Lawyer’s opinion: Where are the risks of DeFi platform?

Recently, DeFi projects have flourished and have become a hot spot in the global cryptocurrency circle.

As of now, the service scope of DeFi projects has covered credit payment, lending, decentralized exchanges, stablecoins and other fields. Although most platforms operating DeFi projects are registered outside mainland China, this does not mean that such platforms will not be regulated by Chinese criminal law.

This article aims to introduce the criminal legal risks of DeFi lending projects in China and provide ideas for the compliance and development of cryptocurrency platforms.

DeFi Lending Project Overview

The textual meaning of DeFi refers to decentralized finance, which corresponds to centralized finance CeFi. Common DeFi projects include MakerDAO, Uniswap, Pound, Aave, etc.

In the common DeFi lending model, lenders can pledge their digital currencies to the platform, and the platform will pay them stablecoins or other assets according to the smart contract. After the contract expires, the lender will return the borrowed currency in exchange for the mortgaged property.

Taking MakerDAO as an example, the platform signs a DeFi agreement with users and provides them with DAI, a stablecoin pegged to the US dollar, as a loan. The lender needs to provide tokens such as ETH that are more than 150% of the loan value as collateral and consideration. When the value of the collateral token is too low, the platform will liquidate the collateral to maintain the stability of the capital flow.

In addition, it is worth mentioning the way a certain pound platform operates DeFi lending projects. In addition to general interest income, a certain pound will distribute governance tokens to users as rewards. Users can exercise part of the power of the decentralized platform through governance tokens. From the results, the governance tokens have attracted a large amount of assets to enter, making a certain pound the leader in the field of decentralized finance.

Criminal risk analysis

In essence, DeFi projects are mostly replicas of traditional financial businesses in the blockchain field, and the platform's operation of DeFi lending projects is itself the lending business of traditional financial institutions. The liquidity pool formed by DeFi lending projects and the stable currency exchange channel anchored to legal currency are the manifestation of the platform's engagement in fund payment and settlement business.

According to Article 225, Paragraph 3 of the Criminal Law of the People's Republic of China, if a platform illegally engages in fund payment and settlement business without a financial license, it may constitute the crime of illegal business operation.

In combination with the provisions of Article 3 of the "Interpretation of the Supreme People's Court and the Supreme People's Procuratorate on Several Issues Concerning the Application of Law in Handling Criminal Cases of Illegal Engagement in Funds Payment and Settlement Business and Illegal Foreign Exchange Trading", the amount of money for conviction for illegal engagement in funds payment and settlement business is the amount of illegal business exceeding RMB 5 million or the amount of illegal income exceeding RMB 100,000.

Considering that platforms operating DeFi lending projects usually have large amounts of capital, once they are investigated by judicial authorities for the above-mentioned crimes, it will be difficult for the platforms and their controllers to make any breakthroughs in determining the constituent elements.

Can domestic laws control it?

Some DeFi platforms believe that their place of registration or business premises are abroad and will not be subject to domestic laws and regulations. However, according to the jurisdiction provisions of my country's Criminal Law, the platform still faces risks in the following situations: First, according to the territorial jurisdiction provisions of Article 6 of the Criminal Law, if the business premises are in China or the place where the crime occurs is in China, my country's Criminal Law shall apply; second, if the management of the platform is of Chinese nationality, according to the personal jurisdiction provisions of Article 7 of the Criminal Law, my country's Criminal Law may apply; third, if the customers using the platform are of Chinese nationality, according to the protective jurisdiction provisions of Article 8 of the Criminal Law, my country's Criminal Law may apply.

In addition, it is important to remind that when judging the nationality of users, the platform cannot simply use the inaccessibility of the domestic Internet as evidence that the platform is not open to domestic users. Generally speaking, judicial practice requires operators to fulfill their due diligence and review obligations. For operators engaged in blockchain business, it is very simple to judge whether users use VPN to log in. Therefore, if the platform does have a large number of users using VPN, the operator is at least indirectly intentional subjectively.

Extension and expansion

Some blockchain platforms do not directly operate DeFi lending projects, but instead provide DeFi platform interfaces. We believe that such behavior cannot evade criminal liability.

Once the behavior of a third-party DeFi platform is deemed to be illegal or criminal, as an industry insider, the subjective situation of the platform providing the interface will be deemed to be knowing or should have known. While providing the interface, there is often a transfer of interests between the two platforms. Based on this, platforms that do not directly operate projects may also be deemed to be accomplices in illegal and criminal activities for providing interfaces.

Final Thoughts

Decentralized finance based on blockchain technology can control assets in the hands of private users through keys. Compared with trusting traditional finance - blindly creating behemoths such as banks that are not controlled by individuals, DeFi projects with the characteristics of financial democratization are more in line with the development trend of contemporary society.

However, in the absence of approval from financial regulatory authorities, the DeFi project does not yet have the soil for promotion and development in China. Recently, it has been plagued by money laundering crimes related to its concealment, and has a poor reputation.

Frankly speaking, we understand the value of financial market stability, so regulators are willing to bear the reputation of being conservative. However, we admire innovators in the field of financial technology even more, because it takes more courage to break the dawn of the long night.