Author: Iris, Mao Jiehao

When we talk about domestic Web3 entrepreneurship, we always mention the 924 document from 2021, emphasizing that conducting virtual currency financial services within the country is illegal financial activity, which constitutes a crime and will be prosecuted under criminal law.

However, we have also noticed that in recent years, there has been a model between Hong Kong and Shenzhen called "front store, back factory," which involves setting up projects/companies in Hong Kong to face regulation and overseas capital, while organizing development and some operational aspects in Shenzhen to enjoy strong technological research and development and low costs.

This naturally raises the question: Is this model really compliant? If it is compliant, does it mean I can set up a project in Hong Kong and then operate it domestically?

It must be said that this is a very interesting and practical question.

Why Does "Front Store, Back Factory" Exist?

Some may wonder, since the 924 document from 2021 has clearly stated that conducting virtual currency-related financial activities domestically is illegal, why has this "Hong Kong front store, Shenzhen back factory" model become active in the eyes of many Web3 entrepreneurs in recent years?

In 2023, Kong Jianping, the director of Hong Kong Cyberport, publicly stated in an interview with The Paper Technology that the "front store, back factory" model between Shenzhen and Hong Kong will facilitate the development of Web3.

*Image source: The Paper News

Lawyer Mankun believes that the reason this model can exist is that regulatory focus does not only look at whether the project directly serves domestic users, but also pays attention to the location of actual operations, core decision-making, and fund management, which is the distribution of actual control and key resources.

On the surface, Web3 project parties register all legal entities and business in Hong Kong or other overseas jurisdictions; through technical means such as IP restrictions and KYC, they limit the provision of financial services to Hong Kong and overseas users; at the same time, fund settlement, license applications, market promotion, and other aspects are also completed through overseas entities.

In this way, both from a business operation perspective and from the service target perspective, they avoid domestic users and align with China's regulatory policies.

From a development perspective, choosing to build a technical team in Shenzhen is based on considerations of cost, efficiency, and technological advantages. As an important part of the Guangdong-Hong Kong-Macao Greater Bay Area, Shenzhen has a mature technological research and development foundation and a large reserve of Web3 talent. Compared to local development teams in Hong Kong, Shenzhen has obvious advantages in terms of labor costs, development cycles, and technological accumulation. For many Web3 project parties, purely outsourcing underlying research and development to Shenzhen is a normal business choice, not much different from the "overseas company + domestic outsourced development" model in the traditional internet industry.

In short, the Hong Kong-Shenzhen "front store, back factory" model seems to temporarily avoid the risk of direct regulatory intervention by clearly delineating domestic and overseas operational functions. However, this model still has a strong sensitivity to compliance.

Potential Challenges of "Front Store, Back Factory"

On the surface, the "front store, back factory" model seems to achieve a "clear division" of domestic and overseas business by registering compliant entities in Hong Kong and retaining only the technical development aspect domestically, thereby avoiding regulatory red lines. But the problem lies precisely in the fact that the technical development, product iteration, and business operation of Web3 projects are highly coupled. Many times, domestic technical teams may not only undertake development work but also inevitably get involved in token design, some operations, data processing, and even user support, which buries hidden dangers for the compliance of Web3 projects.

Because regulatory agencies do not only look at whether the nominal structure complies with regulations but will penetrate to focus on the actual control chain of the project—who holds the core operational rights, fund flow decision-making rights, and user data management rights. If the daily operational management, key decision-making, and fund handling of the project are still concentrated domestically, even if the project entity is registered in Hong Kong and the service target is limited to overseas users, it can easily be deemed by regulators as "substantively" utilizing domestic resources to provide illegal financial services.

Moreover, it is worth noting that some projects, in order to save costs or for efficiency considerations, choose to outsource some market promotion, community management, or even customer service to Shenzhen teams, or even directly initiate operations targeting global users from domestic teams. At this point, regulatory authorities may completely believe that the core operational chain of the project has not been clearly cut, potentially violating legal provisions.

Additionally, since the technical team is deeply involved in product logic design, even if it appears that the project is launching new products or features overseas, the development and launch processes may have already been completed in Shenzhen, further blurring the boundaries between domestic teams and financial services.

In other words, the risk of "front store, back factory" never lies in whether compliant entities have been established on the surface, but in whether domestic and overseas resources have truly achieved functional separation. As long as domestic teams are involved in core aspects such as fund decision-making, operational management, or user services, the compliance risk of Web3 projects will suddenly increase, and it is highly likely to be recognized by regulatory authorities as "selling dog meat under the guise of sheep," leading to legal liability.

Mankun Lawyer's Recommendations

As mentioned above, the "front store, back factory" model superficially achieves a seemingly compliant structure by establishing compliant entities in Hong Kong and restricting domestic user participation. However, as regulatory authorities increasingly focus on "substance over form," if Web3 project parties want to truly reduce legal risks, relying solely on formal functional divisions is far from enough.

Mankun Lawyer recommends that Web3 entrepreneurial teams, when adopting the "front store, back factory" model, must pay attention to the following points:

First, thoroughly cut off the core control chain between domestic and overseas. Whether it is daily decision-making, fund flow, user data processing, or market promotion and operational management, it must be ensured that these are independently completed by overseas registered entities, and it is crucial to avoid outsourcing related functions back to domestic teams. Technical development can be undertaken by the Shenzhen team depending on the project, but it must be strictly limited to "pure research and development" aspects, without involving sensitive content such as fund management, user operations, or market activities after the project goes live, to prevent touching regulatory red lines.

Second, avoid mixing technical development with product operation functions. Many projects, due to the technical team's high understanding of product logic, habitually let them get involved in token design and user interaction, which actually leads to the blurring of domestic and overseas functions. Project parties should clearly define the scope of work for the technical team, strictly separate it from the compliance team and operational team of the Hong Kong entity, ensuring that technical development exists solely as the "back factory" and does not participate in the business operations of the "front store."

Additionally, establish a clear legal and compliance firewall. Web3 project parties should, with the assistance of professional legal personnel, establish clear isolation mechanisms at the contract level, personnel structure level, and fund flow chain with domestic teams. This includes but is not limited to explicitly prohibiting domestic teams from engaging in fund settlement, token distribution, and user management in technical development contracts; at the same time, establishing independent overseas legal entities or foundations to hold project IP, assets, and brand rights, preventing domestic entities from being held accountable as de facto partners or co-operators due to nominal "technical services."

Finally, prepare compliance filings in advance for each jurisdiction. If the Web3 project entity is registered in Hong Kong, it is advisable to apply for relevant licenses as early as possible, either independently or by hiring professional legal advisors, to ensure that all financial service activities targeting users operate within a compliant framework. At the same time, avoid conducting any promotional marketing, community operations, or payment settlement activities in mainland China to reduce the risk of being deemed to be "indirectly providing services to domestic residents."

Ultimately, the current "front store, back factory" model can still serve as a practical option, but the premise is that the team must truly achieve clear separation of resources and responsibilities between domestic and overseas, avoiding turning domestic technical development into an "invisible support" for overseas financial business. However, under the existing regulatory policies, this model is not the best long-term solution. With increasing regulatory strictness, risks will inevitably rise, and a slight misstep could lead to criminal penalties, resulting in a complete loss of previous efforts.

Therefore, Mankun Lawyer still advises Chinese entrepreneurs to strive to truly realize an "overseas" model, fully implementing technological research and development, corporate governance, and financial operations abroad, and accepting compliance management from overseas regulatory authorities.

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