Disorder and Legal Risks of Judicial Disposal of Virtual Currencies in China
Legal Risks of Judicial Disposal of Virtual Currencies in China
In a certain year, month, and place, the police brought Zhang San, an old player in the cryptocurrency circle, from the south to the north late at night.
Looking back at the sudden break-in by the police that night, Zhang San still had lingering fears and even felt a bit magical. It was said that there were also technical personnel from a certain security company accompanying the police to arrest people at his home. With the assistance of these professionals, the police took away Zhang San’s mobile phones, computers, cold wallets, foreign bank cards, and other items.
After arriving at the police station, the police worked overtime to interrogate Zhang San. During the process, the police asked Zhang San to sign an authorization letter, the general content of which was to combat crime and prevent property losses to victims. Zhang San voluntarily authorized the police to dispose of the virtual currency in his cold wallet and exchange accounts through the judicial system.
Although Zhang San felt that something was not quite right, after all, the matter had not been clarified. However, considering that it was necessary to cooperate with the police investigation, as it was the duty of a citizen, Zhang San still cooperated with the police and signed his name on the authorization letter, providing his account number and password on the cryptocurrency exchange. Subsequently, the virtual currency in Zhang San’s cold wallet and on the exchange was sold by the security company.
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Several days later, Zhang San met with a lawyer. After multiple communications between the lawyer and the police, Zhang San was released on bail pending trial. After coming out, Zhang San inquired with friends in the circle and learned that the company that assisted the local police in disposing of virtual currency assets had earned millions in service fees from this case.
It should be noted that the story above is fictional, but the plot that makes up this story is real. Similar plots may occur among cryptocurrency players every day.
01 Secrets of the Blockchain Industry
In September 2021, ten departments of the Chinese government jointly issued a document titled “Notice on Further Preventing and Dealing with Risks of Virtual Currency Trading Speculation” (referred to as “924 Policy”), which classified virtual currency and related business activities as illegal financial activities; virtual currency does not have the same legal status as fiat currency; virtual currency-related business activities are illegal financial activities; overseas virtual currency exchanges that provide services to residents within China through the internet are also engaged in illegal financial activities; participating in virtual currency investment and trading activities carries legal risks. Those who engage in the above-mentioned illegal financial activities that constitute a crime shall be held criminally responsible in accordance with the law.
The introduction of the 924 Policy announced that companies and behaviors engaged in virtual currency and RMB trading services in mainland China are illegal. However, as virtual currency is increasingly used by criminal organizations, the number of criminal cases involving virtual currency naturally increases, and the amounts involved are also rising.
On July 18, 2023, the Public Security Bureau of Shayang County, Jingmen City, Hubei Province, China, brought the main suspect of a cross-border online gambling case to trial. All transactions by the participants were settled using virtual currency, with a total transaction volume of 400 billion yuan. During the process of handling the case, the special task force successfully identified and froze virtual currencies worth 160 million US dollars (approximately 1 billion yuan). In October 2022, the People’s Court of Shayang County issued a judgment to confiscate a portion of the frozen virtual currencies in accordance with the law. This case became the first case in China where virtual currencies were confiscated by a court judgment (interested readers can refer to the article by Lawyer Honglin titled “The First Case of Confiscation of Virtual Currency by a Court Judgment in China: Hubei Police Crack Down on a Cross-Border Online Gambling Case with a Transaction Volume of 400 Billion!”).
Due to their focus on the niche market of blockchain legal services, colleagues including Lawyer Honglin often receive legal consultations and business cooperation opportunities regarding the judicial disposal of virtual currencies, both from legal professionals in various regions and from friends in the blockchain industry who have made fortunes in silence. The amounts involved in individual cases range from millions to billions. It can be said that the cases are getting bigger and the amounts are increasing.
So here’s the question: since conducting transactions between virtual currencies and Chinese yuan within China is illegal, how do the virtual currencies that have been seized and confiscated by Chinese judicial authorities become legal Chinese yuan in the national treasury?
With this simple question in mind, we conducted a special investigation and communicated with multiple virtual currency disposal merchants both domestically and internationally, trying to continuously clarify the common practices and industry chain of judicial disposal of virtual currencies in current Chinese judicial practice. To be honest, the results of the investigation surprised us. There are many things that cannot be said, but many things are being done.
