Web3 Legal Education | What are the legal risks of the controversial round of financing for KOLs in the crypto world?

SatoshiVM has become one of the hot projects in the first half of 24 years, and one of the reasons is the "farce" caused by KOL.

In January 2024, SatoshiVM issued the token SAVM for the first time. Due to the early promotion by many KOLs collaborating with it, the token price of SAVM skyrocketed from the day of issuance. Shortly after its release, its price had already reached $11.66. However, the controversy arose when KOLs were found to have received project tokens and immediately sold them, causing a significant drop in the coin price. According to the trading data on June 12, 2024, the lowest trading price of SAVM within 24 hours was $2.07, far from its former glory.

In fact, the cooperation between encryption projects and KOLs has long been one of the industry's default marketing methods, giving rise to the concept of KOL rounds of financing. However, KOLs participating in KOL rounds face many legal issues, especially when the projects they are involved in experience strong market fluctuations.

Therefore, today Man Kun lawyer will talk to everyone about the topic of encryption KOL round - what is KOL round? What are its legal risks? How to avoid these risks?

KOL and KOL Round

(1) What is KOL

KOL (Key Opinion Leader) directly translated as Key Opinion Leader, refers to a person who has more accurate product information, is accepted or trusted by the relevant group, and has a greater influence on the purchasing behavior of the group.

And KOLs in the Web3.0 field are essentially a group of crypto world big Vs who have rich investment experience or mining awareness and have accumulated a certain number of fans. They have greater exposure due to the large amount of attention they receive and the information they release will be seen by more people.

As a "guru" in the Web3.0 field, they do not necessarily have to accumulate a certain number of fans to be called KOLs. Even KOLs with only 5000 fans have the opportunity to receive promotion invitations from project parties and obtain certain rewards through project promotion.

There are generally two ways for KOLs to earn income: the first is to receive instant rewards, such as the common Giveaway KOL or NBA celebrity endorsements on X; the other is to serve as project investors, using their influence as 'technical shares' or directly participating in investments. After the project goes online, they receive or purchase project tokens at a discount as investors or early contributors.

**(2) How to understand the KOL round?

KOL round is actually the second form mentioned above. The reason for the different names is due to different perspectives.

From the perspective of project financing, some cryptocurrency startups raise venture capital through equity, while others raise funds by selling their own issued tokens or subsidiary tokens. Of course, some companies also raise funds through a hybrid financing round of tokens and equity.

KOL round refers to the project inviting KOLs for promotion while also treating them as financing targets. Unlike other financing targets, KOLs, as early contributors to the project, usually can obtain a certain discount when purchasing project tokens, or even receive token allocations for free.

In April 2024, Web3.0 asset data platform RootData released a statistical data on the financing participation of KOLs in projects over the past six months, with dingaling ranking first in participation in 21 projects financing.

It is worth noting that, from this list, the proportion of NFT players is relatively high. One possible reason is that the NFT market has been underperforming in recent years. Therefore, NFT projects and KOLs also need to seek new growth points and breakthroughs to further stimulate market operations. The linkage between project parties and KOLs may be one of the reasons for the large influx of NFT players into the primary and secondary markets.

What legal issues should be noted in the KOL round

(I) Regulatory Trends Related to KOL Rounds

In China, based on the regulations such as the Advertising Law, the Code of Conduct for Internet Broadcasters, and the Guiding Opinions of the State Administration for Market Regulation on Strengthening the Regulation and Management of Internet Live Streaming, traditional KOLs need to clearly disclose their commissioned promotion relationship with the brand in text or video promotion and are subject to relevant regulations. For example, a KOL needs to include advertising labels when inserting product promotions in a video. However, in the encryption industry, there is currently no specific legal support in China.

However, in the United States, according to a KOL financing document disclosed by Bloomberg, it is stipulated that KOLs who invest at a discounted price must promote the project through long-form podcasts and TikTok videos, and must disclose their relationship with the project when promoting it.

Meanwhile, the encryption promotion by KOLs will also be subject to scrutiny by the Securities and Exchange Commission. For example, in October 2022, Kim Kardashian was found to have violated relevant regulations in the United States for not disclosing her relationship with the project party when promoting a certain token, and was subjected to scrutiny and charges by the U.S. Securities and Exchange Commission.

However, in practice, it is often difficult for external parties to understand the relationship between project parties and KOLs, as well as the internal transaction modes. Moreover, not all project parties or KOLs will disclose their internal relationships to each other. Therefore, unless there are "informants" exposing the information, relevant departments will find it difficult to obtain information about KOL rounds, and it is often difficult to regulate KOL rounds.

(II) Suspected Fraud in False Advertising

As surfers of Web3.0, many investors are aware that even if KOLs only receive payment for advertising and do not participate in project financing, their exaggerated promotion of a project cannot be fully trusted. Following this line of thought, once KOLs purchase or intend to purchase project tokens and invest in the project, the authenticity of the project information they provide is even more questionable.

