SHANGHAI—A Chinese phone maker’s failure to repay around $166 million in bonds has rippled through the world’s largest internet investment marketplace, hitting investors who hadn’t even bought the securities.

The default, by phone maker Cosun Group, is one of the most high-profile failures to hit China’s sprawling network of Internet-based financial firms. It is an embarrassment to Alibaba Group Holding Ltd. because its affiliate Ant Financial Services Group owns the investment marketplace where the bonds were sold, and illustrates a rising risk in China, where hundreds of millions of people seeking higher returns on their savings have used their mobile phones to buy risky, unregulated investments.

One person suddenly unable to get his money back was Liu Bing, a 29-year-old civil servant who hadn’t bought any of the Cosun bonds. Instead, Mr. Liu made a peer-to-peer loan arranged by Ant’s site, but the collateral the borrower used to back the loan was Cosun bonds.

Mr. Liu moved his money into the loan offered via Ant by using its best known service, an online payment system called Alipay. “I trusted the Alipay brand,” said Mr. Liu. A review of his investment contract shows it didn’t spell out that bonds would be used as collateral for a loan.

Ant didn’t respond to requests for comment. After the initial defaults by Cosun, an Ant spokeswoman said the firm doesn’t take user trust for granted and has worked to secure customer investments; she described the Cosun issue as a third-party default.