Written by: Lawyer Liu Honglin
Introduction
In a certain year, month and place, the police took Zhang San, a veteran cryptocurrency player, from the south to the north late at night.
Looking back at the sudden break-in by the police that night, Zhang San still has lingering fears, and even feels a little magical. It is said that the technicians from a security company accompanied the police to arrest him at home. With the assistance of professionals, the police took away Zhang San’s mobile phones, computers, cold wallets, foreign currency bank cards, etc.
After arriving at the police station, the public security personnel worked overtime to interrogate Zhang San. During the interrogation, the police asked Zhang San to sign an authorization letter. The general content was that in order to combat crime and avoid property loss of victims, Zhang San voluntarily authorized the police to take judicial action on the virtual currency in his cold wallet and exchange account.
Although Zhang San felt that something was a bit wrong, after all, the matter had not been investigated clearly. However, considering that it was necessary to cooperate with the police investigation, after all, it was the obligation of citizens, Zhang San still cooperated with the police and signed the authorization letter and provided his account and password in the virtual currency exchange. Subsequently, Zhang San's virtual currency in the cold wallet and the virtual currency in the exchange were transferred and sold by the security company.
A few days later, Zhang San met with a lawyer. After several communications between the lawyer and the police, Zhang San was released on bail. After he was released, Zhang San asked his friends in the industry and learned that the company that assisted the local police in disposing of virtual currency assets had earned millions of dollars in service fees from this order.
It should be noted that the above story is fictional, but the plot that puts together this story is real. Similar plots may happen every day among virtual currency players.
01 The secrets of the blockchain industry that cannot be told
In September 2021, ten national departments jointly issued the "Notice on Further Preventing and Dealing with the Risks of Virtual Currency Trading Speculation" (referred to as the "924 Policy"), which defined virtual currency and related business activities as illegal financial activities; virtual currency does not have the same legal status as legal currency; virtual currency-related business activities are illegal financial activities; overseas virtual currency exchanges providing services to residents in my country through the Internet are also illegal financial activities; and there are legal risks in participating in virtual currency investment and trading activities. Those who engage in the above illegal financial activities and constitute a crime shall be held criminally liable in accordance with the law.
The introduction of the 924 policy declared that companies and behaviors engaged in virtual currency and RMB trading services in mainland China are illegal. However, as virtual currency is used more and more frequently by criminal gangs, criminal cases involving virtual currency are naturally increasing, and the amount involved is also rising.
On July 18, 2023, the Public Security Bureau of Shayang County, Jingmen City, Hubei Province, sent the main culprit of a cross-border online gambling case to trial in accordance with the law. All transactions of the gamblers were settled in virtual currency, and the turnover involved reached 400 billion. During the case handling process, the task force followed the clues and successfully locked and froze the virtual currency involved in the case worth 160 million US dollars (about 1 billion yuan). In October 2022, the People's Court of Shayang County made a judgment to confiscate some of the frozen virtual currency in accordance with the law. This case became the first "virtual currency first case" in the country to be confiscated by court judgment.
(If you are interested, you can click on Honglin’s article "People in the cryptocurrency circle, please eat melons correctly: Hubei police cracked the country’s "first virtual currency case", with a turnover of 400 billion!")
Because of their focus on the blockchain legal services market, Mankiw’s colleagues, including attorney Honglin, often receive legal advice and business cooperation requests on how to deal with the virtual currency involved in the case. These include lawyers from local police departments or courts, as well as friends who have made a fortune in the blockchain industry. The amount of money involved in the judicial disposal of a single case ranges from a few million to tens of billions. It can be said that the bigger the case, the more money is involved.
So the question is: since it is illegal to engage in virtual currency and RMB transactions in China, how can the virtual currencies that have been investigated and confiscated by Chinese judicial authorities be turned into legal RMB in the national treasury?
With such a simple question in mind, we conducted a special investigation, communicated and discussed with multiple virtual currency disposal companies at home and abroad, and tried to continuously sort out the common operations and upstream and downstream of the industrial chain of judicial disposal of virtual currency in China's current judicial practice. To be honest, the results of the investigation surprised us. Many things cannot be said, but many things are being done.
We hope that the publication of Mankiw’s series of research articles, including this one, will attract the attention of friends in the industry, and while ensuring that the legal property of individual citizens before judicial trial is protected, it will also promote transparency and compliance in the judicial disposal of China’s blockchain industry.
