Cryptocurrency projects with referral rewards are not equivalent to pyramid schemes or fraud: it depends on where the money comes from

If a virtual currency project exhibits certain pattern characteristics, and combined with the current domestic policy direction of severely cracking down on cryptocurrency speculation, there is a significant criminal-law risk of being characterized as the crime of organizing and leading pyramid scheme activity.

In the earlier article, “Virtual Currency Pyramid Schemes Get Caught—Involved Projects Are Usually One of These Four Types,” Lawyer Shao has already sorted out the typical patterns of virtual currency projects involved in pyramid schemes and their variations.

However, the Web3 concept iterates quickly, and patterns keep emerging. In judicial practice, there are also cases where judicial authorities, due to unfamiliarity with Web3 project patterns, misjudge some Web3 projects that have genuine commercial logic as crimes involving pyramid schemes.

This article aims to discuss: what kinds of Web3 project models should not be recognized as crimes involving pyramid scheme activity? Where exactly is the space for legal defense? This article will conduct an analysis based on specific cases.

First, look at a case

Machael and others built a virtual-coin platform and issued X virtual currency. The project model is as follows: for each transaction of X tokens by a downstream member, the platform charges a certain percentage of service fees; meanwhile, it awards 20% of the service fees to the upstream member who developed that downstream member, as a referral reward.

In this situation, do Machael and others constitute the crime of organizing and leading pyramid scheme activity?

From a formal perspective, since the platform pays referral rewards to upstream members based on the downstreams’ trading activities, it seems to satisfy the formal element of “using the number of developed personnel as the basis for compensation.” Therefore, identifying it as a pyramid scheme crime appears to be uncontroversial.

But this conclusion is obviously too hasty.

Distinguishing pyramid scheme crimes from administrative violations of team-based compensation: the key is where the upstream’s profits come from

According to the 2013 “Opinions of the ‘Two Supreme Courts and One Ministry’ on Several Issues Concerning the Application of Law in Handling Criminal Cases of Organizing and Leading Pyramid Scheme Activities,” pure “team-based compensation” pyramid scheme activities—where the purpose is selling goods and compensation is based on sales performance—are not handled as crimes.

This provision establishes the core practical criterion for distinguishing pyramid scheme crimes from administrative violations in practice: the source of the upstream’s profits—is it the downstream members’ principal, or the platform’s genuine operating income?

If the source is the downstream members’ principal—essentially “robbing Peter to pay Paul,” using the money from later entrants to cover the earlier participants’ returns—then it is a typical Ponzi structure and is suspected of constituting a pyramid scheme crime. But if the source is profits generated by the platform through genuine business activities, then it can be argued as an administrative violation of team-based compensation rather than a crime.

Therefore, the starting point for lawyers handling such cases is to determine, in the specific project model involved, where the funds for upstream rewards actually come from and what their nature is.

For virtual-coin projects involved in pyramid schemes, how to determine whether the platform has genuine operating income

Returning to Machael’s case at the beginning of this article. To argue that the platform does not constitute a pyramid scheme crime, it is necessary to combine the specific details of the project, find a commercially plausible logic—i.e., to prove that the reward funds paid to upstream members were earned by the platform itself and not taken from the downstream side. This needs to be examined in two scenarios.

Test One: Besides reselling, what else can the token be used for?

If the token’s only use within the platform is to be resold to the next participant, or if, within a project-built “fake DEX,” it can be exchanged into USDT (and this USDT is actually the principal of later entrants), then the token has no independent use value. The project, on the practical level, has no real operating income at all, and the funds for upstream rewards can only come from new users’ principal, making the Ponzi structure hard to deny.

On the other hand, if the token can be used in-app to purchase goods or services that have independent value—such as NFT equipment, membership rights, data services, game items, etc.—and the payments can be traceably entered into the project party’s treasury, then there is a factual basis for the project party to claim “genuine operating income.”

Test Two: Without buying coins, can someone still participate?

This is the key to judging whether the act of purchasing coins constitutes an “entry fee” for pyramid scheme activity. On Web3 platforms, users often need to first exchange RMB for USDT and then exchange it for the platform’s tokens. Whether this coin-purchasing behavior counts as an entry fee mainly depends on the following:

If a user does not buy coins, the account cannot even be activated, and referral links cannot be generated; the purchase of coins is forcibly tied to participation eligibility—then there is a risk that it will be recognized as an entry fee.

