Analysis of the Conviction Pathways of Judicial Authorities in Cases Involving Virtual Money Pyramid Schemes and Fraud Crimes

1. Introduction

Recently, Lawyer Liu (web3_lawyer) has been organizing and researching criminal cases related to virtual currencies. After reviewing many cases, it becomes easy to summarize the "judicial hidden rules" that judicial authorities follow when handling cryptocurrency-related cases, or in a more legal sense, the issue of path dependence in the standards of conviction.

In this article, we will discuss how certain behaviors are determined to constitute a crime in the judicial practice regarding some common cryptocurrency-related crimes.

2. Case Introduction

In April 2020, the Zhejiang Provincial High People's Court issued a criminal verdict in the case of fund-raising fraud by Xia Moumou et al. ((2020) Zhe Xing Zhong No. 9), which stated that "in the name of virtual currency transactions, soliciting investment from the public, and using pyramid marketing methods to develop offline layer by layer, and using blockchain technology to publicize and attract investment to the society, but actually manipulating prices to make profits from it, should be characterized as a crime of fraud, and cannot be determined as a lesser crime of organizing or leading pyramid schemes or illegally absorbing deposits from the public." ”

A case concentrates on business models or scenarios such as token issuance, promotion, marketing, and ICO.

What is interesting about this case is that Xia Moumou and others were sentenced by the Zhongxiang Municipal Court of Hubei Province for organizing and leading pyramid marketing activities ((2013) E Zhongxiang Xing Chu Zi No. 188), and a suspended sentence was applied. However, on December 3, 2019, the Hangzhou Intermediate People's Court revoked the aforementioned judgment of the Hubei Zhongxiang Municipal Court, and Xia Moumou was directly sentenced to life imprisonment by the Hangzhou Intermediate People's Court for the crime of fundraising fraud. Of course, Xia Moumou and others appealed against the judgment, but the Zhejiang Provincial High Court rejected the defendant's above and upheld the judgment of the Hangzhou Intermediate People's Court. What is the reason for such a large gap in the verdicts of the two courts, the gap between probation and life is simply "heaven" to hell.

This involves the study of the conviction logic of common pyramid scheme crimes and fraud-related crimes in the cryptocurrency industry.

3. Common currency-related crimes and the logic of criminalization

(1) Is it illegal to conduct transactions related to virtual currency?

The court held that since September 2017, when seven ministries and commissions of the People's Republic of China jointly issued the Announcement on Preventing the Risks of Token Issuance and Financing (i.e., the "9.4 Announcement"), the issuance of tokens in China is essentially an "act of illegal public financing without approval", which is suspected of illegal fundraising and other illegal and criminal activities. Public publicity in the name of "virtual currency" is non-compliant or even illegal.

Even virtual currencies issued on overseas platforms can only circulate online. If one wants to ultimately realize their value, they still need to be exchanged for fiat currencies that circulate in reality. The issuance of virtual currencies has not received national recognition and inherently has no circulating value; they can only exist as a virtual concept without actual economic value.

In the case of Xia and others, the total amount of virtual currency issued by the parties involved is not fixed. The perpetrators use platform data to gift platform tokens based on the number of participants who develop downlines, thereby expanding the scale of funds and the number of participants; the platform then artificially drives up the token price through efforts such as pump and dump, creating a false prosperity and continuously enticing new investors to join. Essentially, this is a form of a Ponzi scheme.

Therefore, in this case, both the Hangzhou Intermediate Court and the Zhejiang High Court believe that the issuer (seller) in virtual currency transactions is certainly violating the law, but it is not clear whether ordinary participants (buyers) are violating the law.

(2) Common Types of Crimes Involving Cryptocurrency

Common types of cryptocurrency-related crimes include fraud crimes (such as fraud, contract fraud, and fundraising fraud), pyramid scheme crimes, operating gambling houses crimes, and illegal business operations.

For fraud crimes, it essentially requires the perpetrator to defraud others of property (including mainstream virtual currencies with property value) for the purpose of illegal possession; MLM crimes are divided into project parties (coin issuing entities) and active participants, with fictitious projects or projects without real business background as gimmicks, forming more than three layers of structure and having rebate mechanisms, and its essential characteristics are also that the perpetrators are trying to defraud ordinary participants of their property; For example, some common perpetual contracts and virtual currency games may be recognized by the judicial authorities as gambling, and the platform party will be recognized as a casino; There are two situations for the crime of illegal currency operation: one is the crime of illegal foreign exchange operation involving virtual currency, especially stable coins (USDT, USDC), when it is equivalent to foreign exchange or used as an exchange tool for RMB and foreign exchange; Second, when the perpetrator carries out business payment and settlement acts in the name of virtual currency transactions, it constitutes the crime of illegal business operation.

