The Tax Risks Behind the Big Pump in the Meme Coin Market

In 2024, the rise of Bitcoin coincided with the prosperity of meme coins. Data shows that approximately 75% of meme coins were created this year, and by early December, the trading increase of meme coins exceeded 950%, with a total market value surpassing $140 billion. This wave of enthusiasm has not only injected new vitality into the crypto market but also attracted more ordinary investors into this field.

This phenomenon reminds people of the ICO boom around 2017. At that time, the emergence of the ERC-20 standard significantly lowered the threshold for issuing tokens, leading to an influx of hundreds and thousands of projects, with billions of dollars pouring into this space. This year, a group of launch platforms represented by Pump.fun has made issuing tokens even simpler and fairer, triggering a meme coin storm that continues to this day.

Although there are many technical and logical differences between ICOs and meme coins, the tax compliance risks faced by investors and projects may be similar. During the last round of the ICO boom, many participants encountered tax issues. Now, as the meme coin craze continues, tax compliance has once again become a core issue that cryptocurrency investors and meme coin issuers need to pay close attention to.

This article will review the Oyster case and the Bitqyck case, two tax evasion cases related to ICOs, providing tax compliance considerations for investors participating in the meme coin craze.

1. Analysis of ICO Tax Evasion Cases

1.1 Oyster case: Undeclared coin sale income leads to founder's imprisonment

The Oyster Protocol platform was founded by Amir Bruno Elmaani (also known as Bruno Block) in September 2017, aimed at providing decentralized data storage services. In October 2017, the platform launched its ICO, issuing a token named Pearl (PRL). Oyster Protocol claims that PRL will create a win-win ecosystem where both websites and users can benefit from data storage. Bruno Block also publicly promised that there would be no increase in PRL supply after the ICO and that the smart contract that created PRL would be "locked."

Oyster Protocol raised approximately $3 million through an ICO and launched its mainnet. However, in October 2018, Bruno Block exploited a vulnerability in the smart contract to mint a large amount of new PRL privately and sold it on the market, causing the PRL price to big pump, while he personally made a huge profit.

This incident has attracted the attention of regulatory authorities. The U.S. Securities and Exchange Commission (SEC) has filed a civil lawsuit for defrauding investors, while the prosecution has initiated a criminal lawsuit regarding tax evasion. Prosecutors pointed out that Bruno Block not only undermined investor trust but also evaded tax obligations on cryptocurrency profits amounting to millions of dollars. Between 2017 and 2018, he declared approximately $15,000 in "patent design" income in 2017, and completely failed to declare any income in 2018, yet spent at least $12 million on properties, yachts, and other purchases.

Ultimately, Bruno Block admitted to tax evasion, signed a plea agreement in April 2023, was sentenced to four years in prison for tax evasion, and was ordered to pay approximately 5.5 million dollars to the tax authorities.

1.2 Bitqyck case: ICO income transfer not taxed, 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 another path to wealth for those who "missed the Bitcoin opportunity," and conducted an ICO in 2016. The company promised investors that each Bitqy coin came with 1/10 of a share of Bitqyck common stock, but in reality, the company shares have always been held by the founders and were never distributed to investors.

Subsequently, Bitqyck launched BitqyM coin, claiming that buyers could participate in the power supply business of Bitqyck's Bitcoin mining facility in Washington State, but such a facility does not actually exist. Through these false promises, Bise and Mendez raised $24 million from over 13,000 investors, using most of the funds for personal expenses.

The SEC filed a civil lawsuit for fraudulent investor behavior. In August 2019, Bitqyck admitted the facts and reached a civil settlement with the SEC, jointly paying a fine of approximately $10.11 million. The prosecution continued to bring tax evasion charges: from 2016 to 2018, Bise and Mendez earned at least $9.16 million through the issuance of Bitqy and BitqyM but underreported relevant income, resulting in over $1.6 million in tax losses; in 2018, Bitqyck earned at least $3.5 million from investors but did not submit any tax returns.

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

2. Analysis of Tax Issues in the Case

One of the core issues in the cases of Oyster and Bitqyck is the tax compliance of ICO revenue. Some issuers obtained huge revenues through fraudulent means against investors or other improper methods, yet underreported their earnings or failed to file tax returns, leading to tax compliance issues.

