8 Major Legal Challenges in Web3 Entrepreneurship

In recent years, with the rapid development of blockchain technology, more and more entrepreneurs are flocking to the Web3 field, hoping to find opportunities in this blue ocean. However, for domestic Web3 entrepreneurs, carving out a sustainable development path in the cracks of policy and market environment not only requires addressing issues related to the business content itself but also faces complex legal and compliance challenges.

This article summarizes some frequently encountered legal issues by Web3 entrepreneurs, hoping to provide them with some ideas or inspiration.

1. The Red Line of Domestic Web3 Entrepreneurship

Currently, there are three untouchable areas for Web3-related entrepreneurial projects in China: issuing tokens, operating virtual currency exchanges, and mining. Web3 entrepreneurs must be careful to avoid these forbidden zones.

Projects issuing tokens are prone to risks of illegal fundraising. In September 2017, seven ministries issued a notice to halt all domestic ICO activities.

According to policy regulations, virtual currency-related businesses are considered illegal financial activities, while virtual currency exchanges conduct the exchange business between fiat currency and virtual currency, as well as between virtual currencies.

The "mining" activity of virtual currency refers to the process of producing virtual currency through specialized "mining machines", which consumes a large amount of energy and generates significant carbon emissions. A notification in 2021 stated that the development of virtual currency "mining" projects is prohibited under any name.

2. Legal Risks of Web3 Project Models

Crimes such as operating a casino and organizing and leading pyramid selling activities are common and prevalent criminal legal risks in the cryptocurrency space.

Taking Web3 games as an example, they are subject to both gaming regulations and blockchain policies in China. The legal risks are high when developing Web3 games domestically. This is because tokens issued in foreign Web3 games can typically be freely traded on-chain, while in China, both token issuance is prohibited and withdrawals of in-game tokens are not allowed.

If game developers recover game items directly or indirectly, there may be gambling risks involved. If there are promotional models similar to pyramid schemes in the promotion or game mode, such as earning profits through multi-level distribution or recruiting others, there may be pyramid scheme risks.

3. Preventing Financial Crime Risks

Web3 platforms may be exploited by criminals for money laundering activities. Due to the anonymity of transactions, exchanges and cryptocurrency wallets find it difficult to trace the legitimacy of each transaction's origin. Transactions are not restricted by geography, and the customer base may be global. At the same time, this is also an industry that is closest to the funds.

Therefore, in future anti-money laundering regulations, entrepreneurs in the Web3 industry may bear higher responsibilities and obligations. Once business activities are deemed criminal by a certain country, they may face hefty fines, criminal penalties for the actual controllers, and projects may be ordered to exit the market of that country.

Establishing an effective anti-money laundering internal control system and fulfilling the legal obligations of anti-money laundering are important issues that Web3 entrepreneurs need to pay attention to.

4. Legal Applicability of Web3 Projects Going Abroad

The scope of application of Chinese criminal law is very broad; as long as any link in the business model is related to China, it may theoretically fall under the jurisdiction of Chinese criminal law. Adding foreign-related factors to the business model, such as using offshore company entities or nominal foreign operators, seemingly reduces criminal risks on the surface. However, if the Web3 business operated is prohibited by domestic laws and regulations and primarily targets users in mainland China, then even if the project is registered overseas, as a Web3 project substantially operated by Chinese individuals, there still exists relevant criminal legal risks.

5. The Return of Funds for Web3 Entrepreneurship Overseas

A common question for Web3 entrepreneurs is that the company's operating income or financing funds are mainly overseas, while the main team and operating expenses are in the mainland. How can the legitimate income of overseas companies be repatriated to the mainland? One method is through Foreign Direct Investment (FDI).

FDI can be understood as direct investment activities carried out by foreign investors using foreign currency, physical assets, technology, etc., within China. Common scenarios of FDI include: foreign investors establishing foreign-invested enterprises in China or acquiring shares, equity, and other rights in enterprises within China.

Currently, China implements a system of pre-establishment national treatment and a negative list management system for Foreign Direct Investment (FDI). Except for specific sectors, foreign investors and domestic investors enjoy the same rights and obligations. Common entrepreneurial areas for Web3 entrepreneurs, such as public chain development, cross-chain technology, DAPP, DID, or other on-chain infrastructure construction, can apply for FDI.

6. Information Protection and Data Security

Although the core of blockchain is decentralization, Web3 projects still involve data management and cross-regional data linkage in practical operations. If a project neglects user information protection and data security, it may trigger security incidents caused by hacker attacks.

In November 2024, a cryptocurrency exchange platform suffered huge user asset losses due to a hacker attack. The platform has serious security issues, such as improper private key storage and unencrypted private key transmission.

For Web3 projects operating within China, it is necessary to comply with the requirements of the Personal Information Protection Law, the Cybersecurity Law, and the Data Security Law, and to establish and implement a comprehensive data security management system. Web3 projects that operate overseas but target domestic users must comply with the relevant laws and regulations of both China and the country where the project is located.

7. Legal Risks of Virtual Currency Entrusted Investment Services

Although relevant policies classify virtual currency operations as "illegal financial activities," legal disputes arising from virtual currency entrusted financial management are still frequent in practice. If Web3 entrepreneurs act as institutional agents and raise funds from investors for virtual currency investment and financial management, they may face pressure from investors to protect their rights in case of investment losses.

Although the legality of such cooperative transactions is disputed, it is still recommended that both parties sign a written entrusted investment agreement before cooperating. Based on relevant case experience, this can reduce the criminal risk for the entrusted party to a certain extent. In addition, clearly defining jurisdiction clauses (choosing the jurisdiction authority and location) also helps to resolve disputes.

8. Issues with Domestic Employees of Overseas Registered Companies

If the company's business operations violate Chinese criminal law, overseas projects cannot completely avoid domestic criminal risks. Domestic employees face two main risks:

1. Employees lack stability. Domestic employees may be subject to investigation at any time, affecting work stability and labor costs.

2. A formal investigation may impact the overall operation of the company. If an employee is under formal investigation, according to relevant provisions of Chinese criminal law, the employee may disclose related information they are aware of, leading to the leakage of the company's trade secrets and other core confidential information, which could affect normal operations.

Conclusion

For Web3 entrepreneurs and practitioners, it is essential to understand the legal bottom line before deciding to engage in related businesses, and it is strictly prohibited to touch on high-risk criminal activities. Even for overseas operations, if targeting domestic users, one must also comply with the relevant regulations of both the domestic market and the country where the project is located. I hope this article can provide industry practitioners with clear ideas and practical advice to help everyone move forward steadily in the Web3 field.