What are the legal risks of the controversial KOL financing in the cryptocurrency space?

*Written by: Liu Honglin, * Mankun Blockchain

SatoshiVM has become one of the hottest projects in the first half of 2024, one reason being the "drama" caused by KOLs.

In January 2024, SatoshiVM launched its token SAVM for the first time. Due to the hype created by many collaborating KOLs, the price of the SAVM token soared from the day of its launch, reaching $11.66 shortly after its release. However, it was soon revealed that KOLs received tokens from the project party and immediately sold them, leading to significant controversy and a subsequent decline in the token price. According to trading data from June 12, 2024, the lowest trading price of SAVM within 24 hours was $2.07, far from its earlier glory.

In fact, collaboration between crypto projects and KOLs has long been an industry-standard marketing approach, giving rise to the concept of KOL financing rounds. However, KOLs participating in KOL rounds face numerous legal issues, especially when the projects they are involved with experience significant market fluctuations.

Therefore, today, Mankun Lawyers will discuss the topic of crypto KOL rounds—what is a KOL round? What are its legal risks? How can these risks be mitigated?

01 KOL and KOL Rounds

(1) What is a KOL?

KOL (Key Opinion Leader) refers to individuals who possess more and more accurate product information, are accepted or trusted by relevant groups, and have a significant influence on the purchasing behavior of that group.

In the Web3.0 field, KOLs are essentially a group of influential figures in the crypto space with considerable investment experience or a keen sense for opportunities, who have accumulated a certain number of followers. They gain greater exposure due to the attention they receive, and the information they publish is seen by more people.

As "experts" in the Web3.0 field, they do not necessarily need to accumulate a large number of followers to be considered KOLs. Even KOLs with only 5,000 followers may receive promotional invitations from project parties and earn certain rewards through project promotion.

KOLs typically earn in two ways: the first is receiving immediate compensation, which is the common method for influencers, such as Giveaway KOLs on X or NBA stars promoting products; the second is acting as project investors, leveraging their influence as "equity technology" or directly participating in investments, receiving or purchasing project tokens at a discount after the project launches.

(2) How to Understand KOL Rounds?

KOL rounds refer to the second form mentioned above; the terminology differs due to different perspectives.

From the project party's perspective on financing, some cryptocurrency startups raise venture capital through equity, while others raise funds by selling their issued tokens or associated tokens. Of course, some companies adopt a mixed financing round approach that combines tokens and equity.

A KOL round refers to the project party inviting KOLs for promotion while also considering them as financing targets. Unlike other financing targets, KOLs, as early contributors to the project, can usually negotiate certain discounts when purchasing the project’s tokens, or even receive token allocations for free.

In April 2024, the Web3.0 asset data platform RootData released statistics on KOL participation in project financing over the past six months, with dingaling ranking first by participating in 21 projects.

It is noteworthy that the proportion of NFT players on this list is relatively high. One possible reason is that the NFT market has been underperforming in recent years. Therefore, NFT project parties and KOLs also need to seek new growth points and breakthroughs to further stimulate market activity. The collaboration between project parties and KOLs may be one reason for a large influx of NFT players into the primary and secondary markets.

02 Legal Issues to Note in KOL Rounds

(1) Regulatory Dynamics Related to KOL Rounds

In China, based on regulations such as the "Advertising Law," "Guidelines for the Conduct of Online Anchors," and the "Guiding Opinions of the State Administration for Market Regulation on Strengthening the Standardized Management of Online Live Broadcasting," traditional KOLs are required to clearly disclose their commissioned promotional relationships with brands in their text or video promotions and are subject to relevant supervision. For example, if a KOL inserts product promotion in a video, they must label it as an advertisement when releasing the video. However, there is currently no targeted legal support in the crypto industry in China.

In the United States, according to a KOL financing written contract disclosed by Bloomberg, KOLs investing at a discounted price must promote the project through long podcasts and TikTok videos; furthermore, KOLs must disclose their relationship with the project when promoting it.

Additionally, KOLs' crypto promotions are also subject to scrutiny by the U.S. Securities and Exchange Commission. For instance, in October 2022, Kim Kardashian was found to have violated U.S. regulations for failing to disclose her commissioned relationship with a project party while promoting a project token, leading to scrutiny and charges from the SEC.

However, in practice, it is often difficult for outsiders to know the relationship between project parties and KOLs, as well as the internal trading models. Moreover, not all project parties or KOLs will disclose their internal relationships. Therefore, unless there is a "whistleblower," relevant authorities find it challenging to obtain information about KOL rounds and often struggle to regulate them.

(2) False Advertising and Fraud Allegations

As surfers of Web3.0, many investors are aware that even if KOLs are merely paid to advertise and do not participate in project financing, their exaggerated promotions about a project should not be fully trusted. Following this line of thought, once KOLs purchase or intend to purchase project tokens and invest in the project, the authenticity of the project information they provide becomes even more questionable.

