Web3 Practitioners’ Guide to Conscience and Legal Compliance: You must protect yourself outside
Written by:
Will Awang, Master of International Law, Investment and Financing Lawyer, Entrepreneur Veteran, Wildlife Researcher
Chris Chuyan, crypto lawyer, formerexchangeSenior Product Manager, On-chain Data Researcher
The Web3 project, which is built on a public chain, is globalized from the moment it was born and can cover a wider global market. However, from the perspective of legal compliance, it also brings regulatory challenges in different jurisdictions around the world. For example, the battle between US regulators and crypto giants is a typical example of regulatory challenges under global operations.
Web3 practitioners in the Chinese-speaking world must have many connections with China, a highly regulated jurisdiction. Therefore, it is very necessary to understand the positioning and red lines of Chinese regulation on virtual currencies.DAO Made a "How Web3 practitioners can protect themselves in the crypto world"The sharing received a warm response. As Sanzhi said: "I think this is a sharing that any Web3 practitioner needs to listen to."
We feel it is necessary to organize the shared content into a text, and in the spirit of "conscience", we hope to help the majority of Web3 practitioners protect themselves while controlling the overall risks of the project. This article will be positioned from the perspective of China's virtual currency supervision to sort out the compliance operation paths of Web3 practitioners (individuals, developers, project parties) in the crypto world.
1. The Positioning and Regulatory Red Lines of Virtual Currency in China
1.1 Positioning of Virtual Currency in China
Since Bitcoin entered the regulatory field, China has adopted a strict and cautious regulatory attitude. On December 3, 2013, the People's Bank of China and five other ministries and commissions issued the "Notice on Preventing Bitcoin Risks".This directly denies the monetary attributes of Bitcoin - it is not issued by the monetary authorities, does not have monetary attributes such as legal tender and compulsory nature, and is not a real currency.
In terms of nature,Bitcoin should be a specific virtual commodity that does not have the same legal status as currency and cannot and should not be circulated and used as currency in the market.It can be said that this is the basic principle of China's regulation of virtual currencies, which has continued to this day.
Related articles:Briefly describe China's regulatory attitude towards virtual currency
1.2 Regulatory red lines for virtual currencies
China’s regulatory red lines for virtual currencies can be based on the “Notice on Further Preventing and Dealing with Virtual Currency Transaction Speculation Risks” (“924 Notice”) issued by the People’s Bank of China and ten other ministries on September 15, 2021. The core contents include:
(1) Virtual currency does not have the same legal status as legal tenderVirtual currencies such as Bitcoin, Ethereum, and Tether are unofficial currencies, have no legal tender, and cannot be circulated and used as currency in the market.
Interpretation: This is the regulatory red line set since 2013.
(2) Virtual currency-related business activities are illegal financial activities and are strictly prohibited. If they constitute a crime, criminal liability will be pursued in accordance with the law.The content involves: conducting legal currency and virtual currency exchange business, virtual currency exchange business, buying and selling virtual currency as a central counterparty, providing information intermediary and pricing services for virtual currency transactions,TokenVirtual currency related business activities such as issuance of financing and virtual currency derivatives trading.
Interpretation: This is the ban in the September 4th 2017 announcementTokenOn the basis of financing, it is further clarified that virtual currency-related businesses are illegal financial activities and are strictly prohibited in China, including providing legal currency transactions, spot transactions, derivative transactions,exchange, token financing (ICO), token trading intermediary and other services and promote the issuance and circulation of virtual currencies.
(3) Overseas exchanges providing services to residents in China constitute illegal financial activities.
Interpretation: This has prompted many exchanges and Web3 projects to shift their organizational structures and businesses overseas and completely stop operating their businesses in China. They no longer provide services to users with Chinese IP addresses or users holding Chinese passports in order to avoid risks from Chinese regulation.