It should be noted that this article only represents the personal views of Honglin lawyers and does not constitute legal opinions or suggestions on any specific matters. It is not an endorsement or recommendation of any commercial organization. It is purely for learning and communication. Please don't think too much about it.
02 Common Paths for Judicial Disposal of Virtual Currency in China
According to the industry research conducted by Mankiw's legal team, overall, whether it is the police unilaterally obtaining written authorization from the suspect during the investigation stage, or the confiscation of virtual currency after the court trial, there are generally problems such as illegal procedures, unclear regulations, and inconsistent enforcement methods.
There are three common ways to dispose of virtual currency:
Method 1: After obtaining authorization from the criminal suspect or judicial trial, the public security organs will entrust a specialized technology company on the market to carry out disposal. The disposal company will open an account on the virtual currency exchange without going through the judicial evaluation process, and sell it directly to OTC merchants on the virtual currency exchange in an over-the-counter transaction. The OTC merchant pays RMB to the disposal company, and the disposal company deducts the service fee (the price is negotiable, and the price range is exaggerated), and pays it to the account of the local financial department designated by the judicial organ. Of course, considering that large-scale transactions on the exchange can easily bring down prices, this type of disposal is suitable for small-scale judicial disposal or cases where the judicial organs do not have high requirements for the number of days for disposal.
Method 2: After the public security organ and the disposal company sign a contract, the public security organ will pay a small amount of virtual currency to verify the wallet. Then the disposal company will find some buyers with a large amount of cash in Yiwu, Shenzhen and other places. After deducting the service fee, the disposal company will hand over or deposit the cash to the local financial department designated by the judicial organ. After the public security organ checks the funds, it will transfer the money to the address provided by the disposal company. These companies that can take out a large amount of cash in a short period of time are often closely related to underground banks.
Method 3: After the public security organ and the disposal company sign a contract, the disposal company cooperates with a domestic foreign trade company and, through a fictitious export trade model, the foreign company remits money in accordance with the contract, and the foreign exchange is converted into RMB through the People's Bank of China's Foreign Exchange Administration, and then handed over to the disposal company. After deducting the service fee, the disposal company pays it to the account of the local financial department designated by the judicial organ. After each payment is confirmed, the judicial organ pays the corresponding amount of virtual currency to the wallet account designated by the disposal company.
03 A disposal company that strives to comply with regulations
In order to reduce the judicial authorities' concerns about compliance and legality, more and more disposal companies have begun to focus on compliance. However, the current compliance scale and level of their businesses, as our Mankiw team has observed, is that it exists, but is not enough.
At present, the more common compliance efforts of disposal companies in the industry include the following aspects:
1. Obtain written authorization from the public security department
After reaching a cooperation intention with the judicial authorities, the disposal company will ask the public security to issue a relevant explanation letter or authorization letter to authorize it to dispose of the assets of the virtual currency involved in the case; if it is in the investigation stage of the case, there will also be a signed authorization letter from the suspect. When receiving the authorization letter, the disposal company will sign a cooperation agreement with the public security department to stipulate the transaction quantity, pricing basis, disposal completion deadline and other necessary matters. Generally speaking, the text of the contract and authorization is relatively concise, and the relevant legal risks are usually agreed to be borne by the disposal company, which is very considerate of the relevant colleagues in the judicial department.
2. Provide proof of the legality of funds
In order to prove their source of funds and disposal capabilities, the disposal company will proactively provide deposit certificates from multiple banks, emphasizing the legality and cleanliness of its funds. It can also match funds from different channels based on the different disposal recovery ratio requirements of the judicial department. Generally speaking, the higher the legality proof of the funds, the higher the disposal cost.
3. Shell companies that move from one place to another
In order to improve its compliance level, the agency disposal company usually sets up or controls multiple shell companies with only one natural person as shareholder. The company is often registered as a technology company, and its legal representative and shareholder will be arranged to be "eighty-year-old man" or "cancer patient". When a virtual currency asset disposal is completed, a company will be cancelled to avoid subsequent legal liability.
4. Find partners to bid together
In order to meet the procedural requirements of judicial authorities, the disposal company will proactively propose judicial disposal of virtual currency through "auction" and other forms, and arrange other third-party cooperative companies to participate in the bidding, and then sign a formal agreement after winning the bid. Due to the sensitivity of the matters involved, the relevant auction information will not be announced through normal government websites.
