The Compliance Dilemma of Mainland Crypto Practitioners: In-Depth Interpretation of Regulatory Policies and Judicial Practices by Criminal Lawyers

Author: JDI Labs, Harsh Whistle

Interview: Beichen

Guests: Wang Ren, Ding Yanling (collectively referred to as Randy)

As a compliance practitioner in the mainland crypto industry, there are many opportunities to explain to friends outside the industry that I am indeed working in a legitimate field… After all, there are many criminal news stories involving digital currencies, which can easily create a bad impression that this industry itself is illegal, although in reality, it is just that crimes such as gambling, fraud, money laundering, and pyramid schemes have utilized digital currencies.

However, this misunderstanding is not only held by outsiders; even those within the crypto industry have a strong sense of insecurity, as many businesses inevitably encounter unclear legal boundaries during their operations.

We invited criminal lawyers Wang Ren and Ding Yanling from the Digital Economy Legal Services Team of Randy Law Firm to help us understand the compliance issues in the mainland crypto industry based on their rich judicial practice and professional policy interpretation. 1. Beichen: First, let's talk about company registration. Many Web3 projects initiated by mainlanders are registered as legal entities in overseas crypto-friendly countries or regions, and then operate domestically through outsourcing. If there are no crimes involved such as gambling, fraud, money laundering, and pyramid schemes, under what circumstances might they cross the legal red line? Can you summarize a general principle or bottom line?

Randy: Many Web3 project teams have shifted their organizational structure and operations overseas while keeping their R&D teams in China. On the surface, this seems to evade the influence of Chinese law, but according to China's Criminal Law, whether it is based on territorial jurisdiction or personal jurisdiction, as long as there are criminal risks during the project operation, Chinese Criminal Law can still hold accountable the operators, technical personnel, and others who are Chinese nationals or located within China for relevant criminal liabilities.

From the cases we have encountered, the main criminal risks for Web3 projects in China include gambling, fraud, money laundering, pyramid schemes, and illegal fundraising. Each crime has its own specific regulations, and to prevent risks, it is necessary to analyze based on the specific project and consider all aspects of the project's operation.

2. Beichen: Specifically, what key aspects should Web3 projects pay attention to during their operations (or where are they most likely to encounter problems)?

Randy: Currently, the biggest risk for Web3 projects in China comes from criminal penalties, including necessary criminal measures against relevant personnel and assets.

From judicial practice, Web3 projects face regulatory risks under Chinese law (especially criminal law) during the promotion, financing, and "monetization" phases.

3. Beichen: If a Web3 project operates on a public chain, it inevitably involves token issuance and capital inflow/outflow. Even if it is an overseas company, how can it avoid crossing the red line when conducting these two activities in mainland China?

Randy: The regulatory policies regarding token issuance and capital inflow/outflow clearly classify them as illegal financial activities, and no unit or individual is allowed to provide marketing, payment settlement, technical support, or related services.

Of course, according to current judicial practice, if there is no involvement in criminal liability, the law does not protect or penalize individual virtual currency transactions. However, once criminal risks are involved or a certain social impact arises, there may be consequences of judicial authorities conducting investigations.

4. Beichen: If a Web3 project indeed crosses the red line, based on the various cases you have represented, what are the general standards for filing a case?

Randy: For Web3 projects, it is easy to meet the filing standards for relevant criminal charges under Chinese law.

For example, illegally absorbing or disguised absorbing public deposits of 1 million yuan or involving 150 individuals or causing economic losses of over 500,000 yuan would constitute the crime of illegally absorbing public deposits.

For instance, if activities are conducted under the guise of selling goods or providing services, requiring participants to pay fees or purchase goods/services to gain membership, and using the number of recruited individuals as a basis for compensation or rebates, exceeding thirty people and having more than three levels would constitute the crime of pyramid schemes.

5. Beichen: How should we interpret the Hubdex case in Wuxi and the Multichain case in Kunming?

Randy: In the Wuxi Hubdex case, the judicial authorities had a convoluted process in determining the charges. The case was filed for "illegally using information networks," and there were repeated changes to "organizing and leading pyramid schemes" and "illegally absorbing public deposits." Ultimately, the prosecutor concluded that "the exchange's rebate to upstream clients based on dynamic and static income rewards" constituted organizing and leading pyramid schemes, and the case was brought to court.