(4) Investing in virtual currency by Chinese residentsAt your own riskIf the investment behavior is suspected of disrupting financial order and endangering financialSafetyAny legal person, non-legal person organization or natural person who invests in virtual currency and related derivatives and violates public order and good morals shall have the relevant civil legal acts invalid and shall bear the losses caused by them.SafetyIf any violation occurs, the relevant departments shall investigate and deal with it according to law.
Interpretation: Citizens investing in virtual currencies in China are not considered to be committing illegal acts, but the attitude of the regulatory authorities is that they bear the risks themselves. In judicial practice, many business activities involving virtual currency transactions signed between natural persons or between legal persons and natural persons have been identified as violating the financial regulations maintained by the 924 Notice.Safetyand market order, thus causing the contract to be invalid. For invalid civil legal acts, many judgments will share the responsibility based on the fault of both parties.
II. Cross-border architecture under strong supervision
2.1 Cross-border architecture with development at home and operation and promotion outside
Against the backdrop of strong regulation in China, the Web3 project has shifted its organizational structure and business overseas and completely stopped operating its business in China. It will no longer provide any services to users with Chinese IP addresses or users holding Chinese passports in order to avoid risks from Chinese regulation.
Generally, project owners will place management and marketing personnel overseas (such as Hong Kong and Singapore) to target overseas markets. At the same time, due to cost and practical considerations, project owners will "leave" developers in China to provide technical development support for the project, or conduct business through overseas outsourcing cooperation.
Although the above measures can avoid the risks from Chinese supervision to a certain extent, China's criminal law has established a relatively comprehensive extraterritorial application mechanism. When it comes to illegal and criminal activities, cross-border structures cannot be completely immune.
2.2 Strong regulatory control from China
The 924 Notice clearly states that domestic staff of relevant overseas virtual currency exchanges, as well as legal persons, non-legal organizations and natural persons who knowingly or should have known that they are engaged in virtual currency-related businesses and still provide them with marketing, payment settlement, technical support and other services, will be held accountable in accordance with the law.
Although the above regulations only define illegal financial activities conducted by overseas exchanges, we believe that the same applies to other entities that provide illegal financial activities, such as business entities that provide services such as legal currency transactions (deposit and withdrawal, crypto payment), spot transactions (CEX/DEX), derivative transactions (Prep DEX), token financing (ICO), etc. In addition, we believe that it also applies to some projects involving gambling and fundraising fraud.
Once these illegal financial activities constitute crimes, they will face the "strong" intervention of Chinese regulators based on criminal jurisdiction. Here we can understand it from three levels:
First, for those who are employed in China and are the main body of illegal financial activities, depending on the nature of the illegal business and the specific functions they perform, they may be suspected of financial crimes such as illegal business operations, illegal absorption of public deposits, fund-raising fraud, and organizing and leading pyramid schemes.
Secondly, for service providers in China that are the main body of illegal financial activities (such as third-party technology outsourcing, media public relations, and payment settlement), the service providers may be held accountable according to law. In serious cases, they may be suspected of committing a joint crime or a separate crime of aiding and abetting others.
Finally, if the subject of illegal financial activities provides virtual currency services to Chinese citizens through the Internet outside of China and takes corresponding actions that violate Chinese laws, they are still subject to Chinese laws. As long as the location of the information network system used by the victim, the location where the victim was violated, and the location where the victim's property loss occurred are in China, Chinese supervision has extraterritorial jurisdiction.
3. Compliance Paths and Protection Measures for Web3 Practitioners
Although the red lines are clear, the supervision is strong, and the jurisdiction is broad, I have said so much not to spread a sense of crisis, but to sort out some compliance paths for reference by Web3 practitioners, so that everyone can build legally and compliantly in the sun. We still have a bright future.
3.1 Compliance Path from a Personal Perspective
3.1.1 Holding and trading virtual currency
As for holding, although the relevant regulatory documents deny the legal tender attributes of virtual currency, they do not deny the commodity attributes of virtual currency. Holders can still enjoy the property attributes and are protected by law. Therefore, there is no problem with holding virtual currency, a virtual commodity.
