Can the "front store and back factory" model in Hong Kong + Shenzhen be compliant for Web3 startups?

Written by: Iris, Mao Jiehao

When we talk about domestic Web3 entrepreneurship, we always mention the 924 document from 2021, emphasizing that conducting virtual currency financial services domestically is considered illegal financial activity, which constitutes a crime and will be subject to criminal liability under the law.

However, we have found that in recent years, there is a model between Hong Kong and Shenzhen called “front shop, back factory”, which means establishing projects/companies in Hong Kong to face regulatory requirements and overseas capital; while organizing development and some operational processes in Shenzhen to enjoy strong technological research and development capabilities at a low cost.

This naturally raises doubts: is this model really compliant? If it is compliant, does that mean I can set up a project in Hong Kong and then operate it domestically?

I have to say, this is a very interesting and practical question.

Why does the “front store and back factory” model exist?

Some may wonder, since the 924 document from 2021 clearly states that engaging in financial activities related to virtual currencies within the territory is illegal, why has this “front store in Hong Kong, back factory in Shenzhen” model become active in the eyes of many Web3 entrepreneurs in recent years?

In 2023, Kong Jianping, a director of Hong Kong Cyberport, publicly stated in an interview with The Paper Technology that the “front store and back factory” model between Shenzhen and Hong Kong will facilitate the development of Web3.

• Image source: The Paper

Lawyer Mankun believes that the reason this model can exist is that the regulatory focus is not solely on whether the project directly serves domestic users, but also on the actual location of the project’s operations, core decision-making, and capital management, which refers to the distribution of actual control and key resources.

From a structural perspective, Web3 project parties register all legal entities and businesses in Hong Kong or other overseas jurisdictions; they restrict the provision of financial services to users in Hong Kong and overseas through technical means such as IP restrictions and KYC; at the same time, funding settlement, license applications, marketing, and other processes are also completed through overseas entities.

In this way, both in terms of business operations and the target service users, it avoids users within China and aligns with China’s regulatory policies.

From the perspective of underlying development, the choice to establish a technical team in Shenzhen is based on considerations of cost, efficiency, and technical advantages. As an important part of the Guangdong-Hong Kong-Macau Greater Bay Area, Shenzhen has a mature technology research and development foundation and a large reserve of Web3 talent. Compared to local development teams in Hong Kong, Shenzhen has obvious advantages in terms of labor costs, development cycles, and technological accumulation. For many Web3 project parties, purely outsourcing underlying research and development to Shenzhen is a normal business choice, which is not much different from the model of “overseas company + domestic outsourcing development” in the traditional internet industry.

In short, the “front store and back factory” model between Hong Kong and Shenzhen seems to temporarily avoid the risk of direct regulatory intervention by clearly delineating the operational functions between domestic and overseas. However, this model still has a strong compliance sensitivity at its core.

The potential challenges of “front store and back factory”.

On the surface, the “front store and back factory” model seems to achieve a “clear division” of domestic and foreign businesses by registering compliant entities in Hong Kong and only retaining the technology research and development link domestically, in order to evade regulatory red lines. However, the problem lies precisely in the fact that the technical development, product iteration, and business operations of Web3 projects are highly coupled. Many times, domestic technical teams may not only be responsible for development work but also inevitably get involved in token design, partial operations, data processing, and even user support, which lays hidden risks for the compliance of Web3 projects.

Because regulatory agencies will not only look at whether the nominal structure complies with regulations, but will also penetrate to focus on the actual control chain of the project—who holds the core operational rights, the decision-making power over capital flows, and the rights to manage user data. If the daily operational management, key decisions, and capital handling of the project remain concentrated domestically, even if the project entity is registered in Hong Kong and the service targets are limited to overseas users, it can easily be identified by regulators as “substantially” utilizing domestic resources to indirectly provide illegal financial services.

