Recently, the long-awaited Hubdex trial in the domestic cryptocurrency community has attracted significant attention due to the high profile of the individuals involved and the controversy surrounding their conviction. As a witness, participant, and frontline legal practitioner in China’s virtual asset development, the Sa Jie team has been closely following the progress of this case since it occurred in 2021. Today, we take the opportunity of the Hubdex trial to share our views and, from the perspective of legal professionals, explain the concept of “organizational leadership of pyramid schemes” for practitioners in the blockchain technology and virtual asset industry in mainland China.
It is important to note that all the information in this article comes from publicly available internet sources. We have neither seen the case files nor have any so-called “internal information.” All judgments are based on information from public sources and do not represent any comments on the facts of the case or the judgments made. They are for reference only.
01. Hubdex Case, the Tragedy of Blockchain Entrepreneurs
In late 2018, Dr. Liang, who was in his prime, saw the prospects of AI artificial intelligence, internet revolution, and the development of blockchain technology. He formed a small team composed of top talents from prestigious universities and returned to China to start a business. He established a blockchain (public chain) called CoinXP, initially focusing on the research and development of blockchain underlying technology. Even by today’s standards, CoinXP was still one of the few teams in China that “did more and talked less,” making them more reliable than the countless fake chains and fraudulent schemes seen today. Subsequently, the team created the HUBDEX exchange based on the CoinXP chain and issued their own cryptocurrency, HUB tokens.
- Explained in One Article | Will USDT Tether be the Biggest Bombshell in the Cryptocurrency Community?
- Bankless In-depth explanation of Axie Infinity’s new on-chain upgrade system AXP
- Starting from on-chain data, sorting out the current status of the Solana ecosystem.
From publicly available sources, Dr. Liang’s original intention was to build CoinXP into a blockchain comparable to Ethereum. He hoped that in the context of the flourishing development of virtual assets in China at that time, CoinXP could create a prosperous virtual asset ecosystem. Therefore, the Hubdex exchange was like a “showroom” for CoinXP. Dr. Liang wanted to use the success of the “showroom” to prove that CoinXP, as promised in the whitepaper, was clean, transparent, trustworthy, high-performance, and supported cross-chain transactions. This would attract domestic and foreign investors, customers, and application technology partners to use the CoinXP public chain.
The beauty of the original intention was no match for the difficulties of reality. Unlike others, Dr. Liang did not fail due to technical challenges or get lost in luxury. 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 started from June 18, 2020, and set up a hierarchical structure for customers based on an invitation system. Each line can develop unlimited levels. After the downstream customers pledge HUB coins, the exchange rewards the upstream customers based on dynamic and static income, directly or indirectly using the number of development personnel and purchase amount as the basis for rebates. At the same time, Dr. Liang’s team has no actual operational activities. They strengthen the management and training of the people involved through the establishment of online communities, offline promotion meetings, etc., and promote externally to attract investors. As of the time of the case, there were more than 50,000 registered accounts on the platform, with more than 100 hierarchical levels, and the total amount involved in the case was worth more than 239 million yuan.
02. What crime does the Hubdex case constitute?
It must be said that even in the eyes of the Sajie team, who has handled many similar criminal cases involving virtual asset service providers and blockchain practitioners, the Hubdex case has certain particularities. It is quite rare among similar cases in terms of the long investigation and prosecution time and the multiple changes in charges. From the date of the incident on February 26, 2021, from the investigation stage to the prosecution stage, the case underwent repeated changes from “illegal use of information networks” to “organizing and leading pyramid schemes” to “illegal absorption of public deposits.”
So, in this first-instance trial, do Dr. Liang and other individuals involved in the Hubdex case constitute the “organization and leadership of pyramid schemes” as charged by the prosecution? The Sajie team believes that based on the existing publicly available information, there may be some controversy.