According to some industry insiders, few KOLs can accurately state the truth when promoting, and their remarks often contain vague, ambiguous, or even completely false content, with the intention of inducing investors to buy project tokens.

In fact, the way KOL exaggerates and promotes, which is half true and half false, poses legal risks of civil fraud and even criminal fraud. According to Article 148 of the Civil Code, if the false statement of KOL leads investors to misunderstand and purchase tokens or participate in projects, causing financial losses, then KOL's behavior constitutes civil fraud, and investors have the right to claim compensation.

More importantly, if KOL intentionally and deceitfully causes the project party to obtain investors' funds by illegally occupying investors' property, resulting in financial losses to investors, then the actions of KOL may likely constitute the crime of fraud as stipulated in Article 266 of the Criminal Law, and bear criminal responsibility.

(3) Risks of illegal pyramid schemes

Based on the previous description, the cooperation model between KOLs and project parties usually lacks transparency, and it is difficult for the outside world to know the specific way that KOLs obtain project tokens. However, if the allocation of token distribution for KOLs is linked to the number of successful investors they promote, and KOLs promote within their own paid community, then this practice may be suspected of illegal pyramid schemes.

From the definition of the crime of organizing and leading pyramid schemes in Article 224 of the Criminal Law of China, the main elements of pyramid schemes under the Criminal Law are: collecting "entry fees" + rewarding based on "headcount" + luring, coercing participants to continue recruiting others, and forming a hierarchical structure of three levels or more.

Therefore, if KOL meets these criteria when promoting a project, that is, collecting community membership fees, obtaining token rewards based on the number of investors developed, and enticing investors to continue developing downlines to form a hierarchical structure of three levels or more, then KOL's behavior may violate the crime of organizing and leading pyramid schemes and bear criminal responsibility.

(4) The risk of being identified as an accomplice to a criminal offense

Recently, the ZKasino project has aroused widespread concerns about the risks of KOL project promotion. The project team released a funding stake activity in March 2024.

Multiple KOLs participated in the KOL round of financing for ZKasino, and promoted the project through various channels such as Twitter, encryption community forums, offline events, etc., obtaining corresponding token rebates and investment incentives.

However, after more than one million users bridged over ten thousand ETH, the ZKasino project unilaterally changed and deleted the official website's activity instructions. They not only failed to return the staked ETH to users as agreed, but also forcibly converted all users' ETH into platform tokens.

This behavior has caused huge controversy, and some KOLs who participated in the financing and promotion of the project have also been strongly questioned and condemned by fans after the project was accused of 'soft rug' (running away with the money), accusing them of engaging in interest transfer and should bear corresponding criminal responsibility as 'accomplices'.

Like the KOLs in this incident, many KOLs often think that promoting projects and selling project tokens at high prices is just normal business investment behavior, which is neither related to the project party nor responsible to the users.

However, as the saying goes, "What goes up must come down." KOLs may profit from the big pump of project tokens, but there is a high possibility that they may also be implicated and face serious legal risks if the project encounters problems.

If the project party is deeply involved in criminal activities due to fundraising methods, project content, etc., and KOL plays an obvious role in promotion and publicity in the involved project, according to Article 25 of the Criminal Law of the People's Republic of China, KOL is likely to be identified as having knowledge or should have known the insider information of the project party and may face accusations from judicial authorities and be held accountable.

Some experienced KOLs have realized this risk and begun to take self-protective measures. For example, KOL 0xKillTheWolf shared on Twitter the reasons for refusing to participate in the ZKasino KOL round, including questioning the project's valuation and revenue data, as well as mistrust of the founder's character. This cautious attitude is worthy of other KOLs' reference.

KOL round is not that fragrant

From the above legal risk analysis, it can be seen that KOL should pay attention to the following key points when participating in the KOL round financing of Web3.0 projects and conducting promotional activities to avoid misleading investors and prevent involvement in criminal cases:

• Conduct a comprehensive due diligence and risk assessment of the project to understand key information such as the operational model, profit model, development prospects, and potential risks.
• When promoting a project, fully disclose the vested interest in holding the project's tokens.
• Avoid false advertising for projects and refrain from abusing influence to manipulate the market.

Some KOLs may think that they are not subject to the jurisdiction of China if they are abroad or promoting overseas projects. This idea is a bit taken for granted. According to the relevant provisions of the Criminal Law of China, as long as the criminal act or result occurs within the territory of China, or the KOL holds Chinese nationality, China has jurisdiction.

Finally, Lawyer Manjun suggests that KOLs in the field of Web3.0 should be cautious when carrying out any promotion, with a responsible attitude towards investors, so as to exert the professional value of 'Key Opinion Leaders' and contribute to the healthy development of the Web3.0 ecosystem.