As for transactions, the 924 Notice clearly states that "any legal person, non-legal person organization or natural person who invests in virtual currency and related derivatives in violation of public order and good morals shall have the relevant civil legal acts invalid, and the losses caused thereby shall be borne by themselves." However, in terms of judicial practice, the judgments of courts in various places are different.
Previously, the Shanghai No. 1 Intermediate People's Court issued a civil judgment (2021) Hu01 Minzhong No. 11624 after the 924 Notice, which held that "Chinese laws and administrative regulations do not prohibit the holding and legal circulation of virtual currencies or tokens, nor do they prohibit the normal trading of virtual currencies between private individuals."
Unfortunately, this year many local courts are more inclined to rule that contracts involving virtual currency transactions and financial management are invalid, and to share responsibilities based on the fault of both parties. This also reflects the attitude of regulatory authorities that virtual currency-related civil activities are risk-based.
3.1.2 Cryptocurrency deposits and withdrawals
The behavior that is most likely to involve criminal risks for Web3 practitioners and investors is OTC deposits and withdrawals. Investors exchange legal currency for virtual currencies such as BTC and ETH, and then convert virtual currency into legal currency after making a profit. These are all personal investment decision-making behaviors.
However, telecommunications fraud is rampant both at home and abroad. Many criminal gangs exchange fraudulent funds for virtual currencies through OTC transactions. Virtual assets such as BTC, ETH, USDT have become the first choice for telecommunications network criminals to launder money due to their anonymity and decentralization. As a result, many investors have received "black money" from the telecommunications fraud funds involved in the process and their bank accounts have been frozen.
In addition, some investors’ accounts on exchanges have been frozen, in many cases because of deposits and withdrawals on related gambling platforms. Both of these situations are currently the focus of crackdowns by Chinese regulatory authorities, so relevant practitioners and investors must pay attention to the risks that their own behavior may bring.
When depositing or withdrawing funds, it is recommended that relevant personnel carefully review the identity background and source of funds of the counterparty. For some suspicious counterparties or funds, transactions should be terminated in a timely manner to avoid being implicated in relevant criminal cases. If you are accidentally frozen, you should contact the bank, public security organs and other departments in a timely manner to explain the situation. In the process of communicating with relevant departments, the key point is to prove that you have no connection with the criminal offense suspected by the counterparty. If necessary, it is recommended to entrust a professional lawyer to intervene.
3.2 Compliance Path from the Developer’s Perspective
On the basis of clarifying the compliance paths for personal holding, trading, and deposits and withdrawals, developers have an additional identity as a builder of a Web3 project. This identity will be subject to risks from the project parties, especially those project entities defined by regulators as engaging in illegal financial activities.
The way developers "stay" in China in a cross-border architecture will expose them to China's virtual currency supervision. Therefore, it is very necessary for developers to always pay attention to risks from the following perspectives and take appropriate measures to protect themselves.
3.2.1 Identification of Illegal Financial Activities
In the 924 notice, most illegal financial activities have been listed, including business entities that provide services such as fiat currency trading, spot trading, token financing (ICO), derivatives trading, etc. The exchanges are the first to bear the brunt. Developers who build these projects should understand that the high salary given by the project is actually partly a hedge against China's regulatory risks.
Of course, it is necessary to focus on the risk control and compliance measures taken by business entities in Chinese jurisdictions, such as blocking Chinese user IPs/VPNs, strict customer identification (KYC)/anti-money laundering (AML)/counter-terrorist financing (CTF) and other measures. These measures will effectively circumvent the jurisdiction of Chinese regulators.
Although it is difficult for most developers to sort out the overall risks of a project from a whole picture perspective, they should pay more attention and discuss it more.
3.2.2 Positioning of the nature of work
The risks for Web3 practitioners are mainly affected by the nature of their work and their involvement in the project. In some public judicial cases, the crackdown on those responsible for marketing, business, technology, and finance who are deeply involved in the project is more severe, because these people play a decisive role in the operation of the project. Once the project is suspected of criminal risks, the decision-makers related to the project will inevitably be imprisoned.
