Attorney Shao Shiwei | How to Ensure Legal Compliance for Blockchain Gaming (GameFi) Startups?

 Special Disclaimer: This article is an original work by Attorney Shao Shiwei and reflects only the author’s personal views. It does not constitute legal consultation or legal advice on any specific matter. For article reprints, legal consultations, or business exchanges, please add: sswls66

On October 29, 2023, the INweb3 community organized a sharing session discussing applications of AI and Web3. Attorney Shao Shiwei of Mankun Law Firm was invited to participate and presented on the topic “Compliance Guide for ‘Blockchain Game’ Startups.”

 This article is the written transcript of that presentation.

Author: Attorney Shao Shiwei

01

GameFi, i.e., game + finance, literally refers to gamified finance.

In simple terms, blockchain gaming applies blockchain technology to games. All in-game actions are executed on-chain, and through the constraints of smart contract rules, players’ in-game assets are privatized, made transparent, and secured.

1. Differences Between Blockchain Games and Traditional Games

From the perspective of core logic:

In traditional games, developers retain control over the game, including the formulation of game rules, game scenarios, player characters, and ownership of in-game items. Web2 games maximize the protection of developers’ interests, while players’ interests remain unprotected.

“Decentralization” is the most distinguishing feature of blockchain games compared to traditional games. Blockchain gamesare based on a trust relationship established through decentralized distributed ledgers. Their value lies in community building: the more users recognize the game itself, the higher its value becomes.The core concept of blockchain-based games is to enable users to become both investors in and beneficiaries of the game.

From the perspective of developer revenue:

In traditional games, players pay to purchase in-game items or tokens, which constitutes the primary source of profit for game publishers.

In blockchain games, in-game assets are created by players. The appreciation of in-game tokens depends on factors such as the number of players and the game’s popularity. Developers derive revenue from transaction fees generated by players’ trading of in-game assets and from the appreciation of the in-game tokens themselves.

From the perspective of data storage:

Traditional games are susceptible to theft of in-game equipment and other virtual items due to hacker attacks.

Blockchain games are a specific application of blockchain technology. Because blockchain is a distributed ledger technology operated across computers worldwide, hackers cannot compromise the entire network system by infiltrating or attacking a single centralized database. Therefore, the combination of blockchain and gaming enables in-game virtual items to be stored permanently and securely, and prevents them from being tampered with.

From the perspective of player interests:

In theory, operators of Web2 games can arbitrarily modify or even delete user data.

Blockchain games rely on blockchain-based distributed storage and cryptographic technologies, ensuring that players’ virtual assets cannot be arbitrarily deleted by game publishers.

From the perspective of business models:

Traditional games primarily adopt a “free-to-play” model, where playing is free and players may choose to purchase skins, equipment, and other items. Blockchain games primarily adopt a “play-to-earn” model, allowing players to earn income while playing.

2. The Core of GameFi: Play-to-Earn

The core of the GameFi sector is the play-to-earn economic model. Unlike the free-to-play model prevalent in the traditional gaming industry, players in blockchain-based games can earn real monetary value through crypto assets. Participants contribute to the construction of the virtual economy and earn rewards through their in-game activities, which they can then sell in the market to realize profits.

The economic model is a key concept in blockchain games. We categorize all economic models into two types, namely:Single-token economic models and dual-token economic models。

In a dual-token model, tokens are divided into primary tokens and secondary tokens. The primary token typically serves as the governance token for the game, while the secondary token functions as the in-game utility token. The majority of in-game outputs are generated in the form of secondary tokens, with primary tokens playing a supplementary role.

Primary tokens are generally linked to the long-term development of the game and usually serve as governance tokens. Secondary tokens, on the other hand, are typically designed to absorb significant selling pressure from established players; they function as in-game utility tokens, aiming to stabilize the price of the primary token or support the sustainable development of the game.

For example, Axie Infinity is a digital pet breeding game built on Ethereum. Its governance token, AXS, has a fixed total supply, whereas the total supply of its in-game token, SLP, is unlimited.

So, what exactly is the core of blockchain gaming—the “economic model”?In simple terms, an economic model refers to the supply-and-demand dynamics of a blockchain game’s tokens, namely the balance between token generation and token consumption.

