Web3 Law Popularization | The Dilemma and Risks of China’s Blockchain RWA Entrepreneurship

Demystifying Web3 Law Examining the Dilemma and Risks of China's Blockchain RWA Entrepreneurship

Authors: Lawyer Liu Honglin, Lawyer Liu Zhengyao

01, the industry is developing

China’s attitude towards virtual currency regulation is actually very clear:

• This thing is not money, at most it can only be a commodity;

• Since it is a commodity, it cannot have financial attributes and cannot be speculated.

  • Axie Infinity cannot hold the peak, mistaking selling goods as a way out
  • Bitcoin developers spark a wave of controversy over the disabling of inscriptions, a multi-party game of interests.
  • ETH rebounds to $2200, how do cryptocurrency practitioners view the future market trend?

It can be said that by grasping these two red lines, 99% of the risks can be avoided for blockchain entrepreneurs in China.

However, it’s tempting to issue tokens on the edge, and the trend continues. So friends who are thinking of issuing tokens are endless. And the banner they carry also changes with the development of the industry. In the past few years, it may have been ICO. After ICO was banned, it became STO. After STO lost its popularity, the new narrative is RWA.

RWA refers to the transformation of real-world assets into tradable digital tokens through blockchain technology, thereby achieving decentralization, transparency, and efficiency of assets. The advantages of RWA tokenization include reducing transaction costs, increasing asset liquidity, expanding the investor base, and increasing asset value. Application scenarios include real estate, finance, art, and other fields.

From the definition, RWA is a promising and profitable thing. However, if the commodity is not used according to the instructions after leaving the factory, it can be a bit troublesome.

02, the project team at work

It may be hard to believe, but so far, the best use of RWA in China is in the NFT digital collectibles industry. It can be called RWA entrepreneurship v1.0 without exaggeration.

Industry insiders call it empowerment. For example, if you purchase an NFT digital collectible issued by the project team, you will have the right to redeem a certain product/service; what if you don’t want to redeem or pick up the goods? You can wait for the real assets to appreciate and then transfer them to other friends through the consignment market.

In theory, this storytelling narrative is quite logical and good, adding a sales scenario for selling goods, and giving buyers more reasons to hoard and purchase, especially for goods that may appreciate over time, such as tea and white wine.

Some friends may say that what you are talking about is not RWA, but what I want to express is that the form changes but the essence remains the same. It’s just a difference in model parameters.

In such a model, a real asset with a stable price or slow growth may have a stable supply-demand relationship in the traditional market, and it is difficult to bring about a leap in value just by tokenizing it. On the other hand, if the pricing range can be mysterious, such as a digital artwork, different people have different preferences, Zhang San is willing to pay 3 yuan, but Li Si is willing to pay 500 yuan. If the two parties can freely reach an agreement, that’s great. But if Li Si is one of the people who drives up prices in the market and then takes over the deal, it might be a bit dangerous.

So in these two scenarios of RWA, the former is easily dismissed by the market because of its limited investment returns; the latter is prone to harm because of its strong financial attributes.

03. The dilemma of RWA entrepreneurship

A while ago, the team of lawyer Man Kun received a case that can be described as a living example. The general situation is as follows: a company registered a company overseas and this company held some real assets through purchases and business collaborations. How can they maximize the value and strength of these assets? Their solution was to divide these assets into several parts and sell them online in the form of NFTs. In addition to promoting the attractive value of the assets at affordable prices, they also informed the buyers that holding the NFT would entitle them to dividends from the corresponding offline assets. This idea was great, but unfortunately, due to the economic downturn, the appreciation of these real assets was not realized. The company also suffered from poor management and almost went bankrupt. Early users who had initially jumped on the bandwagon to get rich quickly saw that the NFT prices in the market were about to collapse. Those users who came with the idea of making a fortune accused the company of fraud and illegal fundraising. They united to report the project team to the authorities and filed complaints. The project team’s friends were in a panic, fearing that they would be arrested by the police one day.

