Some Hard Truths
In the eyes of the vast majority of Web3 practitioners, decentralization may be optional, but tokens are indispensable.
The reason is that, in addition to providing technical underpinnings such as tamper resistance and privacy protection, blockchain can also provide timely and effective incentives to multiple network participants through tokens, thereby realizing an ideal state of distribution according to contribution. Beyond this ideal blueprint, another reason for the intense enthusiasm surrounding tokens is their widespread recognition as an important fundraising mechanism.
In 2017, relevant regulatory authorities in mainland China issued the widely known “September 4 Notice,” which imposed clear restrictions on token issuance and financing activities, expressly prohibiting public fundraising through initial coin offerings (ICOs). In 2017, a whitepaper alone could secure millions of dollars in funding, and the entire industry was permeated by an atmosphere of fervor and disorder. The issuance of the September 4 Notice was undoubtedly reasonable, as its core purpose was to prevent illegal fundraising, pyramid schemes, and other conduct that disrupts financial order. However, this notice also led many practitioners to misunderstand that any issuance of tokens by project sponsors was unlawful and might even involve criminal liability. This view spread widely both within and outside the industry, and even some legal practitioners and regulators held similar views.
However, in practice, token issuance is not categorically deemed unlawful. The key lies in the nature of the token itself, the identity of the offerees, and the legality of the underlying project. To ensure compliance, entrepreneurs need to deeply understand the nuances in these areas in order to effectively avoid legal risks.
Token Type Is Critical
The compliance status of a token primarily depends on its type. According to industry practice, tokens are generally classified as utility tokens and security tokens. Utility tokens are mainly used for products or services within a platform, granting users usage rights without involving investment returns. By contrast, security tokens possess investment attributes, with token holders expecting to obtain economic returns from the project. These two types of tokens are subject to entirely different regulatory regimes under the law.
Compliance Status of Utility Tokensis generally stronger, because they are primarily used for actual services or functions on a platform rather than as investment instruments. In certain jurisdictions, such as Singapore and Hong Kong, the issuance of utility tokens remains lawful. As long as the token’s use is tied to platform services and lacks the character of economic return, utility tokens typically do not trigger stringent securities regulation. For example, users may use utility tokens to purchase platform services, participate in voting, or enjoy rewards, without thereby being regarded as investors.
However,Regulatory Requirements for Security Tokensare much stricter. Taking the United States as an example, the U.S. Securities and Exchange Commission (SEC) has set a very high threshold for the issuance of security tokens, requiring that all security tokens undergo compliance review. If a token exhibits clear investment attributes, or if token holders expect to derive profits therefrom, the issuer must comply with securities laws. This situation also applies in China; the September 4 Notice expressly provides that unauthorized public token financing activities are likely to be characterized as illegal offerings of securities or illegal fundraising.
Distinguishing token types is the first step in token issuance. Clarifying the nature of tokens helps entrepreneurs select appropriate compliance pathways. If entrepreneurs plan to issue tokens for the international market, they must understand the legal requirements for token types in each jurisdiction and ensure that the token issuance complies with local laws. For example, the Blockstack project received approval from the U.S. Securities and Exchange Commission (SEC) in 2019 and conducted the first compliant security token offering (STO). This case demonstrates a lawful pathway for token issuance in compliance with U.S. securities laws. Although the process is complex, compliance is indispensable for security tokens. Projects that fail to adopt compliant pathways face significant risks. For instance, certain projects claiming to issue "utility tokens" actually provided investment returns and were ultimately determined to involve illegal securities offerings, resulting in severe penalties.
The target investors for token fundraising are critical
In addition to token types, the selection of fundraising targets is equally crucial. Chinese regulatory policies have taken stringent measures against token financing activities directed at the general public, particularly public fundraising through initial coin offerings (ICOs), as such activities are often associated with risks such as fraudulent projects, Ponzi schemes, and illegal fundraising. To mitigate these risks, regulatory authorities have explicitly required that all ICO activities directed at the general public must cease, and projects already underway must be wound down. This means that token issuances in China should avoid targeting the general public.
The underlying rationale of Chinese regulatory policies is to protect investors, especially ordinary investors who lack professional investment capabilities. Publicly offered ICOs often carry extremely high risks and are highly likely to cause substantial losses to a large number of investors, which was one of the primary reasons for the issuance of the September 4 Notice. In contrast,accredited investorstypically possess stronger risk identification and tolerance capabilities. Therefore, raising funds from accredited investors can effectively reduce legal risks.