A major flaw in the GameFi 1.0 economic model is its inability to escape the “death spiral.” Token prices will not decline only if token consumption exceeds token production. In an ideal scenario, new users continuously progress by completing tasks and leveling up, eventually becoming established users. As these established users require more resources during gameplay, they continually increase their investments, driving up the price of in-game tokens. This, in turn, attracts more new users to participate, thereby creating a positive feedback loop.

However, if established users are primarily motivated by short-term “mine, withdraw, and sell” strategies aimed at making quick profits, their substantial sell-offs will be absorbed by new players. A slowdown in the growth rate of new players will result in market oversupply, leading to a decline in token prices. Falling token prices can trigger “FOMO-driven panic” among market participants, prompting more users to sell their tokens out of fear. This causes the user base to shrink continuously, ultimately plunging the game into a “death spiral.”

To cite another example, Big Time significantly enhances playability and game quality compared to GameFi 1.0 titles such as Axie Infinity, while also lowering the barrier to user participation. Unlike most blockchain-based games that require upfront payments to play, Big Time allows users to engage in the gaming experience without purchasing any non-fungible tokens (NFTs).

Only blockchain-based gaming projects with sustainable internal ecosystem cycles can achieve long-term development.

1. Policy-Related Risks

Pursuant to the Notice on Preventing Bitcoin Risks and the Announcement on Preventing Risks Associated with Token Issuance and Financing, bitcoin and other virtual currencies are characterized in China as a type of virtual commodity and do not hold the same status as fiat currency. The issuance of virtual currencies is regarded in China as an unauthorized and illegal form of public financing. Any so-called token financing trading platform is prohibited from engaging in exchange services between fiat currency and tokens or “virtual currencies.”

In overseas blockchain-based gaming projects, in-game tokens and NFTs can be traded on virtual currency exchanges and converted into other types of virtual currencies, which can then be exchanged for fiat currency. If domestic blockchain-based gaming projects adopt the same model, they would violate the aforementioned regulations and expose themselves to policy risks.

2. Criminal Risks

If a blockchain-based game involves gameplay based on probabilistic outcomes, such as obtaining virtual currencies or NFTs through lotteries or blind box openings, such a game model carries a significant risk of constituting the crime of gambling.

Generally speaking,as long as an activity or game simultaneously satisfies the following three elements, it poses a risk of being deemed gambling:

①Payment for the purchase of in-platform items or game currency.

The vast majority of blockchain-based gaming platforms require users to purchase in-game items or tokens by making payments. The typical process is as follows: first, users purchase crypto assets with fiat currency through cryptocurrency exchanges (such as Binance, OKEX, etc.); next, they download a digital wallet (such as TokenPocket, MetaMask, etc.) and transfer the purchased crypto assets into the wallet; after connecting the wallet to the blockchain game, users can use the wallet to purchase in-game items or tokens on the platform.

Even if a small subset of blockchain games initially claims to be free-to-play, this is merely a promotional strategy to attract users; subsequently, users are still required to make in-game purchases to enhance their gaming experience.

②Gameplay mechanics: characterized by chance, offering the possibility of significant gains from small stakes, and carrying a risk of loss.

For example, gameplay mechanics such as blind boxes and lucky draws involve a high degree of randomness in determining outcomes. If the value of in-game items obtained through paid draws varies significantly and there is a possibility of financial loss, the risk of constituting gambling-related offenses is high.

③Direct or indirect withdrawal into fiat currency is possible.

For overseas blockchain gaming projects, users can withdraw their NFTs or in-game tokens held on the platform as crypto assets through cryptocurrency exchanges.

In China, due to regulatory provisions concerning virtual assets, crypto assets do not have legal tender status and are regarded as virtual commodities. Furthermore, under relevant laws and regulations governing online games, providers are prohibited from offering services that facilitate the trading or redemption of game points, or the disguised conversion of "virtual currency" into cash or property.

Traditional Web2 games, such as lucky wheels, treasure chest openings, and fishing games, can be adapted into blockchain games. However, if such adaptations simultaneously satisfy the three elements mentioned above—namely, paid entry, chance-based gameplay, and output in the form of real-world assets or cash—they may constitute the crime of operating a casino.

