Technology + Finance + Law and Classification and Grading: Encryption Business Compliance Strategy (Part 2)

Author: Zhang Feng

Fourth Layer: Substantial Violation of Financial Regulatory Risks - Systemic Risks and Regulatory Arbitrage

This level of risk has touched the core bottom line of financial regulation, mainly manifested as the potential to trigger systemic risks, engage in regulatory arbitrage, and disrupt the stability of financial markets. If RWA business converts illiquid assets into liquid assets on a large scale through tokenization without establishing corresponding risk management mechanisms, it may become a new channel for risk transmission; if arbitrage is conducted by exploiting regulatory differences across jurisdictions, it will undermine the overall effectiveness of financial regulation.

From a macroprudential regulatory perspective, RWA business may trigger systemic risks through two aspects: first, by converting illiquid assets into liquid tokens through liquidity transformation functions, creating a liquidity transformation risk similar to traditional banks; second, through interconnected effects, transmitting risks from the crypto market to traditional financial markets. The People's Bank of China has clearly indicated in its China Financial Stability Report that the increased correlation between crypto assets and the traditional financial system may lead to risk transmission, which requires RWA business to establish effective risk segregation mechanisms.

The emergence of issues such as capital pools, self-financing, and high leverage in the later stages of the P2P industry has essentially evolved into a shadow banking system, posing a threat to financial stability. RWA practitioners must take proactive systemic measures, such as establishing risk firewalls with the traditional financial system, participating in regulatory sandbox testing, and designing business architectures with built-in risk control, to avoid negative impacts on the stability of the financial system. Particularly in the business model design phase, comprehensive systemic risk assessments should be conducted to ensure that the failure of a single business does not trigger a chain reaction.

Level 5: Legal Risks of Basic Business Models - Misalignment of Legal Definitions and Fundamental Conflicts

This is the most fundamental risk, meaning that the business model itself fundamentally conflicts with the existing legal system. If RWA business is deemed to be unauthorized public deposit taking, issuing securities, or engaging in insurance business, and it cannot meet the substantive requirements of relevant laws, then the entire business model faces fundamental challenges.

From the perspective of legal qualification, the criminal risks that RWA business may involve include the crime of illegally establishing financial institutions under Article 174 of the Criminal Law, the crime of illegally absorbing public deposits under Article 176, and the crime of fundraising fraud under Article 192, among others. Especially in the current regulatory environment, if financing activities are conducted through tokenization, they are likely to be regarded as “substantially engaging in financial business,” thereby triggering relevant criminal provisions. The decision issued by the Supreme People's Court of China in 2023 on “Amending the 'Decision on Several Issues Concerning the Specific Application of Law in the Trial of Criminal Cases of Illegal Fundraising'” further clarifies the legal boundaries of various new financing activities, providing important legal reference for RWA business.

The final characterization of the P2P industry as “illegal fundraising” indicates that if the business model contradicts the essence of financial laws, no matter how innovative the packaging may be, it will be difficult to avoid legal scrutiny. RWA practitioners should conduct a thorough legal qualitative analysis at the early stage of business design. For business directions that may constitute a violation of the fundamental model, decisive adjustments or abandonment must be made. Especially during the process of business innovation, the principle of “same business, same risk, same rules” should be adhered to, avoiding the circumvention of substantive regulation through technological packaging.

4. Classification and Hierarchical Compliance Strategy: The Integration of Technology, Finance, and Law in Response

Faced with multi-layered risks, RWA practitioners need to adopt a compliance strategy that categorizes and levels risks, achieving an organic integration of technological capabilities, financial logic, and legal rules. This integration is reflected not only in the application of technology but also requires the establishment of a compliance ecosystem that combines institutions, technology, and law.

( A civil dispute hierarchy: Mechanized response

Establish a dual-driven dispute prevention mechanism of “technology + contracts.” Technically, use formal verification to ensure the security of smart contracts and introduce a decentralized arbitration mechanism to handle on-chain disputes; legally, design legal documents with clear rights and responsibilities, clarifying the allocation of responsibility and resolution paths under various circumstances. By embedding the dispute resolution mechanism into business design, reduce dispute resolution costs and maintain user experience.

Specifically, dispute resolution clauses can be embedded in smart contracts to stipulate arbitration trigger conditions under specific circumstances; utilizing blockchain Oracles technology to introduce external legal fact verification; designing multi-signature mechanisms to address anomalies in contract execution. At the same time, legal documents should clearly define the correspondence between on-chain operations and offline rights to avoid legal ambiguities caused by technical features. This integration solution of “code as law” and “law as code” is the fundamental guarantee for the compliance of RWA business.

