Behind the Meme Coin Craze: Tax Risks in a Massive Market

In 2024, Bitcoin occupies a central position on the global financial stage, while also becoming the year of the meme coin frenzy. Data shows that about 75% of meme coins were born this year, and by the beginning of December, meme coin trading had increased by over 950%, with a total market value exceeding $140 billion. This wave of enthusiasm not only brings a new round of heat to the crypto market but also attracts more ordinary investors into the realm of crypto assets.

The popularity of meme coins reminds people 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 countless projects with hundreds and thousands of times returns, and tens of billions of dollars flowing into the ICO market. This year, a group of launch platforms represented by Pump.fun has made token issuance even simpler and fairer, sparking a meme coin storm that continues to this day.

Despite the numerous 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 investors and project parties encountered related 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 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 crypto investors during the meme coin craze.

Two Typical ICO Tax Evasion Cases

Oyster case: Coin sales income not declared, founder sentenced to four years in prison.

The Oyster Protocol platform was founded in September 2017 by Bruno Block (real name Amir Bruno Elmaani) 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 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, enabling the launch of its mainnet and the initiation of data storage services. However, in October 2018, the founder exploited a vulnerability in the smart contract to mint a large amount of new PRL and sold it on the market, leading to a drastic drop in PRL prices, while he personally made a huge profit.

This incident has attracted the attention of regulators. Ultimately, the SEC filed a civil lawsuit regarding the fraudulent investment issues, while the prosecutor's office initiated a criminal lawsuit for tax evasion. The prosecutor believes that Bruno Block not only undermined investor trust but also violated his tax obligations on cryptocurrency profits amounting to millions of dollars. He only submitted one tax return in 2017, 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, despite spending at least $12 million on properties, yachts, and more.

Ultimately, Bruno Block confessed to the facts of tax evasion and signed a plea agreement in April 2023, being sentenced to four years in prison and ordered to pay approximately 5.5 million dollars in restitution to the tax authorities.

Bitqyck case: ICO transfer revenue 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 Bitqy coin, claiming to provide an alternative way to wealth for those who "missed Bitcoin," and conducted an ICO in 2016. The company promised investors that each Bitqy coin would come with 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 allocated to investors as promised along with the corresponding profits.

Subsequently, Bitqyck launched the BitqyM coin, claiming that purchasing this coin would allow investors to participate in the "bitcoin mining business" by providing power to Bitqyck's bitcoin mining facility in Washington State, but in reality, such facilities do 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 company and its two founders jointly paying approximately $10.11 million in civil penalties to the SEC. The prosecution continued to bring tax evasion charges against Bitqyck: from 2016 to 2018, Bise and Mendez earned at least $9.16 million through the issuance of Bitqy and BitqyM but underreported the related income to the IRS, causing over $1.6 million in tax losses; in 2018, Bitqyck earned at least $3.5 million from investors without submitting any tax returns.

Eventually, 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), and were jointly liable for 1.6 million dollars.

Detailed Explanation of Tax Issues Involved in the Two Cases

One of the core issues in the cases of Oyster and Bitqyck is the tax compliance of ICO revenues. In this emerging fundraising model, some issuers obtain huge revenues through fraudulent means against investors or other improper methods, but underreport their earnings or fail to file tax returns, leading to tax compliance issues.

How does American law determine tax evasion?

In the United States, tax evasion is a felony, referring to the deliberate use of illegal means to reduce tax liabilities, typically manifested through concealing income, falsely reporting expenses, failing to file or pay taxes on time, among other actions. According to Section 7201 of the United States Federal Tax Code, tax evasion is a federal crime, and once determined to be a tax evader, an individual may face up to 5 years in prison and a maximum fine of $250,000, while entities may face a maximum fine of $500,000, with specific penalties depending on the amount and nature of the tax evasion.

To constitute tax evasion, the following must be met: (1) a significant amount of taxes owed; (2) the implementation of active tax evasion behaviors; (3) the existence of subjective intent to evade taxes. Tax evasion investigations typically involve the tracing and analysis of financial transactions, sources of income, and asset movements. In the cryptocurrency domain, due to its anonymity and decentralized characteristics, tax evasion occurs more easily.

tax-related activities in the two cases

In the United States, each stage of an ICO may involve tax obligations, with project teams and investors bearing different tax responsibilities at various stages. Project teams must comply with tax regulations when raising funds during an ICO. The funds raised during the ICO can be considered as revenue from sales or capital raised. If used to pay for company operating expenses, develop new technologies, or expand business, these funds should be regarded as company income and are subject to taxation in accordance with the law.

Investors have a tax obligation 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. In the United States, the value of airdropped and rewarded tokens is typically calculated at market value for tax reporting. Profits from selling the tokens held by investors for a period will also be considered capital gains for taxation.

Objectively speaking, both the Oyster case and the Bitqyck case involved actions by the parties that not only infringed upon the interests of investors and constituted fraud, but also violated U.S. tax law provisions to varying degrees.

Tax evasion in the Oyster case

In the Oyster case, after PRL's ICO, founder Bruno Block exploited a smart contract vulnerability to mint a large amount of PRL privately and sold it, reaping huge profits. Bruno quickly accumulated wealth by selling PRL but failed to fulfill his tax obligations, violating Section 7201 of the Federal Tax Code.

In this case, Bruno Block's behavior is unique because he minted Pearl before selling it. It goes without saying that capital gains tax should be paid on the profits from selling the token, while whether the act of minting tokens is taxable has led to some opinions suggesting it should be treated similarly to the process of mining for tax purposes. In practice, whether income from minting needs to be taxed should depend on the market liquidity of the token. 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 possess market value, and the income from minting should be considered taxable income.

Tax evasion behavior of the Bitqyck case

The tax evasion behavior in the Bitqyck case involves false promises made to investors and the illegal transfer of raised funds. After successfully raising funds through the ICO, founders Bise and Mendez 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 it for project development or fulfilling investors' interests.

According to the U.S. Internal Revenue Code, both legal and illegal income are considered taxable income. The U.S. Supreme Court also 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 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 tax law provisions, and ultimately bore criminal responsibility.

Tips and Suggestions

With the popularity of meme coins, many people in the crypto industry have gained huge returns. However, as evidenced by 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 important matter of tax compliance.

First, understand the tax liabilities of issuing meme coins to avoid legal risks. Although issuing meme coins does not directly generate revenue like an ICO, when the tokens held by meme coin issuers and early investors appreciate, they should still pay taxes on the relevant capital gains upon sale. 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 on-chain anonymity.

Second, pay attention to the trading process of meme coins and ensure the transparency of trading records. Due to the speculative nature of the meme coin market, new projects are constantly emerging, and investors' transactions may be very frequent, leading to a multitude of trading records. Cryptocurrency investors need to keep detailed transaction records, especially by using professional cryptocurrency management and tax reporting software, to ensure that all buying, selling, transferring, and profits are traceable, and to obtain the correct legal classification for tax reporting to avoid potential tax disputes.

Third, keep up with tax law dynamics and collaborate with professional tax experts. The tax law systems concerning cryptocurrency assets in various countries are still in their infancy and may undergo frequent adjustments, with key changes potentially affecting the actual tax burden directly. Therefore, investors and issuers of meme coins should maintain a high level of attention to the tax law dynamics in their respective countries and seek the advice of professional tax experts when necessary to assist in making optimal tax decisions.

In summary, the meme coin market, which has reached 140 billion USD, has a huge wealth effect, but this wealth also comes with a new round of legal challenges and compliance risks. Issuers and investors need to fully understand the associated tax risks, remain cautious and alert in a complex market, and minimize unnecessary risks and losses.