In Web3 entrepreneurship, can the "front shop, back factory" model in Hong Kong and Shenzhen be compliant?

Author of this article: Iris, Mao Jiehao

When we talk about domestic Web3 entrepreneurship, we always mention the 924 document from 2021 and emphasize that conducting virtual currency financial services within the country is an illegal financial activity, which constitutes a crime and will be prosecuted according to the law.

However, we will find that in recent years, there is a model between Hong Kong and Shenzhen called “front store, back factory,” which means establishing projects/companies in Hong Kong, facing regulatory oversight and overseas capital; while organizing development and part of the operational processes in Shenzhen, enjoying strong technological research and development and low costs.

This inevitably raises questions: Is this model really compliant? If it is compliant, does it mean I can establish a project in Hong Kong and then operate it domestically?

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

Why does “front store, back factory” exist?

Some may wonder why, since the 924 document of 2021 has clearly stated that conducting financial activities related to virtual currency within the country is illegal, the model of “front shop in Hong Kong, back factory in Shenzhen” has become active in the sight 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 shop and back factory” model between Shenzhen and Hong Kong will facilitate the development of Web3.

![Can the “front shop, back factory” model in Hong Kong and Shenzhen comply with Web3 entrepreneurship?]###https://img.gateio.im/social/moments-bda7cde4a815bae3aaf767c827ee0d9d(

*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 operation of the project, the location of core decision-making, and the management of funds, which refers to the actual control and distribution of key resources.

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

In this way, both from a business operation perspective and from the service target perspective, it avoids users within China and aligns with China’s regulatory policies.

From the perspective of underlying development, the decision 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-Macao Greater Bay Area, Shenzhen has a mature technology R&D foundation and a large reserve of Web3 talent. Compared to local development teams in Hong Kong, Shenzhen has significant advantages in terms of personnel costs, R&D cycles, and technological accumulation. For many Web3 project parties, outsourcing underlying R&D to Shenzhen is a normal business choice, which is not much different from the model of “overseas companies + domestic outsourcing development” in the traditional internet industry.

In short, the “front shop, 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 inherently possesses a strong sensitivity to compliance.

) Potential Challenges of ‘Front Store and Back Factory’

On the surface, the “front store and back factory” model seems to have achieved a “clear division” of domestic and foreign business by registering compliant entities in Hong Kong and only retaining the technology research and development segment domestically, thus avoiding 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 take on development work but also inevitably get involved in token design, certain 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 rights for fund flows, and the management rights of user data. If the daily operational management, key decisions, and fund handling of the project are still 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 regarded by regulators as “substantially” utilizing domestic resources to provide illegal financial services in disguise.

It is also worth noting that some projects choose to outsource certain aspects of market promotion, community management, or even customer service to teams in Shenzhen in order to save costs or for efficiency reasons, and even initiate global user operation activities directly from domestic teams. At this time, regulatory authorities may completely consider that the core operational chain of the project is not clearly segmented, potentially violating legal provisions.

Moreover, as the technical team is deeply involved in the product logic design, even if it appears on the surface that the project is a new product or feature launched overseas, its development and launch process may have already been completed in Shenzhen, which further blurs the boundaries between the domestic team and financial services.

In other words, the risk of a “front store and back factory” has never been about whether a compliant entity is established on the surface, but rather whether the functional separation of 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 highly likely to be deemed by regulatory authorities as “putting up a sheep’s head to sell dog meat,” leading to legal liability.

Mankun Lawyer Suggests

As mentioned above, the “front shop 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 the current environment where regulatory authorities are increasingly focused on “substance over form,” Web3 projects aiming to genuinely reduce legal risks cannot rely solely on formal functional divisions.

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

First, thoroughly sever the core control chain both domestically and abroad. Whether it is daily decision-making, fund flow, user data processing, or market promotion and operation management, it must be ensured that these functions are independently completed by overseas registered entities, and it is crucial not to outsource related functions back to domestic teams. Technical development can be undertaken by the Shenzhen team depending on the project’s needs, but it must be strictly limited to the “pure R&D” phase and cannot involve sensitive content such as fund management, user operations, or market activities after the project’s launch, to avoid crossing regulatory red lines.

Secondly, avoid the overlapping of technical research and development with product operation functions. Many projects allow their technical teams, which have a high understanding of product logic, to simultaneously get involved 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, strictly separating it from the compliance team and operation team of the Hong Kong entity, ensuring that technical development exists only as a “back office” and does not participate in the “front office” business operations.

Additionally, establish clear legal and compliance firewalls. Web3 project parties should, with the assistance of professional legal personnel, establish clear isolation mechanisms with domestic teams at the contractual level, personnel structure level, and funding flow chain. This includes but is not limited to explicitly prohibiting domestic teams from engaging in fund settlement, token distribution, and user management in technical development contracts; at the same time, set up an independent offshore legal entity or foundation to hold the project’s IP, assets, and brand rights, preventing domestic entities from being held accountable as de facto partners or co-operators due to nominal “technical services.”

Finally, prepare compliance filings in advance for various judicial jurisdictions. If the main body 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 professional legal advisors, to ensure that all financial services directed at users operate within a compliance framework. At the same time, avoid conducting any promotional marketing, community operations, payment settlements, etc., in mainland China to reduce the risk of being deemed to be “disguisedly providing services to domestic residents.”

Ultimately, the current “front shop and back factory” model can still serve as a realistic option, but the premise is that the team must truly achieve 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. Regulations are becoming increasingly strict, and risks are bound to rise accordingly; a slight misstep could lead to criminal penalties and result in a total loss of previous efforts.

Therefore, Attorney Mankun still advises Chinese entrepreneurs to truly realize the “going overseas” model, fully implementing technology research and development, corporate governance, and financial operations abroad, and to accept compliance management from foreign regulatory agencies.