To be honest, this is the visible reality of conducting RWA projects in China. Many well-educated, rational and rule-based entrepreneurial newcomers are easily mentally and physically harmed in this cruel jungle. One important reason for this is mistakenly assuming that what they understand is also understood by others, not only the users but also the police. Additionally, they believe that by registering the company overseas and strictly adhering to the team’s moral bottom line, they can leave everything else to the market and feel contented. They don’t have to worry about any risks. However, as an entrepreneur, you may talk to users about Web3, metaverse, and decentralization, but they just want to know if they can make money with you. If they make money with you, you are their big brother or sweetheart. But if they accidentally become the prey in the market, you are the despicable woman in their eyes.

We have reason to believe that many friends who are doing RWA projects indeed started with the initial intention of revitalizing assets and promoting investment for the benefit of users. But the reality is slapping them in the face. How can we make our RWA projects stay clear and avoid legal risks? Besides the risks of market operations, these are the considerations that RWA enthusiasts have to think about.

04. How to prevent legal risks?

As an RWA entrepreneur, if your market expansion is targeting mainland China, you need to pay extra attention to at least three aspects:

(1) Ensure the legality and authenticity of assets.

Whether issuing a coin or not, when engaging in business, the first rule is not to deceive people. The premise of tokenizing real-world assets (RWA) is to ensure that the assets involved are legal and do not violate national laws and regulations. At the same time, it is important to ensure that the assets involved are authentic and do not involve any fraudulent or deceptive behavior. Whether you anchor large immovable assets like houses or small goods with a pure e-commerce logic, you must comply with criminal law and consumer protection laws. Therefore, it is necessary to conduct due diligence, audits, and sign procurement agreements with relevant parties to ensure the authenticity and after-sales service of the real assets underlying the digital tokens. These are the most fundamental compliance requirements.

(2) Exercise caution in token issuance.

This is of utmost importance for compliance. Whether the asset is tokenized as an NFT or digital collectible, the key question is: what is the nature of these digital tokens after tokenizing real-world assets (RWA)? Are they commodities, currencies, securities, or something else? This will directly affect the classification of token issuance activities. China has a clear regulatory stance on virtual currencies, which is to prohibit any form of currency substitution and circulation activities. Therefore, when entrepreneurs tokenize RWAs, they should avoid positioning the tokens as currencies or substitutes. If RWA tokenization involves issuing shares, debt, fund units, or any other certificates that reflect investor rights or claims, it may constitute securities. If RWA tokenization involves standardized contracts for future delivery of physical assets or cash settlement, it may constitute futures contracts. These are obviously red lines in China’s financial regulation. Please stay away from them.

(3) Beware of high-frequency criminal risks.

In the cryptocurrency community, everyone should be familiar with and avoid two legal provisions:

• According to Article 176 of the Criminal Law, illegal fundraising refers to the act of raising funds from the public without approval in violation of relevant national regulations, and promising to pay interest or return principal and interest in any other way.

• According to Article 266 of the Criminal Law, fraud refers to the act of using fabricated facts or concealing the truth with the purpose of illegal possession to deceive others and obtain their property.

Therefore, if RWA tokenization involves the unauthorized fundraising from the public without approval, promising to pay interest or return principal and interest, or if it involves using fabricated facts or concealing the truth for the purpose of illegal possession and deceiving others to obtain their property, it may constitute illegal fundraising or fraud, and consequently, be subject to corresponding criminal penalties. So if RWA tokenization involves false promotion of the value, returns, or risks of real assets, or concealing the ownership, mortgage, or disputes of real assets, in order to induce others to purchase or invest in RWA tokens, the risk of illegal fundraising or fraud is extremely high.

05, Conclusion

Tokenizing real-world assets (RWAs) into digital tokens sounds like a great idea, but in reality, it can be quite complicated. For entrepreneurs in China venturing into the blockchain RWA space, ensuring the legality and authenticity of assets is crucial, understanding the nature of tokens is key, and guarding against criminal risks is the bottom line. In essence, China has two strict rules when it comes to virtual currency and blockchain: it doesn’t recognize you as currency, only as a commodity; and if you’re a commodity, don’t even think about playing financial games. These rules may be clear and direct, but as long as blockchain entrepreneurs don’t cross the line, they can have a good chance of becoming rich safely.

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