We hope that the publication of research articles in the Man Kun series, including this article, will draw attention from industry friends and promote transparency and compliance in the judicial disposal process of the Chinese blockchain industry, while ensuring the protection of individuals’ legal property before judicial trial.
It should be noted that this article represents Lawyer Honglin’s personal views and does not constitute legal advice or recommendations on any specific matters. It is also not an endorsement or recommendation of any commercial institution. It is purely for learning and communication purposes, so please don’t read too much into it.
02 Common Paths for Judicial Disposal of Virtual Currencies in China
According to the industry research conducted by the Man Kun legal team, overall, whether it is the unilateral written authorization obtained by the public security during the investigation stage or the confiscation and disposal of virtual currencies after the court’s judgment, there are generally problems such as illegal procedures, lack of specific regulations, and inconsistent execution methods.
There are three common ways to dispose of virtual currencies:
Method 1: After obtaining authorization from the suspect or through judicial proceedings, the public security authorities will entrust specialized technology companies to handle the disposal. The disposal company, without going through the judicial evaluation process, opens an account on a cryptocurrency exchange and sells the virtual currencies directly to over-the-counter (OTC) merchants on the exchange through off-exchange transactions. The OTC merchants pay the disposal company in RMB, and after deducting the service fee (which can be negotiated and has a wide price range), the disposal company transfers the funds to the local finance department designated by the judicial authorities. Of course, considering that large-scale transactions within the exchange can easily drive down prices, this method is suitable for small-scale judicial disposals or cases where the judicial authorities do not have high requirements for disposal time.
Method 2: After signing a contract with the public security authorities, the disposal company receives a small amount of virtual currency from the police for wallet verification. Then, the disposal company finds buyers with a large amount of cash in places such as Yiwu and Shenzhen. After deducting the service fee, the disposal company hands over the cash to the local finance department designated by the judicial authorities or deposits it there. After the police confirm the receipt of the funds, they transfer the funds to the receiving address provided by the disposal company. These companies that can provide a large amount of cash within a short period of time often have more associations with underground banks.
Method 3: After signing a contract with the public security authorities, the disposal company cooperates with domestic and foreign trade companies to create a model of fictitious export trade. The overseas company remits money according to the contract, and the People’s Bank of China’s State Administration of Foreign Exchange converts it into RMB. The disposal company then pays the funds to the local finance department designated by the judicial authorities after deducting the service fee. After the judicial authorities confirm the receipt of each payment, they pay the corresponding amount of virtual currency to the wallet account specified by the disposal company.
03 Compliant Disposal Companies
In order to alleviate the concerns of judicial authorities regarding compliance and legality, more and more disposal companies are focusing on compliance. However, based on the standards and level of compliance in the current business, our Manqun team feels that there is some compliance, but it is not sufficient.
Currently, the common efforts of disposal companies to achieve compliance include the following aspects:
1. Obtain written authorization from the public security authorities
After reaching a cooperation intention with the judicial authorities, the disposal company will request the public security authorities to issue relevant explanatory letters or authorization letters, authorizing them to dispose of the relevant virtual assets involved in the case. If it is during the investigation stage of the case, there will also be a signed authorization letter from the suspect. At the same time as obtaining the authorization letter, the disposal company will sign a cooperation agreement with the public security department, specifying the transaction quantity, pricing basis, disposal completion deadline, and other necessary matters. Generally speaking, the wording of the contract and authorization letter is concise, and the relevant legal risks are usually agreed to be borne by the disposal company, taking into account the concerns of the colleagues in the judicial department.
2. Provide proof of fund legality
In order to prove the source and disposal ability of their funds, the proxy disposal company will proactively provide deposit certificates from multiple banks, emphasizing the legality and cleanliness of their funds. They can also match funds from different channels according to different disposal repayment ratio requirements of the judicial department. Generally speaking, the higher the level of legality proof of the funds, the higher the disposal cost.
3. Shell companies in different locations
In order to enhance their compliance level, proxy disposal companies usually establish or control multiple shell companies with only one natural person as the shareholder in advance. These companies are often registered as technology companies, and their legal representatives and shareholders may arrange “eighty-year-old seniors,” “cancer patients,” and other individuals to serve as representatives to complete the disposal of virtual currency assets. Each disposal corresponds to the cancellation of a company, avoiding potential legal liabilities afterwards.
