Source of the article: Shao Shiwei
In recent years, with the rapid development of blockchain technology, more and more entrepreneurs have turned to the Web3 field in search of opportunities in this blue ocean. However, for domestic Web3 entrepreneurs, opening a sustainable development path amidst policy and market constraints requires addressing not only the relevant issues of the business content itself but also complex legal compliance challenges.
This article summarizes the frequently asked legal questions that Lawyer Shao encounters in daily work, hoping to provide some ideas or inspiration for Web3 entrepreneurs.
Author | Lawyer Shao Shiwei
01. What are the red lines for doing Web3 entrepreneurship in the country?
According to policies such as Announcement No. 94 and Notice No. 924, there are currently three negative lists for engaging in Web3-related entrepreneurial projects within China: issuing tokens, operating virtual currency exchanges, and mining. Web3 entrepreneurs must remember not to touch the minefields.
Projects that issue tokens often face risks related to illegal fundraising. On September 4, 2017, seven ministries issued the (Notice on Preventing Risks of Token Issuance Financing) (Announcement No. 94), requiring all token issuance financing activities to be immediately halted from the date of the announcement, thus stopping all ICO activities within China.
According to policy provisions, virtual currency-related businesses are classified as illegal financial activities, while the exchanges conduct exchange operations between legal currency and virtual currency, as well as between virtual currencies.
Virtual currency 'mining' activities refer to the process of producing virtual currency through specialized 'mining machines,' which consume a large amount of energy and produce significant carbon emissions. The Notice on Rectifying Virtual Currency 'Mining' Activities issued in 2021 stated that the development of virtual currency 'mining' projects is prohibited under any name.
02. What legal risks need to be considered in the business model of Web3 projects?
Crimes such as opening a casino and organizing or leading pyramid schemes are common and high-frequency criminal legal risks in the crypto space.
Taking Web3 games (also known as GameFi or blockchain games) as an example, for Web3 game entrepreneurs, they will be subject to dual constraints of gaming laws and regulations and blockchain-related policies in our country. Lawyer Shao believes that such entrepreneurial projects have very high legal risks if done domestically. This is because tokens issued in foreign Web3 games are generally on-chain and allow users to trade freely, while domestically, token issuance is prohibited, and cashing out in-game tokens is not allowed. Therefore, if Web3 games are operated domestically, game merchants recovering in-game items directly or indirectly (in cooperation with payment processors) may face gambling risks. If there are promotional models similar to pyramid schemes, such as earning profits through multi-level distribution or recruiting, there may be pyramid scheme risks.
03. In the operation of Web3 projects, it is necessary to prevent financial crime risks
Web3 platforms may be exploited by criminals for money laundering activities. Due to the anonymity characteristics of transactions, it is difficult for exchanges and crypto wallets to trace the source of each transaction to ensure it is legal and compliant. Moreover, because transactions are not restricted by geography, the customer base may be spread across the globe. Additionally, like traditional financial industries, this is an industry closest to money. Therefore, in future anti-money laundering regulations, Web3 industry entrepreneurs will face higher responsibilities and obligations compared to other industries. If business activities are determined to be criminal by a country, possible consequences may include but are not limited to paying hefty fines, imposing criminal penalties on the controlling person, and ordering the project to exit the market in that country.
Therefore, establishing an effective anti-money laundering internal control system and fulfilling anti-money laundering legal obligations are important issues that Web3 entrepreneurs need to focus on.
04. When Web3 projects go overseas, do they still need to comply with domestic legal regulations?
China's criminal jurisdiction is based on four principles: territorial principle, personal principle, protective principle, and universal principle. In other words, the scope of application of Chinese criminal law is extensive; as long as any link in the business model has some relation to China, it is theoretically possible to be subject to Chinese criminal law jurisdiction. Increasing foreign-related factors in the business model, such as having the company entity as an overseas company or the nominal operator as a foreigner, may seem to reduce the probability of criminal risk at first glance. However, if the Web3 business operated is prohibited by domestic regulations and policies, and the project still targets users in mainland China, then even if the project is registered overseas, it remains a Web3 project essentially operated by locals, thus still facing related criminal legal risks.