In international markets,accredited investorstandards are also very strict. For example, in the United States, accredited investors must meet specific income and asset thresholds to participate in private placement activities for security tokens. This restriction mechanism ensures that only investors capable of bearing risks can participate in token fundraising activities. For instance, a blockchain project publicly raised funds from non-accredited investors, claiming that investing in its tokens would yield high returns. These investors were primarily members of the general public, and many ultimately suffered significant losses. The platform's executives consequently faced legal sanctions.
The token project itself is critical
Many entrepreneurs fall into the misconception that as long as tokens are defined as utility tokens and fundraising targets are carefully restricted, their projects will be fully compliant and free of concerns. In reality, whether the project's operational model complies with legal requirements often determines the overall compliance of the project.
For example, China imposes strict legal restrictions on industries such as gambling. If a project involves gambling-related activities or conducts gambling-like activities through virtual currencies, the project will still be deemed illegal even if the token issuance method and fundraising targets comply with regulations. For instance, a domestic blockchain project involving illegal fundraising and gambling was shut down by public security authorities. Although the project did not raise funds from the general public during its initial token issuance, it operated gambling services using virtual currencies, attracting a large number of Chinese users. Despite the project's avoidance of ICO-related risks in its token issuance, its illegal operational conduct ultimately led to the shutdown of the entire project, and the relevant personnel faced criminal liability.
Similarly, certain blockchain projects adopt pyramid-scheme-style marketing tactics, using token incentives to attract investors to promote the project in multiple tiers, which often crosses the legal red lines concerning pyramid schemes in China. This is why we have consistently advised entrepreneurs:Paying attention to the legality of the project itself is far more important than the token issuance itself.If your project model carries potential legal risks, no matter how compliant your token issuance is, the future of the project will still fall into difficulty.
Compliance Recommendations from Mankun Law Firm
In the vast majority of blockchain projects, tokens are more akin to icing on the cake; how beautifully that flower blooms ultimately depends on whether the project itself is sufficiently solid. From a compliance perspective, there is no fundamental difference between Web3 entrepreneurs and traditional Web2 entrepreneurs when viewed through the lens of legal compliance. To effectively avoid legal risks in token issuance, Honglin Lawyers offer the following practical recommendations:
1. Clarify the Type of Token
Entrepreneurs must first determine whether the token being issued is a utility token or a security token. If it is a utility token, it must be ensured that it is used solely for services or products within the platform and does not possess the nature of an investment return. If it is a security token, strict compliance with the securities laws and regulations of the relevant jurisdiction is required to ensure that the token issuance meets all applicable requirements.
2. Carefully Select Fundraising Targets
During token issuance, entrepreneurs must strictly limit the targets of issuance and avoid raising funds from the general public. Particularly in China, publicly offering tokens easily triggers regulatory risks; therefore, limiting token sales to qualified investors and licensed funds is an effective compliance strategy.
3. Ensure Commercial Compliance of the Project Itself
The design of the project's business model is equally critical. Entrepreneurs should avoid adopting high-risk structures such as pyramid schemes or Ponzi schemes, ensuring that the project's service model complies with legal requirements. In particular, for activities involving virtual assets such as betting, gambling, or illegal fundraising, technical measures must be implemented to block users from China, thereby avoiding unnecessary criminal liability.
In summary, token issuance does not inherently constitute illegality, but its legality depends on multiple factors, including the type of token, the fundraising targets, and the project's underlying business model. Innovation in the blockchain industry brings new opportunities globally, but while exploring these opportunities, entrepreneurs must clearly understand the legal requirements of different jurisdictions and advance project development through compliant pathways. Whether issuing utility tokens or security tokens, entrepreneurs should operate with caution to ensure their projects remain within the legal framework. Therefore, only a solid project foundation and strict compliance controls can enable tokens to truly serve as a catalyst for project development, rather than a source of legal risk.
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*This article is an original work of Mankun Law Firm. It reflects solely the personal views of the author and does not constitute legal consultation or legal advice on any specific matter. We welcome contributions and insights from more Web3 practitioners. For reprint permissions and legal inquiries, please contact our customer service at: MankunLawFirm.
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