It is worth noting that some projects choose to outsource part of their marketing, community management, and even customer service to teams in Shenzhen to save costs or for efficiency reasons, and even initiate global user operations directly from domestic teams. At this point, regulatory authorities may completely believe that the core operational chain of the project is not clearly delineated, and may suspect that it is circumventing legal regulations.

In addition, due to the deep involvement of the technical team in the product logic design, even if it superficially appears that the project is a new product or feature launched overseas, its development and launch process may have already been completed in Shenzhen. This further blurs the boundaries between the domestic team and financial services.

In other words, the risk of “front store and back factory” has never been about whether a compliant entity is established on the surface, but whether the separation of functions between domestic and foreign resources is truly realized. As long as the domestic team is involved in core aspects such as financial decision-making, operational management, or user services, the compliance risk of Web3 projects will suddenly increase, and it is very likely to be deemed by regulatory authorities as “hanging a sheep’s head while selling dog meat,” leading to legal liability.

Mankun lawyer advises

As mentioned above, the “front store and back factory” model superficially establishes a seemingly compliant structure by setting up a compliant entity in Hong Kong and restricting domestic users’ participation. However, in an era where regulatory authorities are increasingly focused on “substance over form”, Web3 project teams must go beyond mere functional divisions to truly reduce legal risks.

Lawyer Mankun suggests that Web3 startup teams must pay attention to the following points when adopting the “front store and back factory” model:

First, completely sever the core control chain between domestic and foreign entities. Whether it is daily project decisions, capital flow, user data processing, or market promotion and operational management, it must be ensured that these functions are independently completed by entities registered abroad, and it is strictly forbidden to outsource relevant functions back to domestic teams. Technical development can be undertaken by the Shenzhen team depending on the project, but it must be strictly limited to the “pure R&D” stage and must not involve sensitive content such as capital management, user operations, or market activities after the project goes live, in order to avoid touching regulatory red lines.

Secondly, avoid the overlap between technical research and product operation functions. Many projects allow their technical teams, who have a deep understanding of product logic, to be involved simultaneously in token design, user interaction, etc. This actually leads to a blurring of functions both domestically and internationally. Project parties should clearly define the scope of work for the technical team and strictly separate it from the compliance team and operation team of the Hong Kong entity, ensuring that technical development exists solely as a “back-end” function, rather than participating in the “front-end” business operations.

Additionally, establish a clear legal and compliance firewall. Web3 project parties should, with the assistance of professional legal personnel, set up a clear isolation mechanism with domestic teams in terms of contracts, personnel structure, and the flow of funds. This includes but is not limited to clearly prohibiting domestic teams from engaging in fund settlement, token distribution, and user management in technology development contracts; at the same time, establishing an independent offshore legal entity or foundation to hold project IP, assets, and brand rights to prevent domestic entities from being held accountable as de facto partners or co-operators under the guise of “technical services.”

Finally, make compliance filings in advance for each jurisdiction. If the主体 of the Web3 project is registered in Hong Kong, it is recommended to apply for the relevant licenses as early as possible, either independently or by hiring a professional legal advisor, to ensure that all financial services directed at users operate within a compliant framework. At the same time, avoid conducting any promotional marketing, community operations, payment settlements, and other activities in mainland China to reduce the risk of being deemed to be “indirectly providing services to residents in mainland China.”

Ultimately, the current “front store, back factory” model can still serve as a realistic option, provided that the team truly achieves a clear separation of domestic and foreign resources and responsibilities, avoiding the transformation of domestic technology development into an “invisible support” for foreign financial operations. However, under the existing regulatory policies, this model is not the best long-term solution. Regulatory scrutiny is increasing, and risks will inevitably rise, with the possibility of criminal penalties if precautions are not taken, rendering previous efforts futile.

Therefore, Lawyer Mankun still advises Chinese entrepreneurs to truly achieve the “going out” model, fully implementing technology research and development, corporate governance, and financial operations abroad, and to comply with the regulatory management of foreign regulatory agencies.