4. Find partners to cooperate in bidding
In order to meet the procedural requirements of judicial authorities, proxy disposal companies proactively propose to dispose of virtual currency through “auctions” and other forms, and arrange for other third-party companies to participate in bidding. After winning the bid, a formal agreement is signed. Due to the sensitivity of the matter, relevant auction information is not disclosed through normal government websites.
04 Current legal risk analysis of judicial disposal of virtual currency
1. What are the legal risks for proxy disposal companies?
As mentioned earlier, proxy disposal companies in the industry are often just general limited liability companies registered for business purposes. They are often registered as technology companies with their business scope related to blockchain technology development and consulting. However, they usually do not have written descriptions of virtual currency judicial assessment or disposal. These companies do not have specific financial licenses or relevant business qualifications, and they do not have any substantial business operations. In short, these companies are created specifically for the judicial disposal of virtual currency.
Based on our understanding of China’s 924 policy, ordinary private companies registered in mainland China that engage in the exchange and matchmaking services between virtual currency and RMB without special operating qualifications are clearly engaged in illegal activities. This illegal behavior will not change due to authorization by grassroots judicial departments or written contractual agreements between parties. Therefore, a large number of judicial disposal companies on the market, when examining their entire transaction methods, actually establish channels for the circulation and exchange between virtual currency and RMB, which clearly violates the provisions of the 924 policy and may be involved in illegal operations.
Furthermore, for disposal companies, the obtained virtual currency must eventually be cashed out. After obtaining virtual currency, proxy disposal companies often clean the relevant virtual currency addresses through technical means for security reasons. For example, they use coin mixers to erase the on-chain addresses of the virtual currency and then sell it in small amounts to domestic foreign traders or high-net-worth buyers. Alternatively, they may cash out the virtual currency overseas through gray channels and then bring it back to China through “underground banks” or “false trade” after applying for foreign exchange settlement with the State Administration of Foreign Exchange, which often involves violations of anti-money laundering laws and regulations on foreign exchange management, carrying significant criminal legal risks.
2. What are the legal risks for judicial personnel?
(1) Risk of property loss
For the majority of judicial personnel, virtual currencies are still unfamiliar. Most grassroots judicial workers are often unaware of their market prices and trading patterns. In the process of judicial disposal, how much can a coin be sold for? Where should the transaction take place? These questions are usually not clear. Therefore, the disposal of the majority of virtual currencies involved in cases often does not go through any standardized procedures such as judicial appraisal or assessment. Instead, the daily transaction price recommended by the recommended disposal company is simply used as the basis for valuation. The manipulation phenomenon of the exchange is highly operable in the hands of large capital speculators, which means that the price benchmark for judicial disposal is also a problem, resulting in a certain risk of loss in the amount of disposal funds that ultimately return to the national treasury.
(2) Risk of disposal funds being involved in the case
Every industry is facing internal competition, and judicial disposal of virtual currencies is no exception. In addition to providing funds for disposal services at different levels of cleanliness, most recommended disposal companies often take the initiative to adopt a “payment first, then delivery” approach in order to dispel concerns about the police giving coins but not receiving money.
For general disposal companies, a daily disposal capacity of 500 million RMB is quite common, while the idle funds in the accounts of normal private trading companies are often not so abundant. Therefore, there may be a situation where multiple recommended disposal companies transfer funds from their bank accounts to the same receiving account. Previously, in China, there have been cases where the funds paid by a recommended disposal company to the police were actually funds frozen by another local police force investigating a different case. It can be said that when the big waters flow, the Dragon King Temple is flooded, and people within the same system do not recognize each other.
(3) Risk of being held accountable for misconduct
The increasing novelty of the industry and the amount of money involved in cases have attracted more and more intermediaries to focus on the lucrative business of judicial disposal of virtual currencies. We often receive inquiries from clients in the industry, claiming that they have billions of virtual currencies involved in cases that need judicial disposal. However, when I ask for some details, the other party starts to say that they are also inquiring on behalf of someone else, and the people in the middle of this inquiry are often like a Russian nesting doll, layer upon layer. Some friends jokingly say that if you haven’t been approached about the judicial disposal of virtual currencies in the industry, then you are definitely not an insider.
In this process, it is inevitable that a lot of rent-seeking activities will occur, which can be described as solving one problem and creating another new problem. As national judicial personnel, being led into a pit by third-party disposal companies under the guise of compliance because of a lack of understanding of industry operations, and then being investigated by the disciplinary inspection commission, is a bit too magical.