Xiao Za team: Is it still possible to issue tokens "compliantly" in 2024?

Author: Xiao Za Lawyer

How to compliantly issue cryptocurrency (ICO) has always been a major concern for Web 3 Builders. After all, from the perspective of project initiation, governance, sustainable operation, and generating economic value, issuing tokens is not just a tool for "harvesting" but an important support tool for the crypto ecosystem. However, due to the scars left by the wild growth era of the crypto market several years ago, the mainland of China still maintains a strict stance on token issuance. The "9.4 Announcement" issued in 2017 and the "Notice on Further Preventing and Dealing with Risks of Virtual Currency Trading Speculation" (referred to as the "9.24 Notice") from 2021 have always been a sword hanging over the heads of practitioners in China's Web 3 industry.

However, we have also seen that since 2021, the entire crypto asset market has undergone several rounds of reshuffling and reconstruction. The underlying blockchain technology has made significant progress, Web 3 projects have gradually begun to operate compliantly, and even traditional financial institutions have found a mutually beneficial path with crypto assets through financial operations such as issuing cryptocurrency EFTs.

So today, the Xiao Za team will discuss whether it is still possible to compliantly issue tokens in the current Web 3 industry. If one wants to issue tokens, what are the considerations?

Can Tokens Still Be Issued in 2024?

First, a simple conclusion: issuing tokens in mainland China is not feasible, and issuing tokens overseas requires careful selection of the jurisdiction.

Currently, issuing tokens in China carries significant criminal risks. According to the second paragraph of Article 1 of the 9.24 Notice: "Activities related to virtual currency are considered illegal financial activities. Engaging in the exchange of legal currency for virtual currency, the exchange between virtual currencies, acting as a central counterparty for buying and selling virtual currencies, providing information intermediary and pricing services for virtual currency trading, token issuance financing, and trading of virtual currency derivatives are all suspected of illegal issuance of token vouchers, unauthorized public issuance of securities, illegal operation of futures business, illegal fundraising, and other illegal financial activities, which are strictly prohibited and will be resolutely banned by law. Those who engage in related illegal financial activities that constitute a crime will be held criminally liable according to the law."

With the clear definition in the 9.24 Notice, we can basically determine that the act of issuing tokens in the general sense (i.e., the initial issuance of project tokens to raise legal currency, Bitcoin, Ethereum, and other general cryptocurrencies, or other valuable assets) is considered illegal financial activity in mainland China. The Xiao Za team believes that without clear legal provisions or normative documents "opening the door" for token issuance, no one should issue tokens or indirectly issue tokens within mainland China, otherwise, there is a significant risk of criminal liability.

Overseas, in countries or jurisdictions where token issuance is not prohibited by legislation or other normative documents, there is theoretically a possibility for token issuance. However, it is important to note that times have changed; we are no longer in an era where crypto assets can grow wildly. Even in countries or jurisdictions that allow token issuance, it is necessary to operate with a license while meeting a series of compliance requirements. Below, the Xiao Za team will share some universal compliance points for overseas token issuance based on practical experience accumulated while serving various project clients.

Summary of Universal Compliance Points for Overseas Token Issuance

(1) Distribution is both the narrative core of crypto assets and community consensus, creating space for compliance.

One of the most intuitive feelings the Xiao Za team has gained while providing compliance services for multiple clients' overseas projects is that distribution is the essential characteristic, narrative core, and community consensus of crypto assets and blockchain technology. A well-distributed project has higher transparency and immutability of assets, which increases investor trust, enabling long-term development and creating a compliant space that can withstand regulatory scrutiny.

Currently, major economically active jurisdictions around the world regulate by defining crypto assets as "securities" and the issuers as "entities issuing financial products without registration." Today, we will use the typical successful case of distribution, Uniswap, to illustrate the compliance space created by a distributed architecture.

The main operating team of Uniswap, Uniswap Labs, first defines itself as a DAO, providing services to users through the creation of the Uniswap Protocol. The open-source code of the Uniswap Protocol allows users to conduct public market transactions while self-custodying their assets. In the 2023 collective lawsuit Nessa Risley Vs. Uniswap ruled by the Southern District Court of New York, the judge explicitly stated that "transactions on Uniswap are not subject to securities laws," primarily because they do not meet the relevant requirements of the Howey Test, and thus cannot be concluded to be subject to securities-related legal constraints.

