Recently, the Hubdex case trial that has been widely discussed in the Chinese cryptocurrency community for a long time has attracted significant attention due to the high profile of the individuals involved and the large controversy surrounding their conviction. As witnesses, participants, and frontline legal practitioners in the development of virtual assets in China, the Sajie team has been closely following the progress of this case since it occurred in 2021. Today, taking the opportunity of the Hubdex case trial, we would like to share our views and explain the concept of “organizational leadership in pyramid schemes” from the perspective of legal professionals for practitioners in the blockchain technology and virtual asset industry in mainland China.
The Sajie team would like to emphasize that all the information in this article comes from publicly available sources on the internet. We have neither seen the case files nor have any “internal information”. Our judgments are based solely on publicly available information and do not represent any comments on the facts of the case or the judgment. They are for reference only.
01 Hubdex Case, the Tragedy of Blockchain Entrepreneurs
In late 2018, Dr. Liang, who was at the peak of his career, saw the prospects of AI artificial intelligence, the internet revolution, and the development of blockchain technology. He formed a small team composed of top talents from prestigious universities to start a business in China and established a blockchain (public chain) called CoinXP. At the beginning, their main focus was on the research and development of blockchain underlying technology. Even with today’s perspective, CoinXP was still a rare team that “did more and talked less” in China’s blockchain industry. From this point of view, it was much more reliable than the numerous fraudulent projects seen today. Subsequently, the team built the HUBDEX exchange based on the CoinXP chain and issued their own cryptocurrency, HUB coin.
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Based on publicly available information, Dr. Liang’s initial intention was to build CoinXP into a blockchain that could compete with Ethereum. He hoped that in the context of the prosperous development of virtual assets in China at that time, CoinXP could create a prosperous virtual asset ecosystem in China. Therefore, the Hubdex exchange was like a “showroom” for CoinXP. Dr. Liang wanted to use the success of the “showroom” to prove that CoinXP could fulfill the promises made in the whitepaper, such as being clean, transparent, trustworthy, high-performance, and supporting cross-chain transactions. In this way, he aimed to attract domestic and foreign investors, customers, and application technology providers to use the CoinXP public chain.
The beauty of the initial intention was no match for the difficulties of reality. Unlike others, Dr. Liang did not fail due to technical challenges or being intoxicated by fame and fortune. In April 2021, Dr. Liang and members of his domestic team were arrested by the police, and virtual currencies worth hundreds of millions of yuan were frozen.
The prosecution believes that the Hubdex exchange controlled by Dr. Liang and others began implementing a referral-based hierarchical structure for customers on June 18, 2020. Each line could develop an unlimited number of levels, and the exchange rewarded the upper-level customers with rebates based on dynamic and static income, directly or indirectly using the number of development personnel and the amount of their purchases as the basis for rebates. At the same time, Dr. Liang’s team did not engage in any actual operational activities. They strengthened the management and training of the individuals involved and attracted investors through the establishment of an online community and offline promotional events. As of the time of the case, there were a total of over 50,000 registered accounts on the platform, more than 100 levels of hierarchy, and the total value of the funds involved in the case exceeded 239 million yuan.
02 What crime does the Hubdex case constitute?
It has to be said that even in the eyes of the Sa sister team, who have dealt with many similar criminal cases involving virtual asset service providers and blockchain practitioners, the Hubdex case has certain peculiarities. Its long investigation and prosecution time and the multiple changes in the charges make it relatively rare among similar cases. From the date of the incident on February 26, 2021, from the investigation stage to the prosecution stage, the case has undergone repeated changes from being investigated for “illegal use of information networks” to being charged with “organizing and leading pyramid schemes” and “illegal acceptance of public deposits.”
So, during the first trial, did Dr. Liang and other individuals involved in the Hubdex case constitute the “organizing and leading pyramid schemes” charge as accused by the prosecution? The Sa sister team believes that based on the existing publicly available information, there may be some controversy.
Article 224(1) of the Chinese Criminal Law stipulates the crime of “organizing and leading pyramid schemes”: Organizing and leading activities that use sales of goods, provision of services, etc. as a pretext, requiring participants to pay fees or purchase goods, services, etc. to obtain membership qualifications, and forming a hierarchical structure in a certain order, directly or indirectly using the number of personnel development as the basis for compensation or rebates, enticing or coercing participants to continue to develop others to participate, deceiving property, and disrupting the economic and social order of pyramid schemes shall be sentenced to fixed-term imprisonment of not more than five years or criminal detention, and shall also be fined; if the circumstances are serious, they shall be sentenced to fixed-term imprisonment of not less than five years and shall also be fined.
