Xiao Za: Using encrypted assets to evade foreign exchange management? Starting from a case of a hundred billion underground bank

Source: Xiao Za Team, Xiao Za Lawyer

For a long time, our country has been one of the stricter nations in terms of foreign exchange management systems. Generally, the annual limit for individuals to convert and purchase foreign currency within the country is $50,000. If this limit is exceeded, one must go to the bank with a large amount of supporting documents, making the process extremely cumbersome and inconvenient. Therefore, in practice, some residents of our country who work abroad, travel overseas, study, or immigrate often need to use some "gray" methods to transfer their assets abroad more conveniently and quickly.

Where there is demand, there is supply. Due to the characteristics of peer-to-peer transmission and global transactions of crypto assets (especially cryptocurrencies) born from blockchain technology, more and more individuals and organizations are attempting to use crypto assets as tools to evade foreign exchange controls and evade taxes. Today, the Xiao Za team will analyze the "red line" risks of using crypto assets to evade foreign exchange management systems, starting from a recent underground money laundering case in Qingdao, Shandong, involving an amount as high as 15.8 billion yuan and spanning 17 provinces and municipalities across the country.

01 What is the foreign exchange management system in our country?

Foreign exchange control, also known as foreign exchange management, simply refers to the restrictive measures implemented by a country's government to balance international payments and maintain the exchange rate of its currency. The concept of foreign exchange management first appeared during World War I. Due to the war, the international monetary system was on the verge of collapse, and developed capitalist countries experienced significant international payment deficits, with severe fluctuations in their currency exchange rates and a large number of capital outflows, which seriously affected the financial order and socio-economic development of these countries. Therefore, on one hand, to concentrate funds for the war; on the other hand, to prevent capital outflows from affecting their economies, countries generally prohibited the free buying and selling of foreign exchange and implemented strict foreign exchange controls.

From the perspective of countries around the world today, most underdeveloped countries adopt strict foreign exchange management systems for the long-term stability of their economic development, currency exchange rates, and financial order. For example, our Southeast Asian neighbors such as Myanmar, the Philippines, and Thailand. Some developed countries also manage foreign exchange, but the severity varies depending on their economic development status and industrial characteristics. For instance, the neighboring island nation does not impose restrictions on trade and non-trade payments in principle but still regulates capital account transactions. Of course, there are a few countries that impose little to no restrictions on foreign exchange, allowing their citizens and legal entities to freely exchange currencies. These countries are generally extremely developed old capitalist countries or some exceptionally wealthy countries that have prospered through energy exports.

As mentioned earlier, our country has a relatively strict foreign exchange management system. Friends with study abroad experience or overseas travel experience must be familiar with the "50,000 yuan rule." According to Article 2 of the "Implementation Rules for Personal Foreign Exchange Management," "The total amount for personal foreign exchange conversion and domestic personal foreign currency purchases is managed on an annual basis. The annual total is equivalent to $50,000 per person per year. The State Administration of Foreign Exchange may adjust the annual total based on the international balance of payments." In simple terms, unless for special purposes and with relevant procedures at the bank, an individual can only convert/receive foreign currency up to $50,000 within a year. Therefore, the "50,000 yuan rule" is also known as the "facilitation quota."

It is important to note that the use of the facilitation quota does not include "capital projects." In other words, if an individual wants to purchase property abroad or invest in overseas securities, insurance, and other financial products, they cannot directly use this quota to convert currency for outbound transactions. Before the popularization of crypto assets, residents of our country often borrowed facilitation quotas from family and friends to solve the problem of insufficient quotas. However, this behavior of lending and borrowing quotas is considered an administrative violation. Once verified, individuals will be blacklisted by the State Administration of Foreign Exchange, losing their facilitation quota for the next two years, affecting personal credit, and in severe cases, may even involve criminal charges.

02 The case of a hundred billion yuan underground money exchange using cryptocurrency

In November 2022, the Qingdao police discovered that there were thousands of accounts with abnormal trading behaviors, with an average daily flow of over three million yuan, and a total transaction amount exceeding two billion yuan. After further investigation, the police found that the large amounts of funds in these accounts had strong liquidity, moving in and out quickly, all operated through online banking or mobile banking, with the operators' IP addresses showing they were abroad. However, apart from the son of a certain Mr. Jin who lived abroad, the account holders had no records of going abroad.

By checking Mr. Jin's account flow, it was found that a large amount of his funds was concentrated in the bank account of a factory employee in a county town, Mr. Li, and the funds only came in without going out. Investigation revealed that Mr. Li was a person engaged in over-the-counter (OTC) trading in the cryptocurrency space, earning intermediary fees by helping others exchange fiat currency for USDT and other stablecoins.