In addition to the more common gambling-related criminal offenses, other criminal risks may also arise.

If a blockchain game employs a multi-level rebate promotion model whereby existing users recruit downstream users by sharing invitation codes or scanning QR codes, and these existing users receive a share of the downstream players' top-ups as well as a share of their in-game earnings, such hierarchical distribution may, if it involves thirty or more participants within the organization and three or more levels, expose the organizers and leaders to criminal liability for the crime of organizing and leading pyramid schemes.

If, during platform operations, there is price manipulation, speculative hype, or fraudulent lucky draws, such conduct may constitutethe crime of fraud。

If users bring proceeds from upstream crimes onto a blockchain gaming platform through the platform (or if the platform facilitates such transfers through users), and then "launder" these illicit funds by engaging in various activities within the platform, such as purchasing tokens or items, the platform may be implicated incrimes related to money laundering, including aiding information network criminal activities and concealing or disguising the proceeds of crime.。

3. Administrative Risks

According to relevant regulations, launching a game requires obtaining the following qualifications.

If an online game is operated without obtaining a game license, once discovered, the game website risks being shut down. Additionally, revenues generated from operating the online game, including but not limited to recharge income and advertising revenue, will not only be confiscated but also subject to fines ranging from five to ten times the operational revenue. Therefore, the higher the operational revenue of an unlicensed online game, the greater the cost of penalties. Upon review,there are numerous cases where online games operating without licenses have been penalized, which game companies should take seriously.

Furthermore, in practice, some judicial authorities consider operating a game without a license as constituting the crime of illegal business operations. We believe that classifying game developers who launch games without licenses as committing the crime of illegal business operations remains controversial. For detailed analysis, please refer to our previous article titled"Is It Permissible for Blockchain Games (GameFi) to Launch Without a Game License?"》。

1. Is It Safe If the Team Is Based Overseas?

Given the administrative and criminal risks associated with developing blockchain games domestically, lawyers are often asked whether relocating the project overseas and having all technical development staff work abroad can help avoid domestic legal risks. This raises the issue of China's criminal jurisdiction.

Given the comprehensive jurisdictional provisions in China’s Criminal Law, it may be understood thatChina has jurisdiction whenever a Chinese national commits a crime, or when the criminal act or its consequences occur within China.。

Furthermore, pursuant to the provisions below, persons providing services such as marketing and promotion, payment and settlement, and technical support bear corresponding liabilities.

Furthermore, if a platform engages in any of the following conduct, Chinese judicial authorities may also determine that it is indirectly providing services to Chinese citizens:

• Failure to block domestic IP addresses, or, although blocking is implemented, indirectly prompting users in promotional materials that they must use circumvention tools (commonly referred to as "climbing over the wall") to access the relevant interfaces;

• The platform supports display of a Chinese-language interface;

• Transactions on the platform support payment and settlement in Renminbi (RMB);

• The platform supports login verification using Chinese mobile phone numbers, national identity card numbers, and other identity information;

• The platform collaborates with relevant promotional personnel to conduct promotional activities within China (e.g., through social media applications, traditional media, or roadshows).

2. How to Select Methods for Resolving Civil Disputes?

From this, we can see that while criminal risks are difficult to avoid, civil risks can be mitigated to a certain extent, primarily depending on how dispute resolution mechanisms are stipulated.

According to the Law of the People's Republic of China on the Application of Laws to Foreign-Related Civil Relations, "unless otherwise provided by law, parties may agree upon the law applicable to their contract. In the absence of such choice, the law of the habitual residence of the party whose performance best characterizes the contract, or the law otherwise most closely connected with the contract, shall apply."

Therefore, if an enterprise has stipulated the applicable law in its contract, even if a lawsuit is brought in China arising from that contract, the application of foreign law may be selected, thereby avoiding corresponding risks.

Additionally, the parties may agree upon the institution for dispute resolution.For example, jurisdictions such as Hong Kong and Singapore have adopted more inclusive and open policies and regulations regarding blockchain. If arbitration is conducted through arbitral institutions in these regions, the rights of the relevant parties can be better protected. Furthermore, given the confidential nature of commercial arbitration, it can significantly safeguard a company’s business reputation as well as individual credibility.