Written by: Liu Honglin and Huang Wenying, Mankiw LLP
Cryptocurrency exchanges are probably one of the first ways for most newcomers to enter Web3. In addition to daily buying and selling of cryptocurrencies, most cryptocurrencies exchanges have also launched a variety of financial services, some of which claim to be low-risk and guaranteed returns, while others have complex gameplay and mechanisms. Among them, simple earning coins are often recommended by the platform to new users because of their user-friendliness.
Yesterday, a certain exchange's simple money-earning financial product attracted much attention due to the surge in the interest rate of USDT current financial management. Under normal circumstances, the interest rate of this product is 6%, but at 23:00 yesterday, the interest rate soared to 44%.
*Source: Screenshot of interest rate on a financial management page of an exchange
Today, Attorney Mankiw will use the exchange’s “Simple Coin Earning Service” user agreement as an example to briefly talk to you about what this type of financial product is all about.
Simple Coin Earning Service Overview
The virtual currency exchange's simple coin-earning service (Earn) provides a convenient way for digital asset holders to increase their value. Users can deposit their virtual currencies into the platform and choose current or fixed-term financial products to obtain returns based on their liquidity needs and expected returns.
From the perspective of the use of funds, this type of simple coin earning service is a lending-based service, that is, users deposit their own virtual currencies on the exchange platform, and the exchange lends these virtual currencies to people in need and charges a certain fee, which is distributed to users in proportion as financial management profits. At present, most exchanges support mainstream currencies for investment and financial management, such as the subscription of USDT, USDC, BTC and ETH current or regular simple coin earning products.
After a user deposits tokens, if their lending needs are successfully matched with the lending needs of other users, they can earn income hourly before the order period ends. Not only that, users can also choose to enable the automatic renewal function. In this way, at the end of the period, the order will be automatically matched again and continue to generate income.
Financial attributes and legal definition
If we compare the simple coin earning service with the products and services of the traditional financial industry, we can find that simple coin earning is similar to deposits or financial management in traditional finance, and the virtual currency earned is equivalent to interest or investment returns. However, compared with traditional financial products, the simple coin earning service of virtual currency exchanges relies on blockchain technology, has the characteristics of decentralization and globality, has stronger capital liquidity, and relatively higher returns.
However, if you want to provide such services, the platform's compliance and licensing is the first step. There are significant differences in the regulatory regulations and qualification requirements for virtual currency exchanges in different countries and regions. Taking Hong Kong as an example, virtual currency exchanges need to apply for Type 1 (securities trading) and Type 7 (automated trading services) licenses from the Hong Kong Securities and Futures Commission (SFC).
*Image source: Hong Kong SFC official website
In addition, different countries and regions have different legal positions on virtual currencies, which directly affects the legal attributes of financial services based on virtual currencies. In my country, regulators have taken a strict stance on virtual currencies. The People's Bank of China and seven other ministries and commissions clearly pointed out in the "Notice on Preventing Risks of Token Issuance and Financing" issued in 2017 that token issuance and financing activities are essentially an act of illegal public financing without approval. In addition, my country has clearly prohibited financial institutions and payment institutions from conducting virtual currency-related businesses.
In such a regulatory environment, the simple coin earning service, as an unapproved financial activity, may be deemed illegal. For investors, if they know or should know that the service may be suspected of being illegal but still accept and establish a legal relationship with the exchange, the legal relationship may be deemed invalid. When disputes occur, it will be difficult for investors to obtain effective legal protection.
Legal risks and advice
Therefore, when investors use the simple coin-earning service of virtual currency exchanges to manage virtual assets, they should fully understand the compliance of the exchange and correctly assess the transaction risks based on the user agreement to avoid unnecessary property losses during the investment process. Specific methods that can be adopted are:
*Source: "Simple Coin Earning User Agreement" of a certain exchange
Pay attention to changes in regulatory policies. Regulatory agencies in various countries may impose stricter regulatory measures on virtual currency exchanges for a variety of reasons, such as requiring exchanges to comply with specific registration and reporting requirements, restricting the operation of exchanges, and even completely stopping related services in some extreme cases, in order to protect investors, maintain financial market stability, prevent money laundering and terrorist financing. Investors will face liquidity risks, which will affect the recovery of investment principal and the expected returns. For example, the once-popular FTX exchange disclosed a debt of tens of billions of US dollars when it filed for bankruptcy, which not only caused millions of retail investors to lose all their money, but also affected well-known investment institutions such as Sequoia and Temasek. Therefore, when participating in the simple coin-earning service, investors should pay close attention to regulatory developments and evaluate the impact of potential policy changes on their investments.
Pay attention to risk and equity assessment. In the traditional financial sector, regulators usually require financial service providers to ensure that investors are fully protected. However, in the field of virtual currency investment, most service providers will minimize their own risks through the terms of the agreement. Therefore, when participating in the simple currency earning service, investors should fully understand the terms of service, risk disclosure and their own risk tolerance.
Pay attention to dispute resolution clauses. These clauses usually appear in the user agreement in the form of standard clauses. The platform party often sets dispute resolution methods from the perspective of maximizing its own interests. For example, it agrees to arbitrate overseas. Users may not pay enough attention to the jurisdiction clause during the registration process. When disputes occur, such dispute resolution clauses often bring additional time and economic costs to users.
Some jurisdictions require that platforms or service providers must, when using standard terms, reasonably remind users of these terms, especially those that may be disadvantageous to users. If the provider of standard terms fails to take reasonable measures to remind the other party, or the content of the terms is obviously unfair, the court may find that the terms are invalid. However, even if such a claim is supported, it usually requires a long negotiation, consultation, or even litigation process, which is not conducive to the efficient resolution of disputes.
Attorney Mankiw's Summary
The low risk and stable yield promised by the simple coin-earning service are particularly attractive in the risky Web3 field, but such promises often require investors to treat them with caution.
Before participating in such services, investors should fully understand relevant regulatory policies, assess risks, and pay attention to relevant provisions in the user agreement. The legal status and regulatory requirements of virtual currencies vary significantly in different countries and regions, and investors need to pay close attention to policy changes to avoid unnecessary legal risks and property losses.