05. For Web3 entrepreneurship overseas, how can funds be lawfully repatriated to the domestic market?
A common issue for Web3 entrepreneurs is that a significant portion of the company's operating income is in overseas companies, or the funds received can only be exchanged for legal currency in compliance in overseas. However, the main team is located in the mainland, and operating expenses are primarily in the mainland. In this context, how can the legal earnings and financing from overseas companies be repatriated to the mainland? One method is through Foreign Direct Investment (FDI).
FDI can be understood as the investment activities conducted by foreign natural persons, enterprises, or other organizations (hereinafter referred to as foreign investors) using foreign currency, physical goods, technology, etc., directly in China. Common situations of FDI include: (1) Foreign investors independently or jointly with other investors establish foreign-invested enterprises in China; (2) Foreign investors acquire shares, equity, property rights, or other similar rights in enterprises within China.
Currently, China implements a system of pre-entry national treatment and negative list management for FDI. In simple terms, except for certain specific fields where special management measures are implemented by the state, foreign investors and domestic investors enjoy the same rights and obligations for other foreign investments. In short, common entrepreneurial fields for Web3 entrepreneurs, such as public chain development, cross-chain technology, DAPP, DID, or other on-chain infrastructure construction, can safely apply FDI.
06. Information protection and data security issues need to be taken seriously
Although the core of blockchain is decentralization, Web3 projects still involve data management and cross-regional data interaction in actual operations. Therefore, if Web3 projects do not pay enough attention to user information protection and data security, it may trigger security incidents caused by hacker attacks.
For example, on November 16, 2024, the cryptocurrency trading platform DEXX was hacked, with reports claiming that user assets worth over $100 million were stolen. In-depth technical analysis by the Bit Jungle monitoring system revealed that DEXX trading platform had serious security issues: private key storage (although the DEXX platform claims it is not a custodial wallet, it recorded users' private keys, which hackers could easily obtain if the system was attacked, thus stealing user assets) and plain text transmission of private key exports (the DEXX platform did not take any encryption measures when users exported their private keys, leading to the exposure of private keys in plain text during transmission, making it easy for hackers to intercept).
For Web3 projects operating within our country, it is necessary to comply with the requirements of the (Personal Information Protection Law), (Cybersecurity Law), and (Data Security Law) by establishing and implementing a comprehensive data security management system to ensure the security of data during storage, transmission, and processing. For Web3 projects operating overseas, if they target domestic users, they must comply not only with domestic legal provisions but also with the relevant laws and regulations of the country where the project is located.
07. Is there any legal risk in operating virtual currency entrusted investment businesses?
Although policies such as Announcement No. 94 and Announcement No. 924 classify virtual currency-related businesses as 'illegal financial activities,' legal disputes arising from virtual currency entrusted asset management are still common in practice. If Web3 entrepreneurs act as investment agents in institutional form and raise funds from investors for virtual currency investment management activities, they may face pressure from investors to protect their rights in case of investment losses.
Although according to our country's policy provisions, virtual currency-related businesses are considered illegal financial activities, the legality of cooperation transactions between agents and clients in such cases is also highly controversial. It is still recommended that both parties sign a written investment entrustment agreement before starting cooperation. Based on our experience in handling related cases, this can help reduce the criminal risk for the agent to some extent. Additionally, clarifying the jurisdiction clause (choosing the jurisdiction authority and location) also helps resolve disputes.
08. Can a company registered overseas have employees in the country?
If the company's business operations violate our criminal law, overseas projects cannot completely avoid domestic criminal risks. If employees are based in the country, there are two main risks they face. First, employees lack stability. Since domestic employees may be investigated as criminal suspects at any time, their job stability is not guaranteed, which also affects labor costs. Second, after an investigation is initiated, the company's overall operations will be affected. If employees are investigated, they may disclose relevant information they know based on the provisions of Chinese criminal law regarding sentence reduction, voluntary surrender, and meritorious service. This could lead to the leakage of the company's trade secrets, high-level personnel, and other core confidential information, affecting the company's normal operations.
09. In conclusion
For Web3 entrepreneurs and practitioners, before deciding to engage in related businesses, it is essential to understand where the legal bottom line lies. High-risk criminal-related businesses must not be touched. Even when conducting business overseas, if the business targets domestic users, it is necessary to comply with both domestic regulations and those of the country where the project is located. It is hoped that this article can provide clear ideas and practical advice for practitioners in the industry, helping everyone move forward steadily in the blue ocean of Web3.