(3) The Logic of Criminalization Involving Cryptocurrency Crimes

Taking the case of Xia XX involving pyramid scheme crimes and fundraising fraud as an example, we will analyze the logic of criminalization in cryptocurrency-related crimes.

1. Pyramid scheme crime

The elements of traditional pyramid scheme crimes (organizing and leading pyramid scheme activities) at least include the following contents:

First, the actor sets thresholds (such as paying membership fees, purchasing goods or services, virtual currencies, etc.) under the pretext of providing goods, services, or developing platforms and projects to attract participants.

The second is to use the number of personnel developed directly or indirectly as the basis for calculating compensation or rebates.

Thirdly, the pyramid scheme organization needs to reach more than three levels and have more than thirty people.

The ultimate goal of the actor (project party) is to defraud participants of their property.

For example, for a coin issuing platform, we need to evaluate whether it constitutes a pyramid scheme, and we need to review whether the virtual currency issued by the platform is a worthless air coin, and whether the participants have a participation threshold (some platforms have a zero threshold on the surface to increase airdrops for free, but with the growth of the platform, ordinary participants still need to replace the platform currency with mainstream currencies such as USDT to expand the pot funds). As for the three-level and 30-person conditions, the current judicial practice adopts an extensive evaluation model, and the downline wallet addresses developed in the virtual currency platform can easily be identified as more than three levels, and more than 30 people are generally fixed through witness testimony in practice, even if the evidence in the case may not be supported by the physical evidence of the witness's purchase and investment in virtual currency. As for the last point of judgment of "defrauding property", the property value attribute of mainstream virtual currencies has been recognized by most judicial authorities in the mainland, and if the platform replaces the participants' mainstream coins with air coins, then there is a high probability that it will be determined to defraud others of their property.

2. Fraud-related crimes

In judicial practice, the essence of fraud is that the perpetrator deceives others to obtain their property. The perpetrator causes the victim to have a misunderstanding, leading them to dispose of their own or others' property, ultimately resulting in damage to the rights of the property owner. For the victim, it is a form of "unconscious self-harm behavior." In cases of virtual currency fraud, air coins have no value, but they can be used as a tool for deception, allowing the perpetrator to exchange them for mainstream coins.

The victim was deceived into giving mainstream coins to the scammer, receiving only worthless air coins that were promised to appreciate a hundredfold or a thousandfold.

The crime of fund-raising fraud and the crime of contract fraud are special crimes of fraud, and the constitutive elements of the fraud part of the two crimes are no different from those of ordinary fraud. Returning to the case of Xia Moumou discussed in this article, the main basis for the Hangzhou Intermediate People's Court and the Zhejiang High People's Court to change the crime of pyramid scheme to the crime of fund-raising fraud is that although Xia Moumou et al. induced the victim to invest in their platform by setting points, levels, and pulling people back, Xia Moumou et al. and their platform essentially implemented illegal fund-raising means to attract investors through virtual currencies with no actual value, and the platform formed a precipitation capital pool (mainstream currency), and the virtual currency issued by them was essentially used for speculation, Tempting the victim to engage in a tool called investment is actually a fraud, and Xia's behavior is essentially an illegal fundraising act.

In addition, Xia and others used the raised funds to purchase real estate, cars, land, and commercial insurance, and some of the funds were also transferred overseas. The court believes that this behavior also demonstrates that Xia and others had the subjective intent to commit fundraising fraud.

From this, we can glimpse the judgment standards and scales of our judicial authorities in practice regarding criminal cases involving cryptocurrencies, especially in cases of pyramid schemes and fraud, as seen in the case of Xia Moumou's fundraising fraud.

IV. Conclusion

As web3 lawyers, we have always advocated that investment in virtual currencies is not explicitly prohibited under the current regulatory policies in China. However, it should be added here that even in the "9.24 Notice" (Notice on Further Preventing and Dealing with the Risk of Speculation in Virtual Currency Transactions), we can conclude from the provisions of the ten national ministries and commissions that "if any legal person, unincorporated organization or natural person invests in virtual currency and related derivatives contrary to public order and good customs, the relevant civil legal acts shall be invalid, and the losses arising therefrom shall be borne by themselves", and we believe that domestic virtual currency investment belongs to the field of citizens' own risk; However, judicial organs can also use the second half of the previous sentence in the "September 24 Notice": "If it is suspected of undermining financial order or endangering financial security, the relevant departments shall investigate and deal with it in accordance with the law" as the basis for their own law enforcement and even justice.

But to what extent does it count as "suspected of undermining financial order and endangering financial security"? The right of interpretation is often in the hands of the relevant departments, and in practice, the understanding of the "relevant departments" in Shenzhen and Shanghai and the "relevant departments" in a certain place in the central and western regions is often different.