Metaverse in China: Beware of these Potential Legal Issues

Introduction

The metaverse is still in its nascent stages, and the Chinese government is already increasingly focused on its development and regulation. At the March 2022 “Two Sessions” (两会), a term given to the back-to-back annual meetings of two of China’s major political bodies (the National People’s Congress (“NPC”) and Chinese People’s Political Consultative Conference (“CPPCC”), the metaverse was examined on a national level for the first time against the backdrop of domestic and global hype around the concept over the past year. In line with China’s national strategy to maintain the competitiveness of its digital economy, delegates of NPC and CPPCC recommended dedicating more resources to nurture talent and support technological developments in the metaverse. While there was a clear sense of optimism and resolution towards the new technological frontier, equally prominent was a sense of urgency to put in place proper regulations to steer such technological developments in China’s best interests. 

As more technology companies and investment institutions invest capital and other resources into developing the metaverse in China, such stakeholders ought to be aware of the constraints within which the metaverse in China is allowed to occur. For example, metaverse-related platform owners in China will need to consider the legal issues in the fields of, among others, cybersecurity and privacy, antitrust, intellectual property, and financial regulation.

In this article, we explore certain legal issues that may arise within the metaverse, focusing on China’s most recent regulations aimed at novel technologies, namely (1) the Algorithm Law and (2) the draft Deep Synthesis Law, (3) how China’s ban on cryptocurrencies might shape the development of the metaverse in China, and (4) anti-money laundering and illegal financing concerns.

Algorithm Recommendation Services

Algorithm-powered recommendation services, popularly used by social media, video streaming services and e-commerce companies, offer targeted suggestions to each user based on his or her history of choices. Given the immense power algorithm recommendation services have in shaping trends and influencing public opinion, the Provisions on the Administration of Algorithm Recommendation for Internet Services in China (the “Algorithm Law”) was implemented on March 1, 2022. The Algorithm Law aims to regulate providers of algorithm recommendation services and sets out the framework within which providers of algorithm recommendation services operate.

Mandatory requirements in regulating information services

The Algorithm Law sets out several mandatory requirements of the providers of algorithm recommendation services, specifically that such providers:

• Shall not set up any algorithm model that encourages excessively indulgent behaviors or induces users to violate laws, regulations or ethics;
  
  
• Shall establish and reinforce the databases used to identify illegal and undesirable information;
  
  
• Shall not use an algorithm to falsely register accounts, manipulate user accounts, create false “likes,” comments or re-sharing, manipulate popular search results or implement any methods which may influence online public opinion; and
  
  
• Shall not use an algorithm to unreasonably restrict other internet information service providers, hinder the normal operations of internet information services, or engage in anti-competitive practices.

Protecting users’ rights and interests

In addition, the Algorithm Law protects user rights and interests by requiring providers of algorithm recommendation services to conspicuously notify users if algorithms are being used to recommend content to them, provide users the choice to opt out of being targeted with algorithmic recommendations based on their personal attributes, or provide the users with a convenient option to turn off the algorithmic recommendations altogether. 

Providers of algorithm recommendation services are also required to specifically consider the needs and susceptibility of vulnerable groups such as the children and the elderly, and ensure that algorithmic recommendations do not recommend information that creates an unsafe environment for such users. In addition to vulnerable groups, the Algorithm Law is also mindful of consumer protection in requiring that algorithms not be used to determine transaction prices and other transaction conditions that might result in differential treatment and other illegal acts, specifically highlighted that the relevant algorithms for the remuneration, working hours, rewards and penalties of gig economy workers should be established and improved on. 

Penalties

In order for the regulators to properly monitor the use of algorithm recommendation services, providers of algorithm recommendation services must disclose algorithmic recommendation technology to China’s Internet Information Service Algorithm Filing System. For violations of the Algorithm Law, the relevant authorities may, based on their authority, issue warnings, circulate a notice of criticism, order remedial measures within a specified period, order the suspension of information updates, revoke the recordation, or impose fines ranging from RMB 10,000 to RMB 100,000 (equivalent to approximately USD 1,570 to USD 15,705).

Deep Synthesis

Deep synthesis technology is capable of generating images, texts, videos and audio content using artificial intelligence, providing important utility to components of the virtual reality. 

On January 28, 2022, the Cyberspace Administration of China released the draft provision on the Administration of Deep Synthesis of Internet Information Services (draft) (the “Draft Deep Synthesis Law”). The Chinese government is concerned that deep synthesis can be used by criminals to produce and disseminate illegal information, slander and tarnish an individual’s reputation, steal identities to commit crimes, all of which not only affect the individuals being targeted but also endanger national security and social and public interests. 

The Draft Deep Synthesis Law targets deep synthesis services, technical support for deep synthesis services, deep synthesis service providers and users within China. Under the Draft Deep Synthesis Law, deep synthesis service providers and users are required to comply with laws and regulations, respect social morality and ethics, adhere to political and social values, and promote the development of deep synthesis services in a virtuous way. Providers of deep synthesis services bear the main responsibility for ensuring that proper safeguards are in place, and must conduct real identity authentication of their users. Providers of deep synthesis services must also prominently mark content as synthetic, and unmarked content must be withdrawn immediately. 