For the crime of organizing and leading pyramid schemes, the most important thing in practice is to determine the organization’s business model, profit method, and personnel composition. According to the Supreme People’s Court, the Supreme People’s Procuratorate, and the Ministry of Public Security’s “Opinions on Several Issues Concerning the Application of Law in Handling Criminal Cases of Organizing and Leading Pyramid Schemes” issued in 2013, Article 1 clearly states: “If the number of participants in the organization engaging in pyramid schemes is more than thirty and the hierarchy is more than three levels, criminal responsibility shall be pursued against the organizers and leaders.”
If we follow the criminal facts determined by the prosecution, that is, HUBDEX exchange requires users to “pledge” virtual currency (obtained after payment of consideration through purchase or other means) as a prerequisite for “entry,” and obtains static returns based on the quantity of “pledged” virtual currency, and then develops downlines through the method of “recruiting,” rewarding and rebating based on the amount of virtual currency “pledged” by the downlines. In the case of a large number of users and a hierarchy of 100 levels, it seems that the crime of organizing and leading pyramid schemes is already a certainty. However, HUBDEX exchange seems to be different from traditional cases of organizing and leading pyramid schemes.
First of all, one of the typical characteristics of pyramid schemes is the coexistence of static returns and dynamic returns. However, the Sa sister team believes that the static returns provided by HUBDEX exchange for user pledges are not significantly different from the dynamic returns obtained from “developing downlines.” In traditional cases of organizing and leading pyramid schemes, pyramid organizations will deliberately create a large difference in profit between static returns and dynamic returns, making it almost impossible to profit from static returns, in order to force victims to continuously develop downlines.
Secondly, in the crime of organizing and leading pyramid schemes, it is necessary for the activity to be a non-“team-based” pyramid scheme where “the number of recruits is used as the basis for rewards or rebates” in order to constitute a crime. This requires the recruited participants of the pyramid scheme to develop other people to join, forming a hierarchical relationship, and calculating and paying rewards to the upline based on the number of recruits in the downline. The judicial interpretation is clear: “Pure ‘team-based’ pyramid schemes that aim to sell goods and use sales performance as the basis for rewards are not treated as criminal activities. Whether HUBDEX Exchange has real business operations or provides services to users will be the key to determining whether it constitutes the crime of organizing and leading pyramid schemes. However, based on publicly available information, it is currently impossible to make a judgment on this.
03Conclusion
The Sa Sister team needs to emphasize that currently, many people believe that HUBDEX Exchange and Dr. Liang have not deceived users or misappropriated property, and therefore do not constitute the crime of organizing and leading pyramid schemes. However, this understanding of the requirement to deceive property in the crime of pyramid schemes is actually inaccurate. The victim’s mistaken belief is an element of the crime of fraud, and the “deception of property” in the crime of organizing and leading pyramid schemes is different in judicial practice.
The “deception of property” in the crime of organizing and leading pyramid schemes refers to the organizer or leader of the pyramid scheme fabricating or distorting national policies, fabricating or exaggerating business, investment, service projects, and profit prospects, concealing the true source of rewards or rebates or other fraudulent means, and carrying out the acts prescribed in Article 224(1) of the Criminal Law of China [crime of organizing and leading pyramid schemes], and illegally profiting from the fees paid by participants or the purchase of goods or services should be deemed as deceiving property. It can be seen that whether the participants in the pyramid scheme subjectively believe they have been deceived does not affect the court’s determination of whether the element of “deception of property” in the crime of organizing and leading pyramid schemes is satisfied.
The Sa Sister team has seen that some people who are more familiar with the case have introduced that the dynamic profit calculation in HUBDEX Exchange is based on the dynamic computing power of the participants. In other words, when a user invites downline users and subsequently invites more users, the upline will be rewarded with a certain amount of “computing power” after the downline pledges HUB coins. In the process of profit distribution, the distribution of the newly released Hub coins is based on the proportion of the individual user’s computing power in the total computing power of all users.
This behavior is highly controversial in the academic community. On one hand, if the blockchain is a thriving ecosystem that can provide users with numerous real services (such as blockchain certification and product traceability), then “computing power” can also be regarded as a real “commodity or service”. On the other hand, if the blockchain itself cannot provide any actual services other than issuing coins and hosting the HUBDEX Exchange, it is likely to be considered as using “computing power” as a disguise to reward “people”.
In short, when the dust has not yet settled and the tide has not receded, all evaluations are subjective. The Sa Team always hopes that China’s virtual asset industry can thrive. This not only requires regulatory agencies and judicial authorities to strengthen their profound understanding of laws and criminal justice policies, but also requires practitioners to understand and stay away from all possible legal red lines and operate in compliance.
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