Therefore, practitioners must fully evaluate the work at hand and the development of projects during the application and daily work process. Some projects that may involve illegal or criminal activities need to be cut off in a timely manner to avoid getting deeper into trouble.
3.2.3 Risks of obtaining salary compensation
At present, many employees’ wages or labor remuneration are paid in the form of stablecoins or project tokens, but it should be noted that Article 50 of the Labor Law and Article 5 of the Interim Provisions on Wage Payment clearly stipulate that wages should be paid in the form of legal tender and cannot be replaced by physical objects or other securities. Virtual currency is not a legal tender in my country. Once a company and an employee sign a labor contract to form a labor relationship, the use of virtual currency to pay wages is illegal.
3.3 Compliance Path from the Project Owner’s Perspective
3.3.1 Effective internal control measures and risk identification
Currently, many exchanges and projects going overseas need to take effective risk control and compliance measures in Chinese jurisdictions, such as blocking Chinese users’ IP/VPN, strict customer identification (KYC)/anti-money laundering (AML)/counter-terrorist financing (CTF) and other measures. These measures will effectively circumvent the jurisdiction of Chinese regulators.
In addition, it is also necessary for exchanges and project parties to actively respond and cooperate with the judicial assistance of Chinese regulatory authorities after going overseas.
3.3.2 Reasonable construction of legal framework for cross-border organizations
In fact, there is no need to limit the project due to regulatory reasons. We are also actively helping project parties explore and evaluate the compliance path of cross-border architecture. Once the project party reasonably disassembles and distributes the work tasks, it can release the advantages of the cross-border architecture. On the one hand, it can fully tap into the "big market" of China and obtain relevant policy dividends. On the other hand, it can also capture global value through the economic model of Web3. Of course, this operation is difficult and needs to be carefully evaluated. For example:
Established in ChinaBlockchainThe underlying technology companyBlockchain(such as DID, ZK, payment and other technologies) empowering domestic entities is very popular in some domestic innovative industrial parks, and can apply for policy support, park subsidies and other preferential policies. At the same time, it can also operate in compliance and export "technology overseas".
Overseas companies can make full use of the characteristics of Web3 to capture global value (such as relevant data,Communityparticipation, global collaboration, etc.). For example, Vita, a decentralized autonomous organization focused on biomedical research to extend human lifespanDAO, through collective ownership and management of scientific intellectual property (IP),BlockchainTechnology has realized democratic funding and decision-making for scientific research. This way of creating and acquiring IP through Web3, on the one hand, greatly reduces the threshold for projects to obtain IP data independently, and on the other hand, it can empower multiple entities through multiple authorizations, coordinate global resource collaboration, and provide economic incentives.
（How VitaDAO Works）
4. The legal dilemma of decentralized projects: Who will bear the responsibility?
Different from traditional projects, the biggest feature of Web3 projects is decentralization, which can unleash the unlimited potential of projects. For example, DAO organizations can start large-scale global collaboration through innovative incentive models. However, Web3 projects cannot blindly rush on the ideal path of decentralization. Some new regulatory compliance challenges will pose direct obstacles to operating projects. These obstacles will not only bring trouble to the project parties, but also affect the developers.
The most intuitive regulatory challenge is: Who will take responsibility after the project is decentralized?
4.1 CFTC Administrative Enforcement - Developers Accept Penalty
It is said that "the decentralized on-chain world is a lawless place and no one will be held accountable for it", but the U.S. Commodity Futures Trading Commission (CFTC) disagrees and believes that developers still have to take responsibility.
In the judicial decision of CFTC v. Ooki DAO, Ooki DAO, as a DAO organization that manages on-chain protocols, was required to bear legal responsibility for violating CFTC regulations on commodity futures. What is more frightening is that since Ooki DAO is on-chain and has no legal entity, the party that bears the responsibility is transferred to the members who participate in the governance of the DAO organization.
