criminal cases involving token issuance, as long as they are accompanied by profit promises, public promotions, public offerings, and have characteristics such as hierarchical structures and rebates, are very easily classified as organizing and leading pyramid schemes.

The above points illustrate why public security organs are prone to classify cryptocurrency-related criminal cases as pyramid scheme crimes based on the characteristics of these cases.

Pyramid Schemes Have No Victims, and the Involved Assets Belong to the State

Analyzing the crime composition of organizing and leading pyramid schemes, there are two main reasons why this crime is widely adopted by law enforcement agencies in cryptocurrency-related cases:

First, the composition of this crime aligns well with the models of cryptocurrency criminal cases, with more connections to pyramid scheme crimes in cases involving multiple stakeholders. For instance, as long as tokens are issued, it inevitably involves promotion and marketing, which generally also involves profit-making or compensation methods, and during this process, hierarchical relationships can easily form. Due to cognitive path dependence, law enforcement agencies first consider pyramid scheme crimes. Lawyer Liu has even encountered instances where public security initially filed cases under organizing and leading pyramid schemes, only to later change the charges to other crimes in the prosecution opinions submitted to the procuratorate.

Second, there are no victims in the crime of organizing and leading pyramid schemes, which means there is no procedure for returning the involved assets; in principle, the involved assets are all confiscated and returned to the state treasury. Although the criminal law uses the term "fraudulently obtaining property" in its provisions on organizing and leading pyramid schemes, from the perspective of lawmakers, participants in pyramid schemes who are defrauded of property are not considered "victims" under criminal law. Participants in pyramid schemes all have a certain profit-seeking mentality, so there is no concept of returning property in pyramid scheme cases. This also validates why law enforcement agencies have the motivation to investigate pyramid scheme cases, especially "lucrative" ones.

In fact, in the past two years, the trend of profit-driven law enforcement in cryptocurrency-related criminal cases, especially in pyramid scheme cases, has been a major reason for the distrust of law enforcement agencies among parties involved in cases, defense lawyers, cryptocurrency practitioners, and even some ordinary citizens. For example, in recent years, the contribution of cryptocurrency-related criminal cases to the confiscated revenue of certain cities in Jiangsu Province has increased by over 50% compared to previous years.

Mankun Lawyer's Recommendations

In the face of increasingly stringent (even reaching a ceiling) regulatory policies on virtual currencies in China, Lawyer Liu offers the following advice to entrepreneurs based on his experience in various criminal cases:

First, be cautious about issuing tokens when your project has the option to issue or not issue tokens. If you choose to issue tokens, consider developing in compliance overseas temporarily, but do not conduct business or promotions targeting citizens within China.

Second, if you issue tokens and promote them to users within China, it is advisable to ensure that your business type is well-isolated (businesses within China must comply with current laws, regulations, departmental rules, and regulatory policy documents). Avoid operations that involve recruiting others for commissions or spreading through referrals, which can easily be classified as pyramid schemes.

Third, if you become involved in criminal accusations or criminal filings, seek professional legal advice immediately to avoid a passive situation where the pursuit of innovative business models overlooks the strict regulatory environment. Do not fall into the trap of believing that finding so-called "acquaintances or capable individuals" can resolve criminal cases, as this may affect the timing of lawyer involvement during the investigation phase, making it difficult to proceed with the case legally afterward.

The world of Web 3.0 is vast, with many possibilities, but the risks of issuing virtual currencies domestically must be clearly recognized. Only then can one navigate the world of Web 3.0 safely and steadily.