The Tax Traps Behind Meme Coin Frenzy: Concerns in a $140 Billion Market

In 2024, Bitcoin took center stage in the world of finance, while also witnessing the frenzy of meme coins. Data shows that about 75% of meme coins were born this year, and by early December, meme coin trading had increased by over 950%, with a total market capitalization surpassing $140 billion. This wave not only injected new vitality into the crypto market but also attracted a large number of ordinary investors into the realm of crypto assets.

This phenomenon inevitably recalls the ICO boom around 2017. At that time, the emergence of the ERC-20 standard significantly reduced the costs of token issuance, leading to an explosion of projects with returns of hundreds or even thousands of times, with billions of dollars pouring into the ICO market. Today, launch platforms represented by Pump.fun have made token issuance simpler and fairer, triggering a meme coin storm that continues to this day. Although there are technical and logical differences between ICOs and meme coins, the tax compliance risks faced by investors and projects may be similar.

In the last round of the ICO boom, many investors and project parties encountered tax issues. 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 attention to. This article will review the Oyster case and the Bitqyck case, two tax evasion cases related to ICOs, to provide cryptocurrency investors with considerations for tax compliance during the meme coin craze.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster case: Unreported coin sale income, founder sentenced to four years in prison

The Oyster Protocol platform was founded in September 2017 by Amir Bruno Elmaani (online name Bruno Block) with the aim of providing decentralized data storage services. In October 2017, the platform began its ICO, issuing a token called Pearl (PRL). Oyster Protocol claims that PRL will create a win-win ecosystem, allowing websites and users to benefit from data storage, and facilitating value exchange and incentive mechanisms through PRL. The founder also publicly promised that the supply of PRL will not increase after the ICO, and that the smart contract will be "locked".

Through an ICO, the Oyster Protocol raised approximately $3 million in its early stages, enabling the launch of its mainnet and data storage services. However, in October 2018, the founder exploited a vulnerability in the smart contract to privately mint a large amount of new PRL and sell it on the market, leading to a dramatic drop in the price of PRL, while the individual made a huge profit.

This incident attracted the attention of regulatory authorities, ultimately leading to a civil lawsuit filed by the SEC and a criminal lawsuit against Bruno Block by the prosecutor's office. The prosecutor believes that Bruno Block not only undermined investor trust but also evaded tax obligations on millions of dollars in cryptocurrency profits. During the period from 2017 to 2018, he only submitted one tax return in 2017, claiming to have earned about $15,000 from his "patent design" business, and did not file a tax return in 2018, nor did he report any income to the IRS, yet he spent at least $12 million on properties, yachts, and other purchases.

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

1.2 Bitqyck case: ICO income transfer 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 an ICO in 2016. The company promised investors that each Bitqy coin would be accompanied by 1/10 of a share of Bitqyck common stock, but in reality, the company's shares have always been held by the founders and have never been distributed to investors as promised, along with the corresponding profits.

Subsequently, Bitqyck launched the BitqyM coin, claiming that buyers could participate in "Bitcoin mining operations" by providing power to Bitcoin mining facilities in Washington State, but such facilities do not actually exist. Through 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, which reached a settlement in August 2019, with the company and its two founders collectively paying approximately $10.11 million in civil penalties. The prosecution continues to bring tax evasion charges against them: from 2016 to 2018, Bise and Mendez earned at least $9.16 million through the issuance of Bitqy and BitqyM but underreported their income, resulting in over $1.6 million in tax losses; in 2018, Bitqyck earned at least $3.5 million from investors but failed to 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 for tax evasion (a total of about eight years), as well as jointly liable for $1.6 million.

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

One of the core issues in the Oyster and Bitqyck cases is the tax compliance of ICO revenues. Some issuers have obtained large revenues through fraudulent means against investors or other improper methods, yet they underreport their earnings or fail to file tax returns, which has raised concerns about tax compliance.

How does U.S. law determine tax evasion?

