Attorney Shao Shiwei | Eight Major Legal Issues That Web3 Entrepreneurs Must Address

In recent years, with the rapid development of blockchain technology, an increasing number of entrepreneurs have turned to the Web3 sector, seeking opportunities in this emerging market. However, for Web3 entrepreneurs in China, carving out a path for sustainable development amid policy and market constraints requires addressing not only business-related issues but also complex legal compliance challenges.

This article summarizes the frequently asked legal questions that Attorney Shao encounters in his daily practice, aiming to provide Web3 entrepreneurs with some insights or inspiration.

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Pursuant to regulatory instruments such as the September 4 Announcement and the September 24 Notice, there are currently three items on the negative list for Web3-related entrepreneurial projects within China:token issuance, operating virtual currency exchanges, and mining.Web3 entrepreneurs must strictly avoid these prohibited areas.

Token issuance projects often carry risks related to illegal fundraising. On September 4, 2017, seven ministries and commissions issued the Announcement on Preventing Risks Associated with Token Issuance and Financing (the “September 4 Announcement”), requiring all token issuance and financing activities to cease immediately as of the date of the announcement, thereby halting all initial coin offering (ICO) activities within China.

Under applicable regulations, business activities involving virtual currencies are classified as illegal financial activities. Virtual currency exchanges engage in the exchange of fiat currency for virtual currencies, as well as exchanges between different virtual currencies.

Virtual currency “mining” refers to the process of producing virtual currencies through calculations performed by specialized “mining rigs.” Given its high energy consumption and carbon emissions, the 2021 Notice on Rectifying Virtual Currency “Mining” Activities prohibits the development of virtual currency “mining” projects under any pretext.

Criminal offenses such as the crime of operating a casino and the crime of organizing or leading pyramid schemes are common and high-incidence criminal legal risks in the crypto industry.

Taking Web3 games (also known as GameFi or blockchain games) as an example, Web3 game entrepreneurs in China are subject to dual constraints imposed by gaming laws and regulations and blockchain-related policies. Attorney Shao believes that the legal risks for such entrepreneurial projects conducted domestically remain very high. This is because tokens issued in overseas Web3 games are generally recorded on-chain and allow users to trade freely, whereas China prohibits both token issuance and the cash-out of in-game tokens. Therefore, if Web3 games are operated domestically, game operators that repurchase in-game items through direct or indirect means (such as collaborating with silver merchants) may face gambling-related risks. Furthermore, if the promotion strategy or game mechanics resemble pyramid scheme models, such as generating revenue through multi-level distribution or recruiting participants, there may be risks associated with pyramid schemes.

Web3 platforms may be exploited by criminals for money laundering activities. Due to the anonymous nature of transactions, it is difficult for exchanges and crypto digital wallets to trace whether the source of each transaction is legitimate and compliant. Moreover, as transactions are not restricted by geography, the customer base may be distributed worldwide. At the same time, similar to the traditional financial industry, this sector is closely linked to capital flows. Consequently, in future anti-money laundering (AML) regulation, Web3 entrepreneurs will be subject to higher responsibilities and obligations compared to other industries. Once business activities are deemed criminal by a certain country, potential consequences may include, but are not limited to, the payment of substantial fines, criminal penalties imposed on actual controllers, and orders for the project to exit that country's market.

Therefore, establishing an effective internal control system for anti-money laundering and fulfilling AML legal obligations are important issues that Web3 entrepreneurs must prioritize.

China’s criminal jurisdiction is governed by four principles: the territorial principle, the nationality principle, the protective principle, and the universal principle. In other words, the scope of application of Chinese criminal law is extensive; theoretically, any business model with even a minimal connection to China may fall under Chinese criminal jurisdiction. Increasing foreign-related elements in a business model—such as establishing the corporate entity overseas or appointing a foreign national as the nominal operator—may superficially appear to reduce the likelihood of criminal risk. However, if the Web3 business operations are prohibited by relevant domestic regulations and policies, and the project continues to target users in mainland China, then even if the project is registered overseas, it will still face relevant criminal legal risks as a Web3 project substantially operated by Chinese nationals.

A common issue for Web3 entrepreneurs is that most of the company's operating revenue is held in overseas entities, or financing proceeds can only be converted into fiat currency in compliance with regulations overseas. However, the core team is located in mainland China, and operating expenses are primarily incurred there. In this context, how can lawful operating income and financing proceeds from overseas entities be repatriated to mainland China? One approach is through Foreign Direct Investment (FDI).

