In recent years, with the rapid development of blockchain technology, more and more entrepreneurs are turning to the Web3 field, trying to find opportunities in this blue ocean. However, for domestic Web3 entrepreneurs, finding a sustainable path for development amidst the squeeze of policy and market environment entails not only addressing issues related to the business content itself but also navigating complex legal compliance challenges.
This article summarizes the high-frequency legal questions that Lawyer Shao is often asked in daily work and hopes to provide some thoughts or insights for Web3 entrepreneurs.
Author | Lawyer Shao Shiwei
01. What are the red lines for doing Web3 entrepreneurship in China?
According to Notice 94, Notice 924, and other policy regulations, 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 be careful not to touch these red lines.
Projects that issue tokens often involve risks related to illegal fundraising. On September 4, 2017, seven ministries issued an announcement (Notice on Preventing Risks of Token Issuance Financing) (Notice 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 regulations, virtual currency-related businesses are illegal financial activities, and what virtual currency exchanges conduct is the exchange business 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 dedicated 'mining machines', which consume a significant amount of energy and produce high carbon emissions. In 2021, the (Notice on Rectifying Virtual Currency 'Mining' Activities) stipulated that developing virtual currency 'mining' projects is prohibited under any name.
02. What legal risks should be considered in the model of Web3 projects?
The criminal offenses of operating a gambling den, organizing and leading pyramid schemes, and other criminal charges are common and frequent criminal legal risks in the cryptocurrency sector.
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 China. Lawyer Shao believes that if such entrepreneurial projects are conducted domestically, the legal risks are still quite high. This is because tokens issued in foreign Web3 games are generally on-chain and allow users to trade freely, while in China, both the issuance of tokens and the withdrawal of in-game tokens are prohibited. Therefore, if Web3 games are conducted domestically, game developers may face gambling risks when recovering in-game items directly or indirectly (in cooperation with payment service providers). If there are promotional models similar to multi-level marketing (such as multi-level distribution and recruiting people) in the promotion or game model, there may be risks associated with pyramid schemes.
03. During the operation of Web3 projects, financial crime risks must be prevented.
Web3 platforms may be exploited by criminals for money laundering activities. Due to the anonymity characteristic of transactions, it is difficult to trace the source of each transaction on exchanges and cryptocurrency wallets to ensure they are legal and compliant. Additionally, because transactions are not limited by geography, the client base may be spread across the globe. Furthermore, like the traditional financial industry, this is also an industry closest to money. Therefore, in future anti-money laundering regulations, compared to other industries, Web3 industry entrepreneurs will be held to higher responsibilities and obligations. Once business activities are deemed criminal by a certain country, potential consequences may include hefty fines, penalties for the actual controller, and orders to exit the country's market.
Therefore, establishing an effective anti-money laundering internal control system and fulfilling the legal obligations of anti-money laundering is an important issue that Web3 entrepreneurs need to pay attention to.
04. If 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 applicability of Chinese criminal law is extensive; as long as any link in the business model has some connection to China, theoretically, it could be subject to Chinese criminal jurisdiction. Adding foreign-related factors to the business model, such as the company being a foreign entity or the nominal operator being a foreigner, may seem to reduce the probability of criminal risk. However, if the Web3 business operates in violation of domestic regulations and still targets users in mainland China, even if the project is registered overseas, as a project essentially operated by Chinese individuals, there will still be relevant criminal legal risks.
05. For Web3 entrepreneurs going overseas, how can funds be legally flowed back to China?
A common question for Web3 entrepreneurs is that most of the company's operating income is in overseas companies, or the funds received can only be exchanged into legal currency overseas in a compliant manner. However, the main team is based in mainland China, and operating expenses are mainly incurred there. In this context, how can the legal operating income and financing income of the overseas company be flowed back to mainland China? One method is through Foreign Direct Investment (FDI).
FDI can be understood as investment activities directly conducted by foreign natural persons, enterprises, or other organizations (hereinafter referred to as foreign investors) using foreign currency, physical goods, technologies, etc., within China. Common scenarios of FDI include: (1) foreign investors establishing foreign-invested enterprises in China alone or in cooperation with other investors; (2) foreign investors acquiring shares, equity, property rights, or other similar rights in enterprises within China.
Currently, China implements a national treatment and negative list management system for FDI. In brief, except for certain specific fields where the state implements special management measures, foreign investors and domestic investors enjoy the same rights and obligations for other foreign investments. In summary, common entrepreneurial fields for Web3 entrepreneurs, such as public chain development, cross-chain technology, DAPP, DID, or other on-chain infrastructure construction, can be safely applied to FDI.
06. Attention must be paid to information protection and data security issues
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 could lead to security incidents caused by hacker attacks.
For example, on November 16, 2024, the cryptocurrency trading platform DEXX was hacked, and related reports indicated that user assets worth over 100 million USD were stolen. In-depth technical analysis by the Bitcoin Jungle Monitoring System revealed the following serious security issues with the DEXX trading platform: Private key storage (although DEXX claims to not be a custodial wallet, it recorded users' private keys; once the system was attacked, hackers could easily access users' private keys and steal their assets) and unencrypted plain text transmission of private key exports (DEXX did not take any encryption measures when users exported their private keys, causing the private keys to be exposed in plain text during transmission, making it easy for hackers to intercept).
For Web3 projects operating within China, it is necessary to comply with the requirements of the (Personal Information Protection Law), (Cybersecurity Law), and (Data Security Law) to establish and implement a comprehensive data security management system, ensuring the security of data during storage, transmission, and processing. For Web3 projects operating overseas that target domestic users, they must not only comply with Chinese laws but also the relevant laws and regulations of the country where the project is located.
07. Is there a legal risk in conducting virtual currency entrusted investment business?
Although Notice 94, Notice 924, and other policies classify virtual currency-related businesses as 'illegal financial activities', in practice, legal disputes arising from entrusted virtual currency management are not uncommon. If Web3 entrepreneurs act as entrusted parties in an institutional capacity, collecting funds from investors for virtual currency investment activities, they may face pressure from investors for accountability if losses occur.
Although according to Chinese policy regulations, virtual currency-related businesses are classified as illegal financial activities, the legality of cooperation transactions between entrusted parties and clients in specific business scenarios is still highly controversial. Nevertheless, it is recommended that both parties sign a written entrusted investment agreement before commencing cooperation. Based on our experience handling related cases, this can help reduce the entrusted party's criminal risk to some extent, and the clarity of jurisdiction clauses (choosing jurisdiction institutions and locations) also aids in resolving disputes.
08. Is it permissible for a company registered overseas to have employees in China?
If a company's business operations violate China's criminal law, overseas projects cannot completely avoid domestic criminal risks. If employees are based domestically, there are mainly two risks they face. First, employees lack stability. Domestic employees may be investigated as criminal suspects at any time, which jeopardizes their job stability and increases employment costs. Second, if an investigation is initiated, the overall operation of the company will be affected. If employees are investigated, according to provisions of Chinese criminal law concerning sentence reduction, voluntary surrender, and meritorious service, employees may disclose relevant information they are aware of. Therefore, this could lead to the leakage of the company's trade secrets and other core confidential information, affecting normal business operations.
09. Written at the end
For Web3 entrepreneurs and practitioners, before deciding to engage in related businesses, they first need to understand where the legal bottom line is. High-risk criminal-related businesses should absolutely be avoided. Even if conducting business overseas, if the business targets domestic users, it is necessary to comply with both domestic and the regulations of the host country. It is hoped that this article can provide clear insights and practical suggestions for industry practitioners, helping everyone to progress steadily in the blue ocean of Web3.