In the United States, tax evasion is a felony that refers to the intentional use of illegal means to reduce tax liabilities, typically manifested as concealing income, overstating expenses, failing to report, or failing to pay 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 $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 must be met: ( a large amount of tax owed; ) engaging in active tax evasion behavior; ( having 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 Tax-related activities in the two cases

In the United States, various stages of an ICO 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 through an ICO. The funds raised in an ICO can be regarded as sales revenue or capital raised. For example, funds used to pay for company operational expenses, develop new technologies, or expand the business should be considered company income and taxed accordingly.

Investors have tax obligations after obtaining tokens through an ICO. Especially when the obtained tokens bring rewards or airdrops, these rewards will be considered capital gains and are subject to capital gains tax. The value of airdropped and rewarded tokens is usually calculated based on market value for tax reporting. Profits obtained by investors from selling tokens will also be considered for capital gains taxation.

Objectively speaking, the actions of the parties in the Oyster and Bitqyck cases 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, after PRL's ICO, the founder exploited a smart contract vulnerability to privately mint a large amount of PRL and sell it off, reaping huge profits. This behavior violated the provisions of Section 7201 of the Federal Tax Code.

In this case, Bruno Block engaged in minting activities before selling Pearl. It goes without saying that capital gains tax should be paid on the proceeds from the sale of the tokens, but there is no consensus on whether minting token activities should be taxed. Some argue that minting tokens is similar to mining, as it involves creating new digital assets through computation, and therefore should also be subject to tax. Whether the income from minting is taxable may depend on the market liquidity of the tokens. When market liquidity has not yet formed, the value of the 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 considered taxable income.

)# 2.2.2 Tax Evasion in the Bitqyck Case

The tax evasion behavior in the Bitqyck case involves false promises to investors and illegal transfer of raised funds. After successfully raising funds through the ICO, the founders failed to fulfill their promises of investment returns, instead using most of the funds for personal expenses. This transfer of funds is essentially equivalent to converting investors' funds into personal income, rather than being used for project development or fulfilling investors' interests. The key tax issues in the Bitqyck case revolve around the illegal transfer of funds raised through the ICO and unreported income.

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 often do not report this income, as it may trigger investigations by relevant authorities into their illegal activities. Bise and Mendez did not report the illegal gains transferred from ICO fundraising as income, directly violating tax law provisions, and ultimately bore criminal liability.

3. Tips and Suggestions

With the boom of meme coins, many people in the cryptocurrency industry have gained huge returns. However, as shown by previous ICO tax evasion cases, in the wealth myths of the meme coin market, we need to focus not only on technological innovation and market opportunities but also on the critical 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 profits through fundraising like an ICO, the issuers of meme coins and early investors should still pay taxes on relevant capital gains when they sell after the tokens appreciate in value. While anyone can anonymously issue meme coins on the blockchain, this does not mean that issuers can evade tax audits. The best way to avoid tax law risks is to comply with tax laws, rather than seeking more effective means of anonymity on-chain.

Secondly, focus on the trading process of meme coins and ensure that transaction records are transparent. Due to the highly speculative nature of the meme coin market, new projects are constantly emerging, and investors' trades may be very frequent. Crypto asset investors need to keep detailed transaction records, especially by using professional crypto asset management and tax reporting software, to ensure that all purchases, sales, transfers, and profits are traceable, and to correctly classify them according to tax laws during tax reporting, avoiding potential tax disputes.

Finally, keep up with tax law developments and collaborate with professional tax advisors. The tax law systems concerning crypto assets in various countries are still in their infancy and may be frequently adjusted, with key changes potentially directly impacting the actual tax burden. Therefore, meme coin investors and issuers should maintain a high level of awareness of the tax law dynamics in their respective countries and seek the advice of professional tax advisors when necessary to make optimal tax decisions.

In summary, the meme coin market, which has reached $140 billion, has a huge wealth effect, but this wealth is also accompanied by a new round of legal challenges and compliance risks. Issuers and investors need to fully understand the relevant tax risks and maintain caution and sensitivity in the rapidly changing market to reduce unnecessary risks and losses.