The Howey Test in the United States originates from the famous SEC v. W.J. Howey Co. case, where the court established four criteria to determine whether a product is a "security": (1) Is it an investment of money? (2) Is there an expectation of profits from the investment? (3) Is the investment in a common enterprise? (4) Do the profits come from the efforts of the issuer or a third party rather than the buyer?

Judge Katherine Polk Failla of the Southern District of New York ruled that there is no investment agreement or commitment between the purely open-source Uniswap Protocol and Uniswap Labs, which primarily undertakes front-end maintenance and operational tasks, and users. Therefore, the governance tokens they issue are naturally not subject to the constraints of the U.S. Securities Act of 1933 and the Securities Exchange Act of 1934. In her ruling, she wrote: "…… the plaintiffs can only argue that Uniswap Labs facilitated the relevant transactions, but the protocol has no centralized ownership structure……" "This case is more like holding the developers of self-driving cars responsible for the car owner's violation of traffic rules or bank robbery."

Thus, this landmark ruling in the U.S. also sends an important signal to the market: open-source developers (distributed entities) should not be held responsible for third-party actions on the distributed protocols (smart contracts) they create.

(2) Carefully choosing the region for token issuance is key to success.

Currently, excluding countries and jurisdictions that prohibit token issuance, the Xiao Za team believes that the regions available for overseas token issuance can be divided into three categories: (1) Strict compliance regulatory type; (2) Clearly prohibitive regulatory type; and (3) Free-spirited type.

The Xiao Za team suggests first excluding the third category of free-spirited countries. Most of these countries have a late start in the crypto asset industry, are economically underdeveloped, or have unstable regimes. While these countries may meet some conditions for the wild growth of crypto assets, the safety of assets and even the personal safety of project operators cannot be guaranteed, making them unsuitable for long-term consideration.

Therefore, the best choice for entrepreneurs is to select either strictly compliant or clearly prohibitive regulatory countries or jurisdictions.

Strict compliance types, such as Hong Kong, are typical. After the release of the crypto declaration, Hong Kong established a regulatory system for crypto asset licensing that operates under the guidance of financial regulatory authorities, referencing the traditional financial industry's segmented regulatory model, based on the "2022 Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance" and "Guidelines for Operators of Virtual Asset Trading Platforms." This system requires all central trading platforms operating in Hong Kong or promoting virtual asset services to Hong Kong citizens to obtain a license issued by the Securities and Futures Commission (SFC). Issuing tokens in such jurisdictions incurs high compliance costs and significant upfront investment, but the advantage is that regulatory norms are clear, and long-term benefits can be anticipated.

Clearly prohibitive regulatory types, such as the United States, currently do not establish a series of guidelines and regulations for crypto assets through legislative bodies like Hong Kong and the EU. Instead, different regulatory agencies (mainly the SEC and the Commodity Futures Trading Commission) self-regulate crypto institutions and the crypto assets they issue. Once they find that these do not comply with securities or futures laws, they take comprehensive judicial measures. Issuing tokens in such jurisdictions has the advantage of lower thresholds, and smaller projects may not attract regulatory attention. However, the drawbacks are also evident; relatively uncertain regulatory norms bring ambiguous legal risks—limiting the imagination of compliant entities while allowing speculators to engage in fraudulent schemes. Additionally, profit-driven enforcement is prevalent in such countries, as evidenced by the recent experiences of a leading crypto asset trading platform.

Therefore, overall, the Xiao Za team recommends that token issuers choose strictly compliant countries or jurisdictions for token issuance.

In Conclusion

In the Web 3 era, the compliant issuance of cryptocurrencies (ICOs) has become a complex and critical issue. Despite the crypto asset market undergoing several rounds of reshuffling and reconstruction, and significant advancements in blockchain technology, the challenges of compliant token issuance remain severe. The Xiao Za team believes that compliant token issuance requires project parties to possess deep market insights, strict legal awareness, and a high sense of responsibility. When choosing an issuance location, careful consideration is essential to ensure that the project can develop healthily in a legal and stable environment. At the same time, we also look forward to more compliant pathways and regulatory frameworks emerging in the future to provide strong support for the prosperous development of the Web 3 industry.

That concludes today's sharing. Thank you to the readers!