Legal Dilemma of Virtual Currency OTC Merchants
OTC trading can easily be exploited by criminals as a means for money laundering, evading foreign exchange controls, and illegal transactions.Author: Zhang Chengjun, Mankun Blockchain Legal Services
On February 2, 2024, the Secretary for Financial Services and the Treasury of Hong Kong, Xu Zhengyu, stated that the government believes there is a need to regulate over-the-counter (OTC) trading of virtual currencies and will soon consult on the proposed regulatory framework, hoping that citizens and stakeholders will actively express their opinions.
This news caused quite a stir in the industry at the beginning of the year. However, it seems to have made no waves for the old coin traders in the domestic market, who continue to cautiously play the role of laborers in the crypto space. At the same time, many crypto enthusiasts, after reading some introductory materials, often ask me, "OTC seems so simple, right? Buy low and sell high, isn't that a sure way to make money?!" Every time I see someone who thinks they have mastered the secret to wealth, I feel compelled as a legal practitioner to say, "My friend, if the secret to wealth were that easy to grasp, there wouldn't be so many people still searching for it."
Old coin traders might also say, "Do you know how I've been surviving all these years?" I'm not trying to discourage anyone interested in understanding Web 3.0. However, please don't oversimplify it.
What is Virtual Currency OTC?
To understand this issue, we first need to know what OTC is.
OTC (over the counter) literally means off-exchange trading, and this "exchange" refers to virtual currency trading platforms. The distinction between on-exchange and off-exchange is based on whether transactions are conducted through a trading platform. OTC can be divided into two forms:
Online peer-to-peer trading (C2C), which still requires the formation of transactions through a digital currency trading platform. Communication occurs on the trading platform, but the transaction is not completed through it. Instead, after both parties confirm the transaction, the buyer transfers money to the seller via Alipay, WeChat, bank transfer, etc.
Traditional methods, which involve personal introductions and the conventional buying and selling model, where individuals privately negotiate the terms of the transaction without using a platform.
Once we understand what OTC is, new friends might feel that there are more opportunities to profit, as it seems like a good old-school model. Is this really what I thought Web 3.0 was? Isn't this just "flipping"? I must say, my friend, you are spot on. The historical period that gave rise to "flippers" was precisely during the early stages of China's reform and opening up, when the market economy was underdeveloped and product demand was unmet.
Common Legal Risks for OTC Traders
Back to the main topic, in the current domestic situation, while virtual digital currency trading has not been legally defined as illegal, the high anonymity, high investment risks, strong secrecy, and cross-border flow characteristics of virtual digital currencies make OTC trading easily exploited by criminals for money laundering, evading foreign exchange controls, and illegal transactions. This brings our attention to the legal risks involved.
This is also the reason why the Hong Kong government aims to legislate and establish industry rules. It may seem like tightening regulations, but in reality, it makes things smoother. An industry without healthy game rules is like a highway without guardrails. It's easy to veer off the right path, leading to disaster.
Although virtual currency OTC in Hong Kong is entering a compliant era, there are no relevant movements indicating similar developments in mainland China. Engaging in virtual currency trading in mainland China is still rife with issues such as "illegal operations," "aiding," "organizing and leading pyramid schemes," and "concealment."
This is also why the risks are significant; one cannot just continue operating without concern, as authorities may come knocking. Of course, if we just want to operate as honest OTC traders, I believe it shouldn't be a big issue.
Through discussions with prominent traders, he pointed out that "aiding" is becoming or has already become the primary challenge for traders. Today, I will elaborate on the issue of "aiding."
The first article of the 2017 "Announcement on Preventing Risks of Token Issuance Financing" states, "Tokens or virtual currencies are not issued by monetary authorities, do not possess the attributes of legal tender and compulsion, do not have the same legal status as currency, and should not be circulated as currency in the market." Based on this, in China, virtual currencies do not possess monetary attributes and do not have payment and settlement capabilities. The announcement also indicates that the prohibited activities are limited to ICOs (Initial Coin Offerings) and prohibits exchanges from engaging in exchange and information intermediary activities. This means that as OTC traders, buying and selling virtual currencies among individuals is not legally defined as illegal activity.
How Do OTC Traders Become "Aiding" Criminals?
Let's first understand "aiding information network criminal activities." Upon seeing the full name of this crime, the word "aiding" stands out, so OTC traders become suspects not because we are traders, but because we "aided" information network criminal activities.
At this point, many OTC traders might cry out in injustice, "I haven't aided anyone! I don't know anything!" Our only means of "aiding" is the act of "receiving money"! This is a dilemma that all OTC traders face: how to receive clean money. I have asked seasoned traders this question, and they gave me a serious yet somewhat unconventional answer: "Receive cash." Indeed, receiving cash can physically sever the possibility of online crime, but what about large-scale or on-exchange traders? The offline business is only a small part of the overall operations. Therefore, we must conduct thorough KYC (Know Your Customer) checks for every client and every transaction. However, this may still not completely eliminate the connection to this crime.