Penalties

For violations of the Draft Deep Synthesis Law, the relevant authorities may, based on their authority, issue certain punishments, or impose fines ranging from RMB 10,000 to RMB 100,000 (equivalent to approximately USD 1,570 to USD 15,705).

If the Draft Deep Synthesis Law is ratified, providers of deep synthesis services will be required to register their applications with the state, and to comply with all necessary filing procedures. Providers of deep synthesis services will also be required to cooperate in terms of supervision and inspection, and to provide necessary technical and data support and assistance on request. 

China’s ban on cryptocurrencies

Metaverse users produce virtual content in the metaverse, and this virtual content has certain economic value and forms part of the user’s virtual properties. Users can exchange specific virtual properties with each other in the metaverse, or exchange virtual properties for virtual currency. The metaverse is therefore closely linked with cryptocurrency. 

China has continued to tighten its regulation of cryptocurrencies, and completely banned cryptocurrencies trading and cryptocurrencies mining in 2021. On September 4, 2017, the Chinese central bank (PBOC) and six other departments issued a Notice on Preventing Financial Risks from Initial Coin Offering, which prohibited cryptocurrencies offering and operation of cryptocurrency exchanges. As a result, cryptocurrency trading exchanges were shut down in China. However, crypto mining, and trading through offshore exchanges were still permitted at that time. On September 15, 2021, PBOC and nine other departments issued Notice on Further Preventing and Resolving the Risks of Virtual Currency Trading and Speculation, which further banned crypto mining, and clarified that services provided by offshore exchanges to domestic residents are also illegal financial activities. As such, it is not possible to use Bitcoin or other cryptocurrencies in the China metaverse. 

E-CNY, China’s digital fiat currency issued by its central bank, is likely to be the substitute for cryptocurrencies in the China metaverse. It is fundamentally different from cryptocurrencies in that it is controlled by a central authority. China became one of the first major economies to begin exploring its own central bank digital currency in 2014. While PBOC has conducted trials in Chinese major cities over the past two years, it has yet to provide an official timetable for a national launch of e-CNY. 

Anti-money laundering and illegal financing concerns

The anonymity, liquidity, and borderless nature of virtual assets makes them highly attractive for money laundering activities and illegal transactions such as blackmail, drug trafficking, gambling, financing for terrorism, tax evasion and cross-border transfer of funds. Chinese regulators have been keeping a close eye on the anti-money laundering (“AML”) risks relating to virtual assets. 

Transactions of virtual assets are subject to the current China AML laws and regulations. For example, service providers of virtual assets are required to conduct KYC, establish reporting mechanism for suspicious transactions and keep transactions record pursuant to relevant AML laws. However, given that the metaverse is a user-generated content platform rather than the traditional professionally generated content platforms, the metaverse raises more challenges for regulators seeking to regulate dispersed users. It is therefore expected that new regulatory policies will emerge to address virtual assets generated by users in the metaverse. 

Regulators are also concerned about the illegal financial activities conducted in the name of developing the metaverse. On February 20, 2022, China Banking and Insurance Regulatory Commission (“CBIRC”), China banking and insurance regulator, made a statement regarding such risks. The statement warned against the risks of illegal fundraising and fraud in the guise of metaverse investment projects, metaverse/blockchain games, and speculation in virtual real estate and virtual currencies. Three days after CBIRC’s statement, the Supreme People’s Court issued an amended judicial interpretation on illegal fundraising (Amended Interpretation on Adjudicating Criminal Cases of Illegal Fundraising), which expressly lists fundraising capital from the public for the purpose of trading virtual currencies as an example of the crime of illegal fundraising. Illegal fundraising, which means raising funds from the public not permitted by any relevant banking and financing laws, is an economic crime pursuant to China Criminal Law. If the funds raised exceed RMB 1 million (approximately USD 157,050), the total number of borrowers involved exceeds 150, or the direct economic loss caused exceeds RMB 500,000 (approximately USD 78,525), such fundraising constitutes a crime and violates criminal law. Given the ever-changing and fast-paced nature of cryptocurrencies and metaverse space, it is important to keep abreast of any regulatory or judicial developments as governmental authorities continue ramping up its efforts in this respect.

Conclusion 

The infancy of China’s metaverse gives the Chinese government plenty of room to co-opt the metaverse’s development as companies innovate, and it is likely that the metaverse will be regulated as it is built. With the metaverse being a focal point of the Chinese regulators, we can expect more legal and regulatory hurdles as the metaverse develops in China. Before investing into the metaverse space, in addition to the usual due diligence exercise, investors will need to examine investment opportunities in metaverse-related companies against the backdrop of the wider legal and regulatory framework within which the metaverse in China operates. 

Despite these legal and regulatory hurdles, the market for metaverse investment has never been stronger. As investors race to get early exposure to the metaverse, it is also important to bear in mind that the mainstream adoption of the metaverse will likely take a considerable amount of time given the potential legal and regulatory hurdles. 

Goodwin Procter LLP and its affiliates have offices in the U.S., England, France, Germany, Hong Kong and Luxembourg, and do not practice PRC law. The information contained in this publication is based upon the current understanding of Goodwin lawyers active in the firm’s Asia practice.