The Tax Crisis Behind Meme Coins: Hidden Risks in a $140 Billion Market

In 2024, Bitcoin takes center stage in the world financial arena, 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 increased by over 950%, with a total market capitalization exceeding 140 billion USD. 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 brings to mind the ICO boom around 2017. At that time, the emergence of the ERC-20 standard significantly reduced the cost of issuing tokens, resulting in a plethora of hundred-fold and thousand-fold projects, with tens of billions of dollars pouring into the ICO wave. This year, a group of launch platforms represented by Pump.fun has made token issuance simpler and fairer, sparking a meme coin storm that continues to this day. Although there are 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 round of the ICO boom, many investors and project parties encountered tax issues related to ICOs. Now, with the ongoing meme coin craze, 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, using these two ICO-related tax evasion cases as examples to provide cryptocurrency investors with insights on tax compliance during the meme coin craze.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster case: Coin sales revenue not reported, founder sentenced to four years in prison.

The Oyster Protocol platform was founded by Amir Bruno Elmaani (alias 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). Oyster Protocol claims that the issuance of PRL is intended to establish a win-win ecosystem, allowing both websites and users to benefit from data storage. Founder Bruno Block also publicly promised that the supply of PRL would not increase after the ICO, and that the smart contract would be "locked."

Through the ICO, the Oyster Protocol raised approximately $3 million initially, achieving the launch of the mainnet. However, in October 2018, Bruno Block exploited a smart contract vulnerability to mint a large amount of new PRL privately and sold it on the market, resulting in a dramatic drop in PRL's price, but he personally gained substantial profits.

This event has attracted the attention of regulatory authorities. The U.S. Securities and Exchange Commission (SEC) has filed a civil lawsuit regarding fraudulent investment issues, while the prosecutor's office has 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.

Between 2017 and 2018, Bruno Block submitted only one tax return in 2017, claiming to have earned approximately $15,000 from his "patent design" business. In 2018, he did not submit a tax return and did not report any income to the IRS, yet he spent at least $12 million on properties and yachts.

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

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 an ICO in 2016. Bitqyck promised investors that each Bitqy coin would come with 1/10 of a share of the company’s common stock. However, the company shares have always been held by the founders and have never been distributed to investors along with the promised shares and corresponding profits.

Soon after, Bitqyck launched a new cryptocurrency called BitqyM coin, stating that purchasing this coin would allow investors to join the "bitcoin mining business" by paying to power bitcoin mining facilities for companies 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 admitted to the facts and reached a civil settlement with the SEC, jointly paying approximately $10.11 million in civil fines. Meanwhile, prosecutors 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 income to the IRS, resulting in over $1.6 million in tax losses; in 2018, Bitqyck earned at least $3.5 million from investors but failed to file any tax returns.

Ultimately, Bise and Mendez pleaded guilty in September and October 2021, respectively, and were each sentenced to 50 months in prison (approximately eight years in total) for tax evasion, with each also bearing joint liability of $1.6 million.

2. 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 or other improper methods, yet report less income 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 intentional use of illegal means to reduce tax liabilities, typically manifested through actions such as concealing income, inflating expenses, failing to file tax returns, or failing to pay taxes on time. According to Section 7201 of the United States Federal Tax Code, tax evasion is a federal crime, and individuals may face up to 5 years of imprisonment 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 a tax evasion crime, the following must be met: (1) a large amount of tax is owed; (2) active tax evasion behaviors are implemented; (3) there is subjective intent to evade taxes. Tax evasion investigations typically involve tracing and analyzing financial transactions, sources of income, asset flows, and more. In the field of cryptocurrency, due to its anonymity and decentralized characteristics, tax evasion behaviors are 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 may be regarded as sales revenue or capital fundraising. If these funds are used to pay for company operating expenses, develop new technologies, or expand the business, they should be considered company income and taxed accordingly.

Investors have tax obligations after obtaining tokens through ICOs. When the tokens acquired by investors through ICOs yield 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 purposes. Profits obtained from selling tokens after holding them for a period will also be regarded as capital gains for taxation.

2.2.1 Tax Evasion in the Oyster Case

In the Oyster case, after PRL conducted its ICO, founder Bruno Block exploited a smart contract vulnerability to privately mint a large amount of PRL and sell it, resulting in substantial profits. Bruno rapidly accumulated wealth by selling PRL but failed to fulfill his tax obligations, violating the provisions of Section 7201 of the Federal Tax Code.

In this case, Bruno Block's actions are unique because he minted Pearl before selling it. It goes without saying that capital gains tax should be paid on the proceeds from the sale of the token, while there is no consensus on whether the act of minting tokens is taxable. 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 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 will have market value, and the income from minting should be considered taxable income.

2.2.2 Bitqyck case's tax evasion behavior

Unlike the Oyster case, the tax evasion in the Bitqyck case involved false promises to investors and the illegal transfer of raised funds. After successfully raising funds through an ICO, Bitqyck's founders Bise and Mendez failed to deliver the 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 investor interests.

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

3. Tax Compliance Recommendations

With the popularity of meme coins, many people in the cryptocurrency industry have reaped huge rewards. However, as shown by previous ICO tax evasion cases, in the meme coin market, we not only need to focus on technological innovation and market opportunities but also place great importance on tax compliance.

First, understand the tax responsibilities of issuing meme coins to avoid legal risks. Although issuing meme coins does not directly generate profits like an ICO, when the tokens held by meme coin issuers and early investors appreciate in value, they still need to pay taxes on the relevant capital gains upon selling. 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 the blockchain.

Secondly, focus on the trading process of meme coins and ensure that the transaction records are transparent. Due to the speculative nature of the meme coin market, new projects are constantly emerging, and investors' transactions may be very frequent, leading to numerous transaction records. Cryptocurrency investors need to keep detailed transaction records, especially using professional cryptocurrency management and tax reporting software, to ensure that all buying, selling, transfers, and profits are traceable, and to obtain the correct legal classification in tax reporting to avoid potential tax disputes.

Finally, keep up with tax law developments and collaborate with professional tax experts. The tax law systems regarding cryptocurrency assets in various countries are still in their infancy and are subject to frequent adjustments, with key changes potentially impacting actual tax burdens directly. Therefore, both investors and issuers of meme coins should remain highly attentive 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 conclusion, the meme coin market, which has reached $140 billion, has a significant wealth effect, but this wealth also comes with a new round of legal challenges and compliance risks. Issuers and investors need to be fully aware of the relevant tax risks, and maintain caution and sensitivity in the complex and ever-changing market to reduce unnecessary risks and losses.