How to prevent Web3 projects from becoming pyramid schemes by attracting new users and offering commissions?

Author: Lawyer Xu Qian

introduction

"Invite gifts", "share rebates", "promotion rewards"... Whether it is traditional e-commerce, content platforms, or Web3 projects, more and more product designs have introduced user incentive mechanisms. However, the compliance boundary of the rebate mechanism is always a blurred line: in the eyes of promoters, this is a reasonable profit sharing; but in the eyes of regulators, it is sometimes regarded as a suspected "pyramid scheme".

Where does this misunderstanding come from? Does the platform rebate really cross the red line of "organizing and leading pyramid selling activities"? This article will combine real cases with judicial identification standards to clarify the boundary between "rebate" and "pyramid selling".

This article aims to explore the boundary between "platform rebates" and "pyramid scheme crimes" from a legal perspective. It only represents the author's personal views and does not constitute legal opinions or suggestions, nor does it constitute a judgment on whether any operating model constitutes a crime. The determination of pyramid scheme behavior is highly case-specific and must be determined by judicial authorities in accordance with the law based on all evidence.

Case Introduction

A certain NFT platform divides NFT into five different levels (level 1 is the lowest and level 5 is the highest). Each level corresponds to different production capacity (computing power), and the price is naturally different. The commission (reward) for introducing the purchase of NFT is also different. The commission can only be given to the NFT level higher than the buyer, and the commission can only be given to one person.

Example:

Will the actual controller of this NFT platform be convicted of pyramid scheme crime?

Legal Analysis | Does Platform Rebate Constitute Pyramid Scheme?

According to Article 224-1 and Article 231 of the Criminal Law, an organization can be the subject of the crime of organizing and leading pyramid selling activities. When convicting and punishing, the directly responsible supervisors and other directly responsible persons should be held criminally liable. So, who are the people that the law focuses on? They mainly include: initiators, organizers, decision makers who play a key role in pyramid selling activities, as well as core personnel responsible for planning, commanding, coordinating, etc.

It is worth noting that such behavior can only be identified as a pyramid scheme crime if it meets the conditions of "defrauding property" and "disrupting the economic and social order". In addition, the Criminal Law clearly states that "paying fees to obtain membership qualifications" and "forming levels in order" must be met at the same time to constitute a pyramid scheme in the legal sense. Only one of them usually does not constitute a criminal offense.

1. Source of profit: Does it rely on “selling human heads”?

The platform's main profit model is the income from the sale of NFTs, as well as the fees for NFT circulation, capacity exchange, etc. The profit comes from real product sales and service fees, which is fundamentally different from the "crime of organizing and leading pyramid schemes" in which the "entry fees" of new joiners or the "head fees" of constantly attracting new members are used as funds.

2. Basis of remuneration: Is remuneration calculated on a per capita basis?

The platform's profit comes from the sale of NFTs and the handling fees of the secondary market. The commission (reward) given by the platform to the introducer comes from the real NFT sales profit. The platform expands the sales scale through promotion and takes out a part of the incremental profit to reward the introducer. This is a real transaction and the sale of real goods, which is different from the "crime of organizing and leading pyramid selling activities" that relies on the number of people developed and the accumulation of property as the basis for remuneration or rebates.

3. Whether it constitutes a "hierarchical structure"

The platform adopts a "single-line direct push" model, and there is no pyramid structure above three levels. Users are not linked up and down level by level, and commissions are only given for a single transaction, and only one person is rewarded at most. It does not have the characteristics of "continuous income" or "multi-layer nesting".

4. Is the value of the product real?

NFT transaction pricing complies with market rules. Buyers have a strong willingness to buy based on their pursuit of goods and their rights. The corresponding production capacity of NFT can be circulated in the secondary market, has a high value, and can be maintained in the long run. The platform does not aim to develop downlines, nor can NFT only be purchased through recommendations from old customers. Instead, any user can purchase directly from the platform.

How to avoid the rebate mechanism being suspected of being a "pyramid scheme"?

1. No "entry fee" and "recruiting people" is prohibited

"Entry fees" and "recruiting people" are the core and most obvious characteristics of pyramid schemes. Users are required to pay membership fees, franchise fees, and subscribe to products in order to obtain promotion qualifications or enjoy higher returns, and the number of downline personnel developed (rather than actual sales performance) is used as the main basis for remuneration.

• No mandatory "entry fee" of any kind

Users can register as users or purchase products without paying any fees and enjoy the right to promotion rebates. Be wary of disguised "entry fees" and avoid designs that actually constitute payment thresholds to obtain promotion qualifications or higher commission rates, such as "senior member benefits" and "enjoy higher commissions". The fees paid should be directly linked to the physical goods or services that can be enjoyed and are of the same value, and purchasing the goods/services is not a prerequisite for obtaining promotion qualifications.

• The basis for compensation/rebates should be anchored on "real sales performance"

• Clarify the source of commissions: clearly explain that the commissions come from the profit sharing of actual completed orders brought about by the promotion. Emphasize that the platform will only reward promoters with part of the profits after the goods/services are sold and profits are obtained.