2.1 The Definition of Tax Evasion under U.S. Law

In the United States, tax evasion is considered a felony, referring to the intentional use of illegal means to reduce tax liabilities, usually manifested as concealing income, inflating 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 $250,000 fine, while entities may face a fine of up to $500,000. The specific penalties depend on the amount and nature of the tax evasion.

To constitute the crime of tax evasion, the following must be met: (1) a large amount of unpaid taxes; (2) the implementation of active tax evasion behavior; (3) the existence of subjective intent to evade taxes. Tax evasion investigations typically involve tracing and analyzing financial transactions, sources of income, and asset flows. In the field of cryptocurrency, due to its anonymity and decentralized characteristics, tax evasion is more likely to occur.

2.2 Analysis of Tax-related Activities in the Two Cases

In the United States, various stages of ICOs may involve tax obligations, with project parties and investors bearing different tax responsibilities at different stages. Project parties must comply with tax regulations when raising funds during an ICO, and the funds raised can be considered sales revenue or capital fundraising. Investors also have tax obligations after obtaining tokens through an ICO, especially when receiving rewards or airdrops, which will be regarded as capital gains subject to taxation.

2.2.1 Tax Evasion in the Oyster Case

In the Oyster case, Bruno Block privately minted a large amount of PRL and sold it using a smart contract vulnerability after the ICO on PRL, obtaining huge profits but failing to fulfill tax obligations, violating Section 7201 of the Federal Tax Code.

The special aspect of this case is that Bruno Block engaged in minting activities before selling Pearl. There is no doubt that capital gains tax should be paid on the proceeds from the sale of tokens, but there is no conclusion yet on whether the minting of tokens should be taxed. Some argue that minting tokens is similar to mining, both of which create new digital assets through computation, and therefore should also be taxed. Whether the income from minting is taxable should depend on the market liquidity of the tokens. When market liquidity has not yet formed, the value of minted tokens is difficult to determine, making it impossible to clearly calculate the income; however, if the market has a certain level of liquidity, these tokens have market value, and the income from minting should be regarded as taxable income.

2.2.2 Tax evasion behavior of the Bitqyck case

The tax evasion behavior in the Bitqyck case involves false promises to investors and illegal transfer of raised funds. Founders Bise and Mendez, after successfully raising funds during the ICO, failed to fulfill their promised returns to investors and instead used most of the funds for personal expenses. This transfer of funds is essentially equivalent to converting investors' money into personal income, rather than using it for project development or fulfilling investor 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 earnings as income when filing their annual tax returns, but such taxpayers typically do not report this income, as it may trigger investigations by relevant authorities into their illegal activities. Bise and Mendez failed to report the illegal earnings transferred from funds raised through ICO as income, directly violating tax laws, and ultimately faced criminal liability.

3. Tax Compliance Recommendations

With the booming meme coin market, many practitioners in the cryptocurrency industry have gained huge returns. However, as previously warned by the ICO tax evasion cases, in this market filled with wealth myths, we need to pay attention not only to technological innovation and market opportunities but also to the key issue of tax compliance.

First, understand the tax obligations of issuing meme coins to avoid legal risks. Although issuing meme coins does not directly generate revenue like an ICO through fundraising, when the meme coin appreciates, the issuers and early investors should still pay capital gains tax upon selling. Although anyone can anonymously issue meme coins on the blockchain, this does not mean one can evade tax audits. Complying with tax laws is the best way to avoid risks, rather than seeking more effective on-chain anonymity measures.

Secondly, pay attention to the trading process of meme coins and ensure that the transaction records are transparent. Due to the highly speculative nature of the meme coin market, new projects are constantly emerging, and investors may engage in very frequent transactions, leading to a multitude of transaction records. Cryptocurrency investors need to properly maintain detailed transaction records, ideally using professional cryptocurrency asset management and tax reporting software, to ensure that all purchases, transfers, and profits are traceable, and that the correct tax classification is obtained for tax reporting, thereby avoiding potential tax disputes.

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

In summary, the meme coin market, which has reached a scale of 140 billion USD, contains a huge wealth effect, but this wealth also comes with new legal challenges and compliance risks. Issuers and investors need to fully recognize the related tax risks, maintain prudence and sensitivity in the rapidly changing market, and reduce unnecessary risks and losses.