According to some industry insiders, very few KOLs can accurately state facts during promotions; their statements often contain vague, ambiguous, or even completely false content, intending to induce investors to buy project tokens.

In fact, KOLs' mixed messages and exaggerated promotions carry legal risks of civil fraud or even criminal fraud. According to Article 148 of the Civil Code, if KOLs' false statements lead investors to misunderstand and purchase tokens or participate in projects, resulting in financial losses, then KOLs' actions constitute civil fraud, and investors have the right to seek compensation.

More seriously, if KOLs have the intent to illegally possess investors' assets and use deceptive means to obtain investors' funds for the project, ultimately causing investors to suffer financial losses, then KOLs' actions are likely to violate Article 266 of the Criminal Law regarding fraud, leading to criminal liability.

(3) Risks of Illegal Pyramid Schemes

As previously stated, the cooperation model between KOLs and project parties often lacks transparency, making it difficult for outsiders to know the specific ways KOLs obtain project tokens. However, if the allocation of tokens to KOLs is linked to the number of investors successfully promoted, and KOLs conduct promotions within their paid communities, then such practices may be suspected of illegal pyramid schemes.

According to Article 224 of China's Criminal Law, the elements of organizing and leading pyramid schemes primarily include: collecting "entrance fees" + compensating based on "headcount" + enticing or coercing participants to continue recruiting others, forming a hierarchical structure of three levels or more.

Therefore, if KOLs meet these criteria while promoting projects—charging community fees, obtaining token rewards based on the number of investors developed, and enticing investors to continue recruiting downlines, forming a hierarchical structure of three levels or more—then KOLs' actions may violate the crime of organizing and leading pyramid schemes, leading to criminal liability.

(4) Risks of Being Identified as Accomplices in Criminal Offenses

Recently, the ZKasino project has drawn widespread attention to the risks of KOL project promotions. The project party announced a capital staking activity in March 2024.

Multiple KOLs participated in ZKasino's KOL round financing and promoted the project through Twitter, crypto community forums, and offline events, receiving corresponding token rebates and investment discounts.

However, after over a million users bridged over ten thousand ETH, the ZKasino project party unilaterally changed and deleted the official website activity description, failing to return the staked ETH as agreed and forcibly converting all users' ETH into platform tokens.

This behavior sparked significant controversy, and some KOLs involved in financing and promotion faced strong criticism and condemnation from fans after the project was accused of "soft rug" (running away with funds), being accused of engaging in profit transfer and shouldering corresponding criminal responsibilities as "accomplices."

Like the KOLs in this incident, many KOLs often believe that their actions of promoting projects and selling project tokens at high prices are merely normal business investment activities, unrelated to the project parties and not requiring accountability to users.

However, as the saying goes, "what brings success can also bring failure." KOLs can profit from the skyrocketing prices of project tokens, but they also face significant legal risks if the project encounters problems.

If the project party becomes embroiled in criminal offenses due to fundraising methods, project content, etc., and KOLs play a significant promotional role in the implicated project, then according to Article 25 of the Criminal Law of the People's Republic of China, KOLs are likely to be identified as having known or should have known about the project party's insider information and face accusations from judicial authorities, bearing relevant responsibilities.

Some seasoned KOLs have already recognized this risk and begun to take self-protection measures. For example, KOL KillTheWolf (0xKillTheWolf) shared on Twitter the reasons for refusing to participate in the ZKasino KOL round, including doubts about the project's valuation, revenue data, and distrust of the founder's character. This cautious attitude is worth emulating for other KOLs.

03 KOL Rounds Are Not So Appealing

From the analysis of the legal risks mentioned above, it is clear that KOLs participating in KOL rounds for Web3.0 projects and promoting them should pay attention to the following key points to avoid misleading investors and prevent involvement in criminal cases:

• Conduct comprehensive due diligence and risk assessments on the project, understanding key information such as the project's operational model, profit model, development prospects, and potential risks;

• Fully disclose their interest in holding the project's tokens when promoting the project;

• Avoid false advertising about the project and refuse to misuse their influence to manipulate the market.

Some KOLs may believe that being based overseas or promoting overseas projects exempts them from judicial oversight in China. This assumption is somewhat naive. According to relevant provisions of China's Criminal Law, as long as the criminal behavior or result occurs within China's jurisdiction, or KOLs hold Chinese nationality, China has jurisdiction.

Finally, Mankun Lawyers advise that KOLs in the Web3.0 field should exercise caution in any promotional activities, adopting a responsible attitude towards investors, so as to leverage the professional value of "key opinion leaders" and contribute to the healthy development of the Web3.0 ecosystem.