FDI can be understood as investment activities directly conducted within China by foreign natural persons, enterprises, or other organizations (hereinafter referred to as "foreign investors") using foreign exchange, physical assets, technology, etc. Common FDI scenarios include: (1) foreign investors establishing foreign-invested enterprises in China, either independently or jointly with other investors; and (2) foreign investors acquiring shares, equity interests, property shares, or other similar rights and interests in enterprises within China.

Currently, China implements a pre-establishment national treatment and negative list management system for FDI. In short, except for specific sectors where the state imposes special administrative measures, foreign investors enjoy the same rights and obligations as domestic investors for other foreign investments. In brief, Web3 entrepreneurs can confidently apply the FDI model[i] in common entrepreneurial fields such as public chain development, cross-chain technology, decentralized applications (DApps), decentralized identity (DID), and other on-chain infrastructure construction.

Although the core of blockchain is decentralization, Web3 projects still involve data management and cross-regional data linkage in their actual operations. Therefore, if a Web3 project does not place sufficient emphasis on user information protection and data security, it may trigger security incidents caused by hacker attacks.

For example, on November 16, 2024, the crypto asset trading platform DEXX was subjected to a hacker attack. According to related reports, user assets stolen by the hackers exceeded USD 100 million. In-depth technical analysis by the BitJungle monitoring system revealed the following serious security vulnerabilities in the DEXX trading platform: private key storage (although the DEXX platform claimed not to be a custodial wallet, it recorded users' private keys; once the system was attacked, hackers could easily obtain users' private keys and thereby steal user assets) and plaintext transmission during private key export (the DEXX platform failed to adopt any encryption measures when users exported their private keys, resulting in the exposure of private keys in plaintext during transmission, making them highly susceptible to interception by hackers).

For Web3 projects operating within the territory of China, it is necessary to formulate and implement comprehensive data security management systems in accordance with the requirements of the Personal Information Protection Law, the Cybersecurity Law, and the Data Security Law, so as 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 laws and regulations but also adhere to the relevant laws and regulations of the countries where the projects are located.

Although policies such as Announcement No. 94 and Announcement No. 924 characterize virtual currency-related businesses as "illegal financial activities," legal disputes arising from entrusted wealth management involving virtual currencies are frequently encountered in practice. If Web3 entrepreneurs act as entrusted investment parties in an institutional capacity, raising funds from investors to conduct virtual currency investment and wealth management activities, they may face pressure for rights protection from investors in the event of investment losses.

Although Chinese policy provisions classify virtual currency-related businesses as illegal financial activities, and the legality of such cooperative transactions between the entrusted investment party and the entrusting party remains highly controversial under specific business circumstances, it is nevertheless advisable for both parties to execute a written entrusted investment agreement before commencing cooperation. Based on our experience in handling related cases, this can, to a certain extent, reduce the criminal liability risks for the entrusted investment party. Furthermore, the clarification of jurisdictional clauses (selection of the adjudicating institution and the place of jurisdiction) also facilitates dispute resolution.

If a company's business operations violate the Criminal Law of China, overseas projects cannot completely avoid domestic criminal risks. If employees are based in China, there are two primary risks. First, employee stability is not assured. Since domestic employees may be subject to case filing and investigation as criminal suspects at any time, their job stability is not guaranteed, which also affects labor costs. Second, the overall operation of the company will be affected after a case is filed for investigation. If an employee is subject to case filing and investigation, the employee will disclose relevant information within their knowledge in accordance with the relevant provisions of the Criminal Law of China regarding sentence reduction, voluntary surrender, and meritorious service. Consequently, this may lead to the leakage of the company's trade secrets and other core confidential information, such as matters concerning senior management, thereby affecting the company's normal operations.

For Web3 entrepreneurs and practitioners, before deciding to engage in related businesses, it is essential first to understand the legal bottom lines; high-risk activities involving criminal liability must strictly be avoided. Even when conducting business overseas, if the business targets domestic users, it is necessary to comply with both domestic regulations and the relevant regulations of the country where the project is located. We hope this article provides clear insights and practical recommendations for industry practitioners, assisting them in navigating steadily through the blue ocean of Web3.

[i] Web3 Overseas Entrepreneurship: How Can Funds Be Repatriated to China in Compliance with Regulations? https://mp.weixin.qq.com/s/6SJVe23Pe7_lysJt1yB0Kg