The focal point of the controversy was whether HUB tokens constituted false goods or services, whether the profit model was based on "recruiting people" or "directly or indirectly compensating based on the number of recruited individuals," and whether there was intent to defraud.

Multichain, as the fourth largest cross-chain bridge for cryptocurrencies, allows users to transfer cryptocurrencies across eight blockchains and holds nearly $1.6 billion in investor deposits. Its CEO was taken directly from his home by the police in China, and all computers, phones, cold wallets, and mnemonic phrases were confiscated. The specific reasons for the arrest remain unclear, but it is highly likely that the platform's funds were involved in illegal activities, specifically suspected money laundering.

6. Beichen: What insights do these two cases provide for teams and businesses operating Web3 projects in mainland China?

Randy: First, it is essential to comprehensively assess the compliance risks of the project itself (especially criminal risks) and whether there are compliance risks in each phase of the project's operation.

After identifying and discovering compliance risks, proactive avoidance is necessary. If clients or investors raise issues, timely responses and resolutions should be provided. If there is already an investigation or inquiry by the police, it is crucial to consult professionals for effective responses.

7. Beichen: In addition to corporate compliance, individuals also face certain risks when holding and trading digital currencies. For example, how should one protect their rights if an exchange goes bankrupt? How to resolve issues with frozen accounts during capital inflow/outflow? Can a case be filed if private keys are stolen?

Randy: According to current regulatory policies and judicial practices, it may not be possible to protect rights through civil lawsuits or criminal accusations in cases of exchange bankruptcies or stolen private keys. Civil lawsuits require a clear defendant, and criminal accusations may not be able to identify a suspect. Without sufficient factual evidence, the police cannot initiate investigations. Moreover, virtual currency-related activities are currently classified as illegal financial activities, and the law does not provide protection.

Regarding the issue of frozen accounts during capital inflow/outflow, if it is a legitimate transaction, one can specifically contact the relevant authorities and cooperate in providing evidence to discuss the unfreezing of the account.

8. Beichen: Currently, how do judicial authorities handle virtual currencies involved in criminal cases?

Randy: According to Chinese law, all property obtained through illegal activities should be recovered or ordered to be returned, thus granting judicial authorities the power to dispose of the property involved in the case. However, due to the uniqueness of virtual currencies and current domestic regulatory policies, the disposal by judicial authorities also faces issues of legality and compliance.

As far as we know, some authorities persuade parties to handle it themselves, some seek buyers domestically, and some entrust third parties for disposal. Among these three paths, the relatively compliant approach is to allow the parties to handle it themselves.

In July 2023, at a seminar hosted by the Supreme People's Procuratorate on "Telecom Network Fraud Recovery and Property Disposal," representatives discussed topics such as "the attributes of virtual currencies and the judicial disposal of involved virtual currencies" and "the application of illegal income confiscation procedures and the distribution of accomplice responsibilities," also suggesting the establishment of systems for auditing, evaluating, and pricing virtual currencies.

9. Beichen: What is your judgment on the regulatory trends for the crypto industry in mainland China in the coming years?

Randy: We believe that based on current regulatory policies and the ongoing handling of cases involving Web3 projects across the country, it is easy to trigger relevant criminal risks due to involvement in "cyber black and gray industries." The regulatory trend will definitely become stricter, especially regarding whether the project itself may involve illegal financial activities, fraud, money laundering, gambling, and pyramid schemes.

We recommend that Web3 project teams consult legal professionals to comprehensively assess the project and its various phases, proactively identify and discover risks, and seek effective countermeasures.

About Randy Law Firm

Shanghai Randy Law Firm is a rapidly developing comprehensive international law firm that gathers elite lawyers from various countries, dedicated to building specialized legal teams in various fields. Headquartered in Shanghai, China, it has established branches in 29 cities across the country and offices in 16 countries.

The Randy Digital Economy Legal Services Team focuses on the fields of the internet, digital economy, digital collectibles, and the metaverse, specializing in providing legal services for data product transaction compliance, cross-border data compliance, data-related commercialization compliance, intellectual property, and criminal compliance. They offer clients a full range of legal services covering compliance due diligence, risk analysis, solution output, system construction, execution, implementation, and optimization.

Team members have diverse backgrounds in computer science, law, and industry, having served as senior legal directors in several internet technology companies, provided data compliance legal services for large enterprises, handled legal disputes and related criminal cases for multinational companies, and participated in important legislative and standard-setting drafting work in this field, as well as pilot practice work.