• Strictly distinguish between "promotion" and "recruiting people": the promoter's commission should be based on indicators directly related to real transactions, such as effective user registration, actual sales, and the number of completed orders. It is prohibited to use "number of promoters directly or indirectly developed", "team growth", "number of downline levels" and other "headcount" indicators as the main or decisive factors in calculating promoter remuneration.

• Transparent and traceable data: The source of each commission (specific orders, users, and amounts) is clearly shown to promoters, proving its relevance to real sales.

2. It is recommended to have a "linear" level of rewards, rather than a "pyramid" level of rewards with three or more levels.

A multi-level pyramid structure (usually three levels and above) is a typical feature of a pyramid scheme, which can easily lead to the upper-level income mainly relying on the "performance" of the lower-level and its team (actually the accumulation of per capita fees or entry fees), rather than the real circulation value of the goods. The more levels there are, the risk increases exponentially. One of the key elements of the Criminal Law's determination of the crime of organizing and leading pyramid schemes is the formation of a pyramid structure of more than three levels.

• Suggested "straight-line" first-level rebate

Promoter A invites user B. Only when B makes real purchases can A get a commission. B then invites user C to make purchases, but C's purchases have nothing to do with A, and A will not get any benefits from this. All commissions only occur between the direct promoter (A) and the consumer (B) he or she directly brings. This structure is simple and transparent, focusing on direct sales results. The hierarchical relationship is clear and stops at one level, which basically eliminates the suspicion of "team compensation" and "recruiting people", and has the lowest legal risk.

• Allow up to two levels of rewards, and design multi-dimensional reward indicators

If you have to use multi-level rebates in order to expand the promotion efforts, increase the promoter's income or enhance the fun, you also need to be cautious and strictly limit the levels. If you consider motivating promoters to manage the team, a maximum of two levels of relationships are allowed, for example: A invites B to become a promoter, and B invites C to consume. C consumes, B gets direct promotion commissions, and A gets rewards for managing B's team. The calculation basis of the reward is the actual total sales performance of the team, but you can design rewards for A with different weights of multiple indicators to recognize his efforts in team building, training, management, etc., rather than rewards for the development of people or levels themselves. There must never be a situation where there are unlimited levels and unlimited transfer of benefits.

3. Ensure that transactions are authentic, legal and sustainable

The essence of pyramid scheme crime is to "swindle money and property". If the project itself is fake, the goods are "props" with a serious premium, or the model itself is not sustainable, and ultimately a large number of participants (especially the bottom) lose money, even if the first two points are avoided in form, it may be identified as a pyramid scheme in essence.

• Provide real, valuable, and reasonably priced goods or services

The project must be based on goods or services that meet the real needs of the market. Consumers should purchase based on their recognition of the value of the goods/services themselves, rather than for the purpose of obtaining promotion qualifications or speculative profits. At the same time, the price of goods/services must be basically consistent with their market value, and ordinary goods must not be packaged as sky-high "props" to cover up the nature of the capital pool. The cost and profit structure should be relatively transparent or have a reasonable basis.

• Ensure the authenticity and legitimacy of transactions

There must be real and verifiable records of goods shipment and service delivery and evidence of actual use/consumption by consumers. Prevent false orders and self-purchase and self-selling to boost sales. Establish and improve after-sales service mechanisms to protect the legitimate rights and interests of ordinary consumers and reflect normal business logic. The flow of funds such as commission payments and payment settlements must be clear and compliant, carried out through formal channels, and taxed in accordance with the law.

• The profit model is sustainable and does not rely on funds from "latecomers"

The overall profit of the platform should mainly come from the sales profit of goods/services, rather than the fees (entry fees or disguised entry fees) paid by new promoters or consumers. Ensure that the commissions paid to promoters are not mainly dependent on the funds invested by later entrants. The business model itself should be sustainable, and even if the growth of new users slows down, it can still rely on the repurchase and normal sales of existing users to maintain operations.

• Seek truth from facts in publicity and promotion, and avoid fraud and misleading

Promotional materials must be true and accurate, and must not exaggerate the benefits or promise "making money easily" or "getting rich quickly". It should be clearly stated that the promotional benefits are related to personal efforts and market conditions, and there are uncertainties. Compliance publicity and consumer guidance should be done well. The focus of publicity should be on the advantages and value of the product/service, rather than over-exaggerating the promotional profit opportunities.

Conclusion: Legal rebates are marketing; illegal rebates are crimes

The law will see through the packaging of "marketing methods" and determine whether it is actually "pyramid selling".

Even if the multiple levels and entry fees are avoided in form, if the core is to defraud money (such as seriously inflated prices of goods and unsustainable models), it may still be characterized. If a project wants to go far, it must return to real value creation: win with products and services, rather than relying on layers of rebates to create a myth of wealth. Only by keeping the boundaries can we move more steadily.