This case itself is not complicated. Mr. Jin was responsible for collecting funds from residents of our country who needed to go abroad and handing them over to Mr. Li, who would then use his own channels to exchange fiat currency for various crypto assets and convert them into more easily "liquidated" USDT and other stablecoins through overseas exchanges. Since USDT is a crypto asset, it not only allows for extremely convenient and discreet transactions but also makes it very easy to carry out of the country and exchange for foreign currency abroad.

Currently, according to public information from the State Administration of Foreign Exchange, the individuals involved in this case have been subjected to criminal coercive measures for suspected illegal business operations.

03 What legal risks exist in using crypto assets to evade foreign exchange management?

1. Legal risks of underground money exchanges — illegal business operations

It is important to note that foreign exchange management has always had a special "status" in our country. In the legal system of our criminal law, the "Decision on Punishing the Crime of Fraudulently Purchasing Foreign Exchange, Evading Foreign Exchange, and Illegally Buying and Selling Foreign Exchange" (hereinafter referred to as the "Decision") issued by the Standing Committee of the National People's Congress in December 1998 is the only independent criminal law outside of our "Criminal Law" that is currently effective, highlighting the importance our country places on the foreign exchange management system. Article 4 of the "Decision" states: "Buying and selling foreign exchange outside the trading places designated by the state, disrupting market order, and causing serious circumstances shall be punished according to the provisions of Article 225 of the Criminal Law for 'illegal business operations.'"

In 2018, the Supreme Court and the Supreme Procuratorate issued an interpretation on several issues concerning the application of laws in criminal cases of illegally engaging in fund payment and settlement business and illegally buying and selling foreign exchange, readjusting the prosecution standards for buying and selling foreign exchange. Specifically, engaging in illegal fund payment and settlement business or illegally buying and selling foreign exchange, if any of the following circumstances exist, shall be recognized as "serious illegal business operations": (1) the amount of illegal operations exceeds five million yuan; (2) the amount of illegal gains exceeds one hundred thousand yuan. The standard for particularly serious circumstances is: (1) the amount of illegal operations exceeds twenty-five million yuan; (2) the amount of illegal gains exceeds five hundred thousand yuan.

Therefore, using crypto assets to operate underground money exchanges and evade our country's foreign exchange management system is absolutely inadvisable and constitutes a criminal act.

2. Legal risks for currency exchange residents

Generally speaking, for the model of directly exchanging fiat currency for foreign currency, the main targets of regulatory authorities in our country are underground money exchanges, and the enforcement against individuals exchanging currency is not very strong. Moreover, due to the strict inspection by our customs and the relatively small amount of traditional currency exchange, if caught, it is usually handled with administrative penalties. In this traditional model, the risk of property loss is greater for currency exchange residents. However, if the model involves exchanging fiat currency for cryptocurrency, it falls into a legal gray area for currency exchange residents, presenting several potential risks.

First, the currency exchange behavior violates the risks outlined in the "Notice on Further Preventing and Dealing with Risks of Virtual Currency Trading Speculation" issued by the People's Bank of China and ten other ministries (hereinafter referred to as the "9.24 Notice"). The "9.24 Notice" explicitly states: "Illegal financial activities such as conducting exchange businesses between legal tender and virtual currencies, and exchanges between virtual currencies are strictly prohibited and shall be resolutely banned according to law." For those engaging in related illegal financial activities that constitute a crime, criminal responsibility shall be pursued according to law. However, so far, there have only been cases punishing individuals and organizations conducting exchange businesses, with no cases punishing exchange customers.

Secondly, the legal risks may depend on the purpose for which the currency exchange residents are exchanging currency, which could constitute various illegal or even criminal acts. For example, some currency exchange residents exploit the difficulty of tracing crypto assets to use this new exchange method as a means to evade tax supervision. According to the "Individual Income Tax Law of the People's Republic of China" and its implementation regulations, citizens of our country are required to pay taxes on their income earned abroad. However, cryptocurrencies can effectively help users evade tax supervision under the traditional financial system, making such behavior illegal and potentially subject to administrative penalties or even criminal charges.

04 Conclusion

The Xiao Za team reminds us that in recent years, there has been a gradual increase in crimes involving the use of cryptocurrencies for money laundering, evading foreign exchange management, and financing terrorism internationally. Major countries around the world are also gradually strengthening their regulation of cryptocurrencies, and our country is no exception. In fact, cryptocurrency-related activities are considered illegal financial activities in our country, and using cryptocurrencies to evade tax supervision directly infringes upon our country's normal management order of foreign exchange, violating the "red line" of our criminal law. Therefore, both for underground money exchanges and residents of our country with currency exchange needs, there are multiple legal risks.