Tax Risk Reminder Behind the Booming Meme Coin Market

In 2024, as Bitcoin takes the world financial stage, it also welcomes the carnival year of meme coins. Data shows that about 75% of meme coins were born this year, and by early December, the trading volume of meme coins has increased by over 950%, with a total market capitalization exceeding $140 billion. This wave not only brings a new round of excitement to the crypto market but also attracts a large number of ordinary investors into the crypto asset field.

This wave of meme coins inevitably reminds one of the ICO boom around 2017. At that time, the emergence of the ERC-20 standard significantly reduced the cost of issuing tokens, leading to a plethora of hundred-fold and thousand-fold projects, with billions of dollars pouring into the ICO frenzy. This year, a group of launch platforms represented by Pump.fun has made it even simpler and fairer to issue tokens, sparking a meme coin storm that continues to this day.

Despite the many technical and logical differences between ICOs and the issuance of meme coins, the tax compliance risks faced by investors and projects may be similar. In the last wave of the ICO boom, many investors and project parties fell into tax dilemmas related to ICOs. Now, with the ongoing craze for meme coins, tax compliance issues have once again become a core concern that cryptocurrency investors and meme coin issuers need to pay attention to.

This article will review the Oyster case and the Bitqyck case, using these two tax evasion cases related to ICOs as examples to provide crypto investors with cold reflections on tax compliance amidst the meme coin craze.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster case: Coin sale income not reported, founder sentenced to four years in prison

The Oyster Protocol platform was initiated by Bruno Block in September 2017, aiming to provide decentralized data storage services. In October 2017, the platform began its ICO, issuing a token called Pearl (PRL). The platform claims that the issuance of PRL is to create a win-win ecosystem, allowing both websites and users to benefit from data storage. The founder also publicly promised that the supply of PRL would not increase after the ICO, and the smart contract would be "locked".

Through the ICO, the Oyster Protocol raised approximately $3 million in its early stages and achieved the launch of its mainnet. However, in October 2018, the founder exploited a vulnerability in the smart contract to privately mint a large amount of new PRL and sold it on the market, causing the price of PRL to plummet, but he personally made a substantial profit.

This incident has attracted the attention of regulatory authorities. The U.S. Securities and Exchange Commission (SEC), the Internal Revenue Service (IRS), and the Federal Bureau of Investigation (FBI) have launched investigations. Ultimately, the SEC filed a civil lawsuit against the fraud of investors, while the prosecution initiated a criminal lawsuit against Bruno Block for tax evasion.

Prosecutors believe that Bruno Block not only undermined investor trust but also violated tax obligations on millions of dollars in cryptocurrency profits. He submitted only one tax return in 2017 during the period from 2017 to 2018, claiming to have earned approximately $15,000 from his "patented design" business, and did not file a tax return in 2018, nor report any income to the IRS, yet spent at least $12 million on properties, yachts, and other expenses.

Ultimately, Bruno Block admitted to tax evasion in court, signed a plea agreement in April 2023, and was sentenced to four years in prison for tax evasion, as well as ordered to compensate the tax authorities approximately $5.5 million to cover the tax losses.

1.2 Bitqyck Case: ICO transfer income not taxed, two founders sentenced to a total of eight years in prison.

Bitqyck is a cryptocurrency company founded by Bruce Bise and Samuel Mendez. The company first launched the Bitqy coin, claiming to provide an alternative way to wealth for "those who missed out on Bitcoin," and conducted its ICO in 2016. The company promised investors that each Bitqy coin came with 1/10 of a share of Bitqyck common stock. However, in reality, the company's shares have always been held by the founders, and the promised shares and corresponding profits were never allocated to the investors.

Soon after, Bitqyck launched a new cryptocurrency called BitqyM coin, claiming that purchasing this coin would allow investors to join the "bitcoin mining business" by paying to power Bitqyck's bitcoin mining facility in Washington State, which in reality does not exist. Through these false promises, Bise and Mendez raised $24 million from over 13,000 investors and used most of the funds for personal expenses.

The SEC filed a civil lawsuit against Bitqyck for defrauding investors. In August 2019, Bitqyck acknowledged the facts and reached a civil settlement with the SEC, with the company and its two founders jointly paying approximately $10.11 million in civil fines. The prosecuting authorities continued to bring tax evasion charges against Bitqyck: from 2016 to 2018, Bise and Mendez earned at least $9.16 million by issuing Bitqy and BitqyM but underreported their relevant income to the IRS, causing over $1.6 million in tax loss; in 2018, Bitqyck earned at least $3.5 million from investors but failed to file any tax returns.

Ultimately, Bise and Mendez both pleaded guilty in September and October 2021, respectively, and were each sentenced to 50 months in prison for tax evasion (a total of about eight years), and they are jointly liable for $1.6 million.

2. Detailed Explanation of the Tax Issues Involved in the Two Cases

In the cases of Oyster and Bitqyck, one of the core issues is the tax compliance of ICO revenue. Some issuers have obtained substantial income through defrauding investors or other improper means, yet they report less revenue or fail to file tax returns, which has raised tax compliance issues.

How does U.S. law determine tax evasion?

In the United States, tax evasion is a felony, referring to the intentional use of illegal means to reduce tax liabilities, typically manifested as concealing income, falsifying expenses, failing to report, or not paying taxes on time. According to Section 7201 of the Federal Tax Code, tax evasion is a federal crime, and individuals may face up to 5 years in prison and a fine of up to $250,000, while entities may face a fine of up to $500,000, with specific penalties depending on the amount and nature of the tax evasion.

