Why does exchanging currency using stablecoins constitute illegal business operations?

Written by: Lawyer Liu Zhengyao

Introduction

Recently, a case involving the exchange of virtual currency has attracted a lot of attention. The situation is that on July 16, the People's Court of Pudong New District in Shanghai announced a major illegal virtual currency exchange case that was ruled in March this year — with an amount involved as high as 6.5 billion yuan! In this case, the parties used Tether (USDT) as an "intermediary" to help people exchange RMB for foreign currency.

Why have judicial authorities begun to frequently crack down on illegal foreign exchange cases involving virtual currencies in the past two years? The reason is not complicated: China implements a foreign exchange control system, and ordinary citizens have a facilitation limit of only 50,000 USD per person per year. Want to exchange more? It's not impossible, but you need to go to the bank, queue up, fill out a lot of forms, and explain the purpose.

The emergence of virtual currencies can indeed objectively break the domestic foreign exchange control system, which creates a space for illegal arbitrage. As a judicial authority, there will naturally be attention to and crackdown on the use of virtual currencies for foreign exchange trading and illegal currency exchange. As a web3 lawyer, I would like to discuss the construction logic of illegal business crimes related to virtual currencies and defense suggestions within the legal framework of mainland China, hoping to benefit web3 practitioners and fellow lawyers.

1. Case Summary: The major foreign exchange case reported by the Pudong Court.

According to a report by China Central Television citing the Huaxia Times, at the end of 2023, Ms. Chen from Shanghai needed to remit money to her daughter abroad. However, due to China's foreign exchange restriction of $50,000 per person per year, she contacted a so-called "currency exchange company." The company instructed Ms. Chen to deposit RMB into the account of Company A, and soon after, her daughter overseas received the equivalent amount in foreign exchange. Of course, the currency exchange company would charge a certain percentage as a service fee.

According to the disclosed case information, as of the time of the crime, Yang and Xu, among others, manipulated domestic shell companies to provide cross-border transfers of funds for unspecified clients using stablecoins (such as Tether USDT) as a medium and obtained illegal profits, with the illegal operation amount reaching up to 6.5 billion yuan. The specific model is as follows: the aforementioned domestic companies collect clients' renminbi, which does not leave the country through banks or underground money exchange houses, but is instead purchased by Yang, Xu, and others into virtual currencies like USDT; when the "currency exchange company" receives funds from domestic clients, it will notify its partners located abroad to exchange the "inventory" foreign currency to the overseas clients at market exchange rates. This model is commonly referred to as "round-trip currency exchange." In cryptocurrency-friendly regions (such as areas that allow local virtual currency and fiat currency exchange businesses), this model of using virtual currency for round-trip currency exchange between renminbi and local foreign currencies has already matured significantly.

II. The Threshold for Criminal Liability in Illegal Foreign Exchange Operations

(1) Legal Provisions

The crime of illegal business operations is stipulated in Article 225 of China's Criminal Law, originating from the "speculative crime". Friends who have a slight understanding of the domestic criminal defense circle will definitely be familiar with this crime — illegal business operations are known as the "pocket crime" in the field of economic crimes. It mainly regulates four types of behavior: First, illegally operating "exclusive sales" items or restricted trading items without qualifications; Second, buying and selling import and export licenses, import and export certificates of origin; Third, illegally operating securities, futures, insurance business, or illegally engaging in fund payment and settlement business; Fourth, "other illegal business activities that seriously disrupt market order."

(2) Provisions of Judicial Interpretations

The first three types of behaviors mentioned above are relatively easy to understand, while the key lies in the fourth type, "other illegal business activities that seriously disrupt market order." In the early days, due to the lack of unified standards, the judicial practices in various regions were quite chaotic, and some relatively novel business models were arbitrarily identified as illegal business crimes. In 2011, the Supreme Court issued the "Notice on Accurately Understanding and Applying the Relevant Issues of 'National Regulations' in Criminal Law" (Fa Fa [2011] No. 155), which clearly required courts at all levels to strictly grasp the application scope of Item (4) of the legal provisions when hearing cases of illegal business crimes (i.e., the aforementioned "other illegal business activities that seriously disrupt market order").

First, the "national regulations" in "violating national regulations" refers to the laws and decisions made by the National People's Congress and its Standing Committee, as well as the administrative regulations, rules, administrative measures, decisions, and orders promulgated by the State Council.

Second, for the application of "other illegal business activities that seriously disrupt market order," which are not explicitly stipulated by judicial interpretation, requests should be made step by step to the Supreme People's Court.