) (2) Administrative Procedure Violations: Actively Embrace Regulation

Adopt an active compliance strategy of “communication + adaptation.” Actively communicate business models with regulatory agencies and participate in regulatory sandbox projects; establish a cross-jurisdiction compliance monitoring system to track global regulatory trends in real-time; design modular compliance solutions to quickly adapt to the procedural requirements of different jurisdictions. By productizing compliance procedures, operational risks are reduced.

In practice, we can draw on the compliance management experience of traditional financial institutions to establish a dedicated regulatory relationship management team; participate in industry self-regulatory organizations to jointly develop technical standards and business specifications; and utilize RegTech solutions to automate the completion of regulatory reports and information disclosures. Especially in cross-border business, a compliance strategy of “home country regulation + host country adaptation” should be adopted to ensure global consistency in operations while meeting local specific requirements.

(3) Administrative Substantive Violations: Technical and Legal Synergy Prevention

Build a three-dimensional defense system of “Regulatory Technology + Compliance Design.” Utilize blockchain to achieve transparency in asset flow and real-time monitoring; identify abnormal trading patterns through big data analysis; codify investor suitability requirements to ensure business execution complies with regulatory substantive requirements. At the same time, deeply integrate compliance concepts into product design rather than remedying them afterward.

Specific measures include: deploying on-chain analysis tools to monitor large abnormal transactions; establishing dynamic risk assessment models to adjust business parameters in real-time; and achieving “selective transparency” through technologies such as zero-knowledge proofs, which both protect business privacy and meet regulatory needs. In terms of investor protection, automated suitability management can be achieved through smart contracts, such as setting investment limits and risk exposure for different levels of investors.

(4) Substantial Violation of Financial Regulation: Mechanistic Risk Isolation

Design a system importance response mechanism of “risk buffering + business layering.” For businesses that may have system importance, establish a risk firewall with the traditional financial system; isolate high-risk links through business segmentation; introduce traditional financial institutions as specific roles to share systemic risks. Through mechanism design, ensure that business innovation does not jeopardize financial stability.

Specific measures that can be taken include: establishing independent entities to operate high-risk businesses to avoid risk contagion; transferring part of the risk through reinsurance mechanisms; introducing stress testing and scenario analysis to assess risk tolerance under extreme conditions. In particular, in the area of liquidity risk management, a liquidity reserve system similar to traditional finance should be established to prevent the risk of a run.

(5) Basic Model Violation: Bottom-line Thinking and Proactive Adjustment

Adhere to the baseline compliance principle of “legal qualification first + continuous monitoring.” Conduct in-depth legal substantive judgments before business innovation to avoid crossing legal red lines; establish a regular legal re-evaluation mechanism to adjust business directions based on regulatory trends; for gray areas, adopt conservative strategies or seek clear legal opinions. Maintaining the legal baseline is the prerequisite for sustainable development.

In practice, a compliance committee composed of internal legal personnel, external lawyers, and industry experts should be established to conduct preliminary reviews of innovative businesses; regular compliance audits and risk assessments should be carried out; and close attention should be paid to legislative developments and regulatory cases to adjust business strategies in a timely manner. Especially before scaling the business, authoritative legal opinions should be obtained to clarify the legal nature and compliance requirements of the business.

V. Conclusion: Finding a Balance Between Innovation and Compliance

RWA cryptocurrency business, as a fusion product of “technology + finance + law,” relies on the coordinated adherence to three types of rules for its healthy development. From the lessons of P2P, we see that ignoring the essence of finance and legal rules in “innovation” will eventually come at a cost; from the opportunities of RWA, we see that businesses that incorporate technological innovation into a compliance framework have long-term value.

Practitioners should abandon the complacent mindset of “develop first, comply later” and establish a risk identification and response system that categorizes and levels risks, implementing differentiated strategies for different risk levels. Only by finding a balance between innovative enthusiasm and compliance rationality can RWA crypto businesses avoid repeating the mistakes of P2P and truly unleash their tremendous potential to transform traditional finance.

In an era where digital assets are rapidly merging with the real world, those practitioners who can organically combine technological capabilities, financial logic, and legal wisdom will not only gain an advantage in competition but also contribute to building a more secure, efficient, and inclusive financial ecosystem. Compliance is not the opposite of innovation, but rather the cornerstone of sustainable innovation - this is the most valuable insight left to us by the P2P regulatory storm and the path that RWA crypto businesses must follow to mature. With the development of China's digital economy and the opening of financial markets, RWA businesses are expected to become a bridge connecting traditional finance and the digital economy under an effective regulatory framework. However, the realization of this vision completely depends on the compliance choices and strategic vision of practitioners today.