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, carving out a sustainable path amidst the cracks of policy and market environment requires addressing not only issues related to 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 Web3 entrepreneurship in China?
According to policies such as Announcement 94 and Notice 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 be careful not to touch these sensitive areas.
Token issuance projects often involve risks related to illegal fundraising. On September 4, 2017, seven ministries issued the "Announcement on Preventing Risks of Token Issuance Financing" (Announcement 94), requiring all token issuance financing activities to cease immediately from the date of the announcement, effectively halting all ICO activities within China.
According to policy regulations, virtual currency-related businesses are considered illegal financial activities, and the exchanges operate by facilitating the exchange between fiat currency and virtual currency, as well as between virtual currencies.
The activity of virtual currency "mining" refers to the process of producing virtual currency through specialized "mining machines," which consumes a large amount of energy and generates significant carbon emissions. The 2021 "Notice on Rectifying Virtual Currency Mining Activities" prohibits the development of virtual currency mining projects under any name.
02. What legal risks should be noted in the operational model of Web3 projects?
Criminal charges such as operating a casino and organizing or leading pyramid schemes are common and high-frequency legal risks in the cryptocurrency sector.
Taking Web3 games (also known as GameFi or blockchain games) as an example, Web3 game entrepreneurs in China are subject to both gaming laws and blockchain-related policies. Lawyer Shao believes that the legal risks for such entrepreneurial projects are still very high if conducted domestically. This is because tokens issued in foreign Web3 games are generally on-chain, allowing users to trade freely, while in China, token issuance is prohibited, and cashing out in-game tokens is not allowed. Therefore, if a Web3 game is operated domestically, game developers recovering in-game items directly or indirectly (in cooperation with payment service providers) may face gambling risks. If there are promotional models similar to pyramid schemes in the promotion or game model, such as multi-level distribution or recruiting others for profit, there may be pyramid scheme risks.
03. What financial crime risks should be prevented during the operation of Web3 projects?
Web3 platforms may be exploited by criminals for money laundering activities. Due to the anonymous nature of transactions, it is difficult to trace the source of each transaction as legal and compliant. Additionally, since transactions are not limited by geography, the customer base may be spread across the globe. Similar to the traditional financial industry, this is also an industry closest to money. Therefore, in future anti-money laundering regulations, Web3 entrepreneurs will be held to higher responsibilities and obligations compared to other industries. If business activities are deemed criminal by a certain country, possible consequences include but are not limited to paying hefty fines, criminal penalties for the actual controllers, and being ordered to exit that country's market.
Thus, establishing an effective anti-money laundering internal control system and fulfilling anti-money laundering legal obligations is an important issue that Web3 entrepreneurs need to prioritize.
04. If a Web3 project goes 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 relation to China, it may theoretically fall under Chinese criminal jurisdiction. Adding foreign factors to the business model, such as having a foreign company as the entity or a foreigner as the nominal operator, may seem to reduce the probability of criminal risk. However, if the Web3 business operated is prohibited by domestic regulations and the project still targets users in mainland China, then even if the project is registered overseas, as a project essentially operated by Chinese individuals, it will still face relevant criminal legal risks.
05. How can funds from overseas Web3 entrepreneurship be legally repatriated to China?
A common question for Web3 entrepreneurs is that most of the company's operating income is in overseas companies, or the financing received can only be exchanged for fiat currency in compliance overseas. However, the main team is located in mainland China, and operating expenses are primarily incurred there. In this context, how can the legitimate operating income and financing income of the overseas company be repatriated to mainland China? One method is through Foreign Direct Investment (FDI).
FDI can be understood as investment activities conducted directly in China by foreign individuals, enterprises, or other organizations (hereinafter referred to as foreign investors) using foreign exchange, physical goods, technology, etc. Common FDI scenarios include: (1) foreign investors establishing foreign-invested enterprises in China alone or in partnership with other investors; (2) foreign investors acquiring shares, equity, property shares, or other similar rights in enterprises within China.
Currently, China implements a pre-access national treatment and negative list management system for FDI. In short, 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 under FDI[i].
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 a Web3 project does not pay enough attention to user information protection and data security, it may lead to security incidents caused by hacker attacks.
For example, on November 16, 2024, the cryptocurrency trading platform DEXX was hacked, with reports indicating that user assets worth over $100 million were stolen. In-depth technical analysis by the Bitcoin Jungle monitoring system revealed serious security issues with the DEXX trading platform: private key storage (although DEXX claims not to be a custodial wallet, it recorded users' private keys, which hackers could easily access if the system was attacked) and plaintext transmission of private key exports (the DEXX platform did not take any encryption measures when users exported their private keys, leading to the private keys being exposed in plaintext 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," and to establish and implement a comprehensive data security management system to ensure 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 legal regulations but also adhere to the relevant laws and regulations of the country where the project is located.
07. Are there legal risks in operating virtual currency entrusted investment businesses?
Although policies such as Announcement 94 and Announcement 924 classify virtual currency-related businesses as "illegal financial activities," legal disputes arising from virtual currency entrusted investment are still common in practice. If Web3 entrepreneurs act as investment agents in an institutional form, raising funds from investors for virtual currency investment activities, they may face pressure from investors for rights protection in the event of investment losses.
Although according to Chinese policy, virtual currency-related businesses are considered illegal financial activities, the legality of such cooperative transactions between the agent and the principal is still highly controversial in specific business scenarios. However, it is still recommended that both parties sign a written entrusted investment agreement before starting cooperation. Based on our experience with related cases, this can reduce the criminal risk for the agent to a certain extent. Additionally, clarifying jurisdiction clauses (selection of jurisdictional institutions and locations) can also help resolve disputes.
08. Can a company registered overseas have employees in China?
If a company's business operations violate Chinese criminal law, overseas projects cannot completely avoid domestic criminal risks. If employees are located in China, there are two main risks. First, employees lack stability. Domestic employees may be investigated as criminal suspects at any time, which does not guarantee their job stability and also affects labor costs. Second, if an investigation is initiated, the overall operation of the company will be impacted. If an employee is investigated, according to Chinese criminal law provisions on sentence reduction, voluntary surrender, and meritorious service, the employee may disclose relevant information they are aware of. This could lead to the leakage of the company's trade secrets and core confidential information, affecting normal business operations.
09. Final Thoughts
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 businesses must not be touched. Even if conducting business overseas, if the business targets domestic users, it is necessary to comply with both domestic and the laws 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 to move forward steadily in the blue ocean of Web3.
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