Article 224-1 of the Criminal Law of China stipulates the “crime of organizing and leading pyramid schemes”: those who organize and lead pyramid schemes under the name of selling goods, providing services, and other business activities, requiring participants to pay fees or purchase goods, services, etc. to obtain membership qualifications, and to form a hierarchical structure in a certain order, directly or indirectly using the number of development personnel as a basis for rewards or rebates, enticing or coercing participants to continue to develop others, deceive property, and disrupt economic and social order, 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 operating model, profit method, and personnel composition. According to the opinions issued by the Supreme People’s Court, the Supreme People’s Procuratorate, and the Ministry of Public Security in 2013 on “Several Issues Concerning the Application of Criminal Laws in Handling Cases of Organizing and Leading Pyramid Schemes,” Article 1 clearly states: “If the number of participants in the organization engaged in pyramid schemes is more than 30 and the hierarchical level 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, the Hubdex exchange uses the “pledging” of virtual currency (obtained by purchasing or other means of payment) as a prerequisite for “entry,” obtains static income based on the amount of “pledged” virtual currency, and then develops downstream by “recruiting” people, rewards and rebates are calculated based on the amount of virtual currency “pledged” by the downstream, and obtains dynamic income. In the case where the hierarchical level has reached 100 levels and the number of users is extremely large, it seems to be a clear case of organizing and leading pyramid schemes. However, the Hubdex exchange seems to be different from traditional cases of organizing and leading pyramid schemes.
First of all, the coexistence of static income and dynamic income is one of the typical characteristics of pyramid schemes, but the Sa Jie team believes that the difference between the static income provided by HUBDEX Exchange and the dynamic income obtained from “developing downlines” is not extremely large. In traditional organized and leading pyramid schemes, pyramid organizations will greatly exaggerate the difference in profits between static income and dynamic income, making it almost impossible to profit from static income, thereby forcing victims to continuously develop downlines.
Secondly, in the crime of organizing and leading pyramid schemes, it must be a non-“team reward” pyramid scheme that “bases rewards or rebates on the number of people developed”, rather than a “team reward” pyramid scheme, in order to constitute a crime. This requires that the people developed in the pyramid scheme develop other people to join, forming a relationship between uplines and downlines, and calculating and paying rewards to uplines based on the number of downlines developed. The judicial interpretation clearly states: “Pure ‘team reward’ pyramid schemes based on selling goods and using sales performance as the basis for rewards are not treated as crimes. Whether HUBDEX Exchange has real business or actually provides what kind of services to users will be the key to determining whether HUBDEX Exchange constitutes the crime of organizing and leading pyramid schemes. According to public information, it is currently impossible to make a judgment on this.
The Sa Jie team needs to remind everyone that there are currently many people on the internet who believe that HUBDEX Exchange and Dr. Liang did not deceive users and did not defraud property, and therefore do not constitute the crime of organizing and leading pyramid schemes. However, this understanding of the requirement of defrauding property in the crime of pyramid schemes is actually inaccurate. The victim’s involvement in mistaken cognition is a constitutive element of the crime of fraud, and the so-called “defrauding property” in the crime of organizing and leading pyramid schemes is different from the crime of fraud in judicial practice.
The “defrauding property” in the crime of organizing and leading pyramid schemes refers to the behavior of the organizers and leaders of pyramid schemes 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, as stipulated in Article 224(1) of the Criminal Law, and illegally profiting from the fees paid by participants in pyramid schemes or the fees for purchasing goods and services. Therefore, whether the participants in pyramid schemes subjectively believe that they have been deceived does not affect the court’s determination of whether the requirement of “defrauding property” in the crime of organizing and leading pyramid schemes is satisfied in judicial practice.
The Sa Jie team has seen that some people who have a better understanding of the case have introduced that the calculation of dynamic income in HUBDEX Exchange is based on the participants’ dynamic computing power. In other words, when users invite downline users and subsequently invite more users under their downline to pledge HUB coins, the uplines will be rewarded with a certain amount of “computing power”. In the process of profit distribution, the distribution of newly released Hub coins each day is based on the proportion of individual users’ computing power to the total computing power of all users.
This behavior is highly controversial in the academic community. On the one hand, if the blockchain is a thriving ecosystem that provides users with many real services (such as blockchain certification, product traceability, etc.), then “computing power” can also be considered as a real “commodity or service”. On the other hand, if the blockchain itself, apart from issuing coins and hosting the HUBDEX exchange, cannot provide any actual services, it may be deemed as remuneration in disguise using “computing power” in the name of “human”.
In conclusion, while the dust has not settled and the tide has not receded, all evaluations are subjective. The Sajie team always hopes that China’s virtual asset industry can thrive. This not only requires regulatory agencies and judicial authorities to strengthen their deep understanding of laws and criminal justice policies, but also requires practitioners to understand and stay away from any possible legal red lines, and operate in compliance.