In the "Interpretation of Several Issues Concerning the Application of Law in Criminal Cases Involving Illegal Use of Information Networks and Aiding Information Network Criminal Activities," the standards for establishing this crime are clearly defined:
From the perspective of the scope of assistance provided, there are standards for the number of individuals being assisted.
Considering the act of providing payment and settlement assistance, there are standards for the amount of payment and settlement.
Considering the act of providing advertising assistance, there are standards for the amount of funds provided through advertising.
From the perspective of the illegal gains of the perpetrator, there are standards for the amount of illegal gains.
From the perspective of the perpetrator's subjective malice, there are provisions for situations where the perpetrator has been administratively punished for illegal use of information networks, aiding information network criminal activities, or harming computer information system security within the past two years and has continued to aid information network criminal activities.
Considering the situation where the assisted individual commits a crime, there are provisions for cases where the crime committed by the assisted individual results in serious consequences. Furthermore, the elements of the crime clearly state that the suspect must be aware that their actions are aiding criminal activities, and it explicitly outlines seven scenarios of "awareness" for the "aiding" crime:
Continuing to engage in relevant activities after being informed by regulatory authorities, such as the Cyberspace Administration, telecommunications, or public security departments, that others are using the technical support or assistance provided to commit crimes.
Failing to fulfill legal management responsibilities after receiving reports, meaning the perpetrator knows that others are using their technical support or assistance to commit crimes but does not fulfill their obligations to stop providing services, cease transmission, or eliminate the issue as required by laws and regulations.
The transaction price or method is obviously abnormal, meaning the transaction price significantly deviates from market prices, and the transaction method does not conform to market norms.
Providing programs, tools, or other technical support specifically for illegal activities, meaning the programs, tools, or support provided are not necessary for normal production, life, or network services but are specialized services for aiding illegal activities, such as building phishing websites or creating Trojan programs.
Frequently using measures such as concealed internet access, encrypted communication, or data destruction, or using false identities to evade regulation or investigation.
Providing technical support or assistance to others to evade regulation or investigation.
Other circumstances sufficient to establish that the perpetrator was aware.
My suggestion for friends currently engaged in OTC trading is to compare their actions against the above situations. For example, if a client finds you through an exchange and requests a large deposit with immediate payment, could this situation be deemed as having an obviously abnormal transaction price and method?
OTC Traders Should Beware of "Illegal Business Operations"
Relevant legal provisions: Article 225 of the Criminal Law of the People's Republic of China states that illegal business operations refer to behaviors that violate national regulations and disrupt market order, with serious circumstances leading to imprisonment for less than five years or criminal detention, and fines of more than one to five times the illegal gains; in particularly serious cases, imprisonment for more than five years and fines of more than one to five times the illegal gains or confiscation of property:
- Operating items that are exclusively sold or restricted for sale without permission as specified by laws and administrative regulations.
- Buying and selling import and export licenses, certificates of origin, and other operating licenses or approval documents as specified by laws and administrative regulations.
- Illegally operating securities, futures, or insurance businesses without approval from relevant state authorities, or illegally engaging in payment and settlement services.
- Other illegal business activities that seriously disrupt market order.
From past cases, the third clause of the above legal provisions is the main basis for convicting OTC traders of illegal business operations. However, as mentioned earlier, in OTC, both modes involve direct transactions between buyers and sellers, and the settlement methods are conducted through payment institutions like WeChat and Alipay. Therefore, as normal OTC traders, we do not directly engage in payment and settlement services.
The "Notice on Issuing the Provisions on the Standards for the Filing and Prosecution of Criminal Cases Under the Jurisdiction of Public Security Organs (II)" issued by the Supreme People's Procuratorate and the Ministry of Public Security in 2022 also includes a provision used for convicting OTC traders of illegal business operations, stating that engaging in illegal foreign exchange transactions or disguised foreign exchange trading that disrupts financial market order is applicable. This is due to the fact that OTC traders may engage in transactions using foreign currencies. However, whether this constitutes the "realization" mentioned in the clause, I believe does not exist in normal OTC transactions. Although there are stablecoins like Tether that can be exchanged for USD, they are not classified as any foreign currency. Therefore, fundamentally, there is no issue of foreign exchange.
OTC traders are still diligently working to avoid receiving dirty money and having their accounts frozen, tirelessly engaging in risk avoidance. So, I genuinely want to ask all OTC traders, how are you doing? I believe this article may not provide much new content for seasoned OTC traders, as they have been treading carefully for a long time. For new OTC traders, I think it should provide a relatively clear understanding of legal risks. For those who have not entered the field, my clear suggestion remains: I do not recommend it.
Mankun Lawyers
Be diligent! KYC is extremely important; it is essential to uphold thorough checks for every client and every transaction. OTC traders face significant risks in promoting the circulation of virtual currencies, and in the process of risk avoidance, Mankun strives to use legal principles and regulations to address the issues faced by OTC traders. What we discussed today seems to highlight the original sin of OTC traders. However, this does not constitute a crime.