Conversely, if users can register for free, obtain initial tokens by completing tasks, and only earn more slowly without buying coins, then the compulsory nature of purchasing coins is insufficient to be recognized as an entry fee.

Taking Move-to-Earn projects as an example: three possible legal characterizations

Taking a “move-to-earn” (Move-to-Earn) type project as an example, based on the two tests above, the same type of project could, in law, fall into three completely different categories.

First category: No violation of any pyramid scheme law

Users can use basic functions for free. Buying NFT running shoes is merely an option for value enhancement, not a mandatory threshold to enter. Referral rewards are based on the recommended person’s actual consumption amount (e.g., NFT royalty splits), not on the number of people recruited. Tokens can be used for in-app consumption, purchasing items, or paying for services, with real use scenarios. The project party has genuine operating income such as NFT royalties and advertising collaborations. The source of upstream rewards is this, rather than new users’ principal.

— In this model, there is neither a mandatory entry fee nor a tiered rebate structure, and it does not constitute any form of pyramid scheme violation.

Second category: Constitutes an administrative violation of team-based compensation, but is not recognized as a crime

There is a tiered rebate structure, and upstream members can obtain rewards from the downstreams’ consumption purchase behavior. But the rebates are calculated based on the sales performance of the downstreams (the amount or quantity of NFT purchases), rather than being based on the number of developed persons. The project is aimed at selling NFTs/tokens, with real goods circulation. There is no subjective intent to defraud property.

— Meeting the requirements of Article 7, Item (3) of the “Prohibition of Pyramid Schemes” regulation, it is classified as team-based compensation pyramid scheme, and is not recognized as a crime.

Third category: Constitutes a pyramid scheme crime

Forced purchase of high-priced NFTs/tokens as an entry threshold. Rebates are directly calculated based on the number of developed downstream members, unrelated to consumption behavior. There are promises of high-interest static returns, and the funds come from the principal of later entrants. Tokens have no real consumption scenarios and are used only as accounting tools for pyramid schemes. There is subjective intent to defraud property.

— It satisfies all four elements at the same time: “entry fee + tiered structure + recruiting-headcount-based compensation + defrauding property,” and thus constitutes the crime of organizing and leading pyramid scheme activity.

One additional point: If the project party has no real consumption scenarios, what does that mean?

This is the key issue in most virtual-coin pyramid scheme cases.

If the platform’s tokens are merely resold within the platform to the next participant, and there is fundamentally no real consumption scenario—then the only purpose for users to buy coins is to wait for appreciation or to receive static returns.

— In that case, the project party lacks any genuine operating income, and the funds for upstream rewards can only come from new users’ principal.

No matter how the platform internally designs its reward rules, the underlying model is a Ponzi structure of “robbing Peter to pay Paul,” and it is difficult to change the project’s inherent characterization as a pyramid scheme crime.

Defense points: all four must be backed by evidence

If the project party intends to argue that it does not constitute a pyramid scheme crime, or only constitutes an administrative violation, the following four points must be simultaneously supported by evidence:

1. The token has genuine consumption scenarios, and can be used to purchase goods or services with independent value within the application;

2. The consumption payments do in fact enter the project party’s treasury, and the on-chain fund flows are traceable;

3. The upstream rewards originate from the project party’s income, rather than being directly deducted from downstream principal;

4. The reward trigger occurs upon completion of consumption, rather than at the time of purchasing or staking the token.

If any one of the above links lacks evidence or breaks, the risk of being characterized as a pyramid scheme crime will increase significantly.

Conclusion

In this type of case, issues such as reviewing the project party’s token-economy design, the authenticity of on-chain fund flows, and the authenticity of consumption scenarios—if the judicial authorities are unfamiliar with the Web3 business model—may lead to deviations in how the case is characterized.

In addition, the Web3 field itself evolves extremely fast. When each new model appears, the corresponding judicial understanding is often still blank.

But this also means that there is considerable room for legal defense. As a defense lawyer, only by being familiar with the business models and operating logic of such projects can one find effective entry points.