In addition, in the three DeFi protocol administrative enforcement settlement cases in September, the CFTC also pointed the finger at the protocol developers. Although the protocol is decentralized on the chain and anyone can access the deployment, the CFTC still directly attributes the responsibility of the malicious third party to the developer, that is, the developer cannot control the occurrence of malicious third-party behavior.
4.2 Uniswap Judicial Judgment——Developers are not guilty, technology is not guilty
However, in the Uniswap case, the result was completely opposite. The judge believed that DEX (Uniswap protocol) would not be responsible for the losses suffered by users due to investing in tokens issued by malicious third parties, that is, the technology itself is innocent, and the guilty ones are the people who use the technical tools. This is a major benefit for decentralized projects.
Of course, this is related to the fact that Uniswap was established in the United States, actively cooperated with supervision, and the single governance function of its token. But it does not prevent Uniswap from providing a good example for other decentralized projects to deal with supervision.
4.3 A Regulatory-Friendly Decentralized Path — Uniswap Playbook
As the most successful decentralized exchange, Uniswap’s growth path is worth learning from, especially when it comes to sensitivecryptocurrencyTrading business, and in the context of opaque regulation in the United States. The title of the previous article by Ludong: "Uniswap, the most successful American Internet Fintech company under the Web3 dividend" summarizes it well. Among them, the compliance of Fintech companies is the top priority.
We have sorted out the compliance path of Uniswap Labs after the divestiture of the protocol, which provides a regulatory-friendly sample for Web3 decentralized projects. The purpose of such divestiture is to achieve progressive decentralization on the one hand, and to gain more room for maneuver at the regulatory compliance level on the other.
Decentralized + Non-Securities Tokens：The Uniswap protocol runs autonomously on the chain, and is governed by the Uniswap DAO to achieve decentralization, with the single-function token UNI as its governance token. This model avoids the SEC's securities determination and brings a successful court ruling;
DAO Legal Package + Members’ Limited Liability：Uniswap DAO established the legal entity of Uniswap Foundation as the legal package of DAO, which on the one hand guarantees the limited liability of DAO members, and on the other hand enables interaction with the Web2 world and expands its influence;
Labs independent operation + flexible front-end development：The Uniswap Labs team, which previously developed and maintained the protocol, has become a major contributor to the protocol as a separate legal entity. On the one hand, it has gotten rid of the restrictions from the protocol, and on the other hand, it can build and maintain front-end products by calling the back-end protocol to achieve sustainability, just like Uniswap, which previously started a charging model. DApp.
Regulate applications, not protocols：As a16z advocates for regulatory principles, decentralized on-chain protocols are difficult to be compatible with regulation, while front-end applications are fully capable of complying with regulatory requirements, allowing the team and product itself to escape possible regulatory risks. Like any App, front-end applications can include KYC/AML/CTF verification according to regulatory requirements, remove tokens that have been warned by regulators at any time, and apply for license qualifications, etc.
In contrast, Tornado Cash was severely sanctioned because its protocol was incompatible with regulation, it was unable/did not take KYC/AML/CTF measures, and it did not cooperate with regulation. The decentralized project had no legal packaging, which led to the developer being sued by the Ministry of Justice.
5. Final Thoughts
We believe that virtual currency is not just about “criminal” or “non-criminal” for us as legal practitioners. Although this is important, we should also protect the development of Fin and Tech in the crypto world from the perspective of FinTech.
We share the above content with you in the spirit of LXDAO’s “conscience”. We do not hope that these cases will have a negative impact on the majority of Web3 practitioners, but we hope that these contents can also become sustainable.Public Goods, creating positive externalities for the industry. From a long-term perspective, we help the majority of Web3 practitioners to comply with laws and regulations, protect themselves, and better build the ideal world in our hearts.
Feel free to contact us and build together!
The article comes from the Internet:Web3 Practitioners’ Guide to Conscience and Legal Compliance: You must protect yourself outside
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