Traders Accused of Illegally Collecting $56 Million in Bitcoin for Loan Scheme

Two over-the-counter (OTC) market makers in China have been accused of illegally collecting bitcoin now worth $56 million from more than 100 OTC traders as part of a loan scheme.

According to a report from state-owned newspaper BJNews on Wednesday, a group of 20 OTC traders in China filed a complaint to police in the city of Hangzhou in mid April, alleging that the two individuals, Yi Zhou and Xiang Li, had lured traders with the promise of interest on their bitcoin deposits.

Based on the report, Li and Zhou operated chat groups on messaging app WeChat used by OTC traders to post bid and ask prices for various cryptocurrencies including bitcoin, which is usually referred as "pancake" to avoid censorship and monitoring by government agencies.

OTC trading remains the primary fiat currency gateway for crypto traders in China after the country's central bank issued a ban on initial coin offerings and fiat-to-crypto spot trading exchanges in September 2017.

The two reportedly built up their credibility after operating an OTC chat group over the last two years, leading to other OTC traders believing the two would be able to pay interest on their deposits of bitcoin.

However, since early April, investors said they started noticing delays in their interest payouts (made in Chinese yuan) while Li and Zhou made excuses, claiming unexpected situations had led to the hold ups.

Some investors even went as far as accusing the two of fraud since they continued raising deposits from investors even when they knew they wouldn't be able to pay back interest, the report added.

The Hangzhou police told BJNews it has established a criminal case against Li and Zhou, who are now being held in custody.

Legal implication

The case highlights the somewhat gray area of OTC trading and financial loans based on cryptocurrencies.

For instance, Sa Xiao, a partner at multinational law firm Dentons' Beijing office, thinks a line should be drawn between individual traders and those that fulfill orders to make profits on a spread (the difference between the bid and ask prices).

Xiao told the newspaper that "occasional transactions between individuals should be legal," since they are exchanging ownership of personal property.

However, she said it could be a criminal offence if anyone uses bitcoin as a financial product to operate a business that makes profits from a spread, but causes consequential losses for customers.

"Specifically, it could be violating the Article 225 of the Criminal Law," she said, which protects against "illegal acts in business operation and thus disrupts market order."

Kai Xu, a legal practitioner at the Chinese law firm Deheng, also weighed in on the definition of "illegally collecting funds from the public." He said in the report that the OTC traders' intention is an important detail when defining the nature of the act of collecting the claimed crypto loans.

If Li and Zhou solicited the bitcoin loans from non-eligible investors, but did not raise the fund to make off with the money, then it is an illegal collection of public funds, he explained.

"But if they started with the purpose to possess investors' funds, then it falls under the nature of fraud," he said.

Crypto loans have been drawing attention in the past a few months as major crypto firms in China are capitalizing on investors who do not wish to liquidate their assets in a bearish market. CoinDesk reported in April that several firms had originated a combined $60 million worth of loans over the prior five months.

However, for such loans, collateral is required at a rate of at least 60 percent in order to protect investors in case of default.

Chinese yuan image via Shutterstock