(3) Specific Threshold for Criminal Offense

According to the "Two Highs" Interpretation on Several Issues Concerning the Application of Law in Criminal Cases Involving Illegal Engagement in Fund Payment and Settlement Business and Illegal Foreign Exchange Trading, the common criteria for determining "serious circumstances" are (imprisonment for less than five years or criminal detention): first, the amount of illegal business operations exceeds 5 million; second, the amount of illegal gains exceeds 100,000.

For the determination criteria of "particularly serious circumstances" (imprisonment for more than five years), there are two common standards: one is that the illegal business amount exceeds 25 million yuan; the other is that the amount of illegal income exceeds 500,000 yuan.

The so-called "illegal operating amount" refers to the amount of funds involved in the illegal buying and selling of foreign exchange, illegal currency exchange, and cashing out foreign exchange; the "amount of illegal income" simply refers to the profits of the party involved.

3. Why does buying and selling USDT for currency exchange constitute the crime of illegal business operations?

Returning to the topic of this article, let's first step away from the business models of Yang, Xu, and others. One situation in practice where buying and selling USDT has been deemed illegal business operations is the illegal buying and selling of foreign exchange using USDT, illegal currency exchange, and disguised foreign exchange trading. As mentioned earlier, its transactions can be divided into two main steps:

First, the customer gives RMB to the 'domestic shell' to exchange for USDT;

Second, the overseas gang exchanges USDT for US dollars and provides customers with overseas accounts.

Although they seem independent in the middle, together they convert RMB into USD. This method is called "matched trading": domestically it involves RMB inflows, and externally it involves USD outflows, but it does not go through formal channels or undergo reporting and review. This evades the country's foreign exchange regulation and anti-money laundering control system. This operation essentially completes foreign exchange conversion in a disguised manner, which constitutes illegal foreign exchange trading. If it meets the aforementioned threshold for criminal liability, it constitutes the crime of illegal business operations.

However, there is another situation in practice where a certain entity in the mainland is only responsible for selling USDT to customers and collecting RMB from them. Customers exchange USDT for foreign currency through their own channels, and the domestic selling entity is not aware of this, or even if they might be aware, they did not participate. In this case, we believe that the domestic entity does not constitute the crime of illegal operation, and the specific reasons are detailed below.

4. Lawyer Defense Suggestions

As a web3 criminal defense lawyer, I will briefly summarize the defense strategies for criminal cases involving illegal operations of virtual currencies based on the actual cryptocurrency cases I have represented.

First of all, in a judicial practice environment that heavily relies on testimonies, defense lawyers need to examine whether there are any relevant statements or declarations in the client's testimony regarding their actions that are "operational" or "profit-oriented." If the domestic team does not acknowledge having illegal currency exchange, buying, or selling foreign exchange purposes, then, in the absence of other objective evidence to confirm this, the so-called "evidence" obtained by the investigative authorities through phone communication with overseas currency exchange groups (i.e., collecting customers' USDT and then converting it into foreign currency) cannot be used as criminal evidence.

Secondly, the examination of objective evidence requires an understanding of specialized knowledge. For example, during the process of buying and selling USDT, it is necessary to verify whether the transfers on the blockchain, the KYC information of the centralized cryptocurrency exchange trading account, and the timing, flow, and amounts of the cryptocurrency transactions match. To illustrate with a simple example, a foreign cryptocurrency exchange cooperated with mainland law enforcement to provide the registration information of a certain account (including the registrant's name, ID number, phone number, email, etc.), but how can we ensure the authenticity and legality of the information provided by that exchange? Is there a possibility that identity information was used fraudulently for registration? This requires criminal defense lawyers to understand the specific KYC requirements of different exchanges, and even the relevant regulations regarding KYC in the country/region where the foreign cryptocurrency exchange is located.

Finally, be cautious regarding materials issued by third-party institutions such as judicial appraisals and audit evaluation reports. Currently, some judicial authorities adopt a "utilitarian" attitude towards the appraisal opinions and audit reports issued by third-party institutions, assuming that they can be used directly as evidence for criminal charges. As the defense, with the consent of the parties involved and their families, you can also rebut the opinions or reports issued by third parties by appointing "qualified individuals" to testify in court.

Of course, if the defense lawyer is familiar with the current domestic regulatory policies regarding virtual currencies, common bugs in judicial identification and evaluation of cases involving virtual currencies, etc., then the defense lawyer can also make a strong effort. Based on my practical experience, new cases involving virtual currencies are most likely to achieve breakthroughs and effective defenses in terms of evidence and identification.