04 Analysis of the legal risks of current judicial disposal of virtual currencies
1. What are the legal risks of disposing of a company on behalf of others?
As mentioned above, the disposal companies in the industry are often just general limited liability companies registered with the Industrial and Commercial Administration. They are often technology companies, and their business scope may include blockchain-related technology development and consulting, but usually there is no written description of virtual currency judicial evaluation or judicial disposal. The company does not have a specific financial license or relevant business qualifications, and there is no substantive business under the company's name. In short, this company was born for the judicial disposal of virtual currency.
According to our understanding of China's 924 policy, ordinary private companies registered in mainland China, without special business licenses, are clearly illegal in providing exchange and matching services between virtual currencies and RMB in China; this illegal behavior will not be changed by authorization from grassroots public security and other judicial departments and written contractual agreements between the two parties. Therefore, if we sort out the entire transaction method of a large number of judicial disposal companies on the market, we will find that they have essentially opened up the circulation and transaction channels between virtual currencies and RMB, which is obviously in violation of the provisions of the 924 policy and is suspected of illegal operation.
More importantly, for the disposal company, the virtual currency must be exported. After the disposal company obtains the virtual currency, based on security considerations, it often uses technical means to clean the virtual currency address involved in the case, such as erasing the on-chain address of the virtual currency through a coin mixer, and then breaking it down into small pieces to other foreign trade merchants or high-net-worth buyers in China; or it uses gray channels to cash out the virtual currency overseas, and then cash it out through "underground banks" or "false trade", and then applies to the State Administration of Foreign Exchange for foreign exchange settlement and then flows it back to China. These operations are often suspected of violating the national anti-money laundering law and relevant laws and regulations on foreign exchange management, and there are great criminal legal risks.
2. What are the legal risks faced by relevant judicial personnel?
(1) Risk of property loss involved in the case
Virtual currency is still unfamiliar to most judicial personnel. Most grassroots judicial personnel are often unclear about its market price and trading model. In the judicial disposal process, how much can a coin sell for? In what kind of place should it be traded? These questions are usually not very clear. Therefore, the disposal of most virtual currencies involved in the case often does not undergo any standardized procedures such as judicial identification and judicial evaluation. It simply uses the transaction price of a certain exchange recommended by the disposal company as the basis for pricing. The control of the exchange is more manipulable in the hands of large capital dealers, which leads to a problem with the price benchmark of judicial disposal, which makes the amount of disposal funds that are finally converted back to the treasury have a certain risk of loss.
(2) Risks of funds involved in the case
All walks of life are in a state of internal competition, and the judicial disposal of virtual currencies is no exception. In addition to providing payment services with different levels of cleanliness, most disposal companies often take the initiative to pay first and then hand over the currency in order to dispel the concerns of the police that they have given the currency but have not received the money.
It is common for a disposal company to have a daily fund disposal capacity of RMB 500 million, while the idle funds in the accounts of normal private trading companies are often not so abundant. Therefore, there will be a situation where multiple bank accounts controlled by disposal companies transfer funds to the same receiving account. Previously, there have been cases in China where the funds paid by disposal companies to the public security were frozen by the public security in another case in other parts of the country. It can be said that the flood washed away the Dragon King Temple, and the family members did not recognize each other.
(3) Risk of being held accountable for improper performance of duties
The novelty of the industry and the increasing amount of money involved have made more and more middlemen start to focus on the good business of virtual currency judicial disposal. We often receive inquiries from customers in the industry, saying that they have hundreds of millions of virtual currencies involved in the case that need judicial disposal, but if I ask for some details, the other party will start to say that he is also asking for help from the higher-ups, and the people asking in the middle are often like Russian nesting dolls, one layer after another. A friend joked that if no one in the industry has talked to you about the judicial disposal of virtual currency these days, then you are definitely not an insider.
In this process, it is inevitable that a lot of rent-seeking will occur, which can be said to be creating a new problem in order to solve one problem. As a national judicial staff, because I don’t understand the industry operations, I was led into a pit by the third-party disposal company under the guise of compliance. One day, I will be investigated by the Commission for Discipline Inspection and Supervision. This is a bit too magical.