To constitute tax evasion, the following conditions must be met: (1) a substantial amount of taxes owed; (2) active participation in tax evasion behaviors; (3) the existence of subjective intent to evade taxes. Investigations into tax evasion typically involve tracing and analyzing financial transactions, sources of income, and asset flows. In the field of cryptocurrencies, tax evasion is more likely to occur due to its anonymity and decentralized characteristics.

2.2 Tax-related activities in the two cases

In the United States, various aspects of an ICO may involve tax obligations, with project teams and investors bearing different tax responsibilities at different stages. When raising funds through an ICO, project teams must comply with tax regulations. The funds raised through the ICO can be considered as sales revenue or capital raised. For example, if the funds raised from the ICO are used to pay for company operating expenses, develop new technology, or expand the business, then these funds should be regarded as company income and must be taxed in accordance with the law.

Investors have tax obligations after obtaining tokens through an ICO. Especially when the tokens obtained through the ICO come with rewards or airdrops, these rewards will be considered capital gains and are subject to capital gains tax. In the United States, the value of airdropped and rewarded tokens is typically calculated based on their market value for tax reporting. When investors hold the tokens for a period of time and then sell them for profit, this profit will also be considered capital gains for taxation.

Objectively speaking, in the cases of Oyster and Bitqyck, the actions of the parties not only infringed upon the interests of investors and constituted fraud, but also violated U.S. tax laws to varying degrees.

2.2.1 Tax evasion in the Oyster case

In the Oyster case, founder Bruno Block privately minted a large amount of PRL and sold it after the ICO of PRL, taking advantage of a vulnerability in the smart contract, resulting in enormous profits. He rapidly accumulated wealth by selling PRL, but failed to fulfill related obligations regarding taxes, violating Section 7201 of the Federal Tax Code.

It is worth noting that Bruno Block had also engaged in minting Pearl before selling it. It goes without saying that capital gains tax should be paid on the profits from the sale of the tokens, but the IRS has yet to reach a conclusion on whether minting tokens should be taxed. Some argue that minting tokens is similar to mining, as both involve creating new digital assets through computation, and therefore should also be taxed. Whether the income from minting is subject to tax may depend on the market liquidity of the tokens. When the token market has not yet formed liquidity, the value of the minted tokens is difficult to determine, making it impossible to calculate the income clearly; however, if the market has a certain level of liquidity, these tokens possess market value, and the income from minting should be regarded as taxable income.

2.2.2 Tax Evasion in the Bitqyck Case

The tax evasion behavior of the Bitqyck case involves false promises to investors and illegal transfer of raised funds. Founders Bise and Mendez, after successfully raising funds through an ICO, failed to fulfill their promised investment returns and instead used most of the funds for personal expenses. This transfer of funds is essentially equivalent to converting investors' funds into personal income, rather than using them for project development or fulfilling investors' interests.

According to the U.S. Internal Revenue Code, both legal and illegal income are included in taxable income. The U.S. Supreme Court confirmed this rule in the case of James v. United States (1961). U.S. citizens must report illegal gains as income when filing their annual tax returns, but such taxpayers typically do not report this type of income, as reporting illegal income may trigger investigations by relevant authorities into their illegal activities. Bise and Mendez failed to report the illegal gains transferred from ICO fundraising as required, directly violating the relevant provisions of tax law, and ultimately bore criminal liability for this.

3. Tax Risk Warning and Recommendations

With the popularity of meme coins, many people in the cryptocurrency industry have gained huge returns. However, as demonstrated by the previous ICO tax evasion cases, in the meme coin market, we should not only focus on technological innovation and market opportunities, but also pay attention to the key issue of tax compliance.

First, understand the tax responsibilities of issuing meme coins to avoid legal risks. Although issuing meme coins does not directly generate revenue through fundraising like an ICO, when the tokens held by meme coin issuers and early investors appreciate, they are still liable to pay taxes on the relevant capital gains upon sale. While anyone can anonymously issue meme coins on-chain, this does not mean that the issuer can evade tax audits. The best way to avoid tax law risks is to comply with tax laws rather than seeking more effective on-chain anonymity measures.

Second, focus on the trading process of meme coins and ensure transparency in transaction records. Due to the high speculative nature of the meme coin market and the constant emergence of new projects, investors may engage in very frequent meme coin trading, leading to a multitude of transaction records. Cryptocurrency investors need to properly maintain detailed records of all transactions and are advised to use specialized cryptocurrency asset management and tax reporting software to ensure that all buying, selling, transfers, and profits are traceable, and to obtain correct tax classification during tax reporting, thereby avoiding potential tax disputes.

Third, keep up with tax law developments and collaborate with professional tax experts. The tax systems of various countries regarding crypto assets are still in their infancy and may be frequently adjusted. Key changes may directly impact the actual tax burden. Therefore, investors and issuers of meme coins should closely monitor the tax law developments in their respective countries and seek advice from professional tax experts when necessary to make optimal tax decisions.

In summary, the meme coin market, which has reached as high as 140 billion USD, has a significant wealth effect, but this wealth is also accompanied by a new round of legal challenges and compliance risks. Issuers and investors need to fully recognize the related tax risks, remain cautious and vigilant in the complex and volatile market, and reduce unnecessary risks and losses.