The Tax Risks Behind Meme Coins: Compliance Challenges in a $140 Billion Market from the ICO Case

2024 witnessed Bitcoin leap to the center of the world financial stage, while also being the year of the meme coin frenzy. 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. This wave not only injected new vitality into the crypto market but also attracted a large number of ordinary investors into the crypto asset space.

The popularity of meme coins inevitably 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 a plethora of hundred-fold and thousand-fold projects, with billions of dollars pouring into this wave. This year, a group of launch platforms represented by Pump.fun has made it even easier and fairer to issue tokens, sparking 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 quite similar. During the last round of the ICO boom, many investors and project parties encountered tax issues. Now, with the ongoing meme coin craze, tax compliance has once again become a core issue that crypto asset investors and meme coin issuers need to take seriously.

This article will review the Oyster case and the Bitqyck case, two tax evasion cases related to ICOs, providing crypto investors with a cold reflection 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 founded by Bruno Block (real name Amir Bruno Elmaani) in September 2017, aiming to provide decentralized data storage services. In October 2017, the platform began its ICO, issuing a token named 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 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 in its early stages, achieving the launch of its mainnet and officially starting data storage services. However, in October 2018, Bruno Block exploited a vulnerability in the smart contract to mint a large amount of new PRL and sell it on the market, resulting in a sharp decline in the price of PRL, while he personally gained huge profits.

This incident has attracted the attention of regulatory authorities. Ultimately, the SEC filed a civil lawsuit against investors for fraud, while the prosecution brought criminal tax evasion charges against Bruno Block. The prosecution believes that Bruno Block not only undermined investor trust but also evaded tax obligations on millions of dollars in cryptocurrency profits. Between 2017 and 2018, he submitted only one tax return in 2017, claiming to have earned about $15,000 from "patent design" business, and did not submit a tax return in 2018, nor reported any income to the IRS, yet spent at least $12 million on purchasing properties, yachts, and more.

Ultimately, Bruno Block admitted to tax evasion, signed a plea agreement in April 2023, and was sentenced to four years in prison and ordered to pay approximately $5.5 million in restitution 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 initially launched the Bitqy coin, claiming to provide an alternative wealth opportunity for those who "missed out on Bitcoin," and conducted an ICO in 2016. Bitqyck promised investors that each Bitqy coin came 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 as promised.

Subsequently, Bitqyck launched BitqyM coin, claiming that purchasing this coin would allow investors to participate in the "Bitcoin mining business" by powering Bitqyck's Bitcoin mining facility in Washington State, but in reality, such a facility 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 fraudulent activities. In August 2019, Bitqyck admitted to the facts and reached a civil settlement, with the company and its two founders jointly paying approximately $10.11 million in civil fines 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 but did not 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 for tax evasion (a total of about eight years), and each was held jointly liable for $1.6 million.

2. Analysis of 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 revenues. Some issuers obtained huge revenues through fraudulent means or other improper methods, yet reported less income or failed to file tax returns, leading to serious tax issues.

2.1 The Judgment of U.S. Law on Tax Evasion

In the United States, tax evasion is considered a felony, referring to the deliberate use of illegal means to reduce tax liability, typically manifested as concealing income, falsely reporting expenses, failing to report, or not paying taxes on time. According to Section 7201 of the U.S. 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.

The elements constituting tax evasion must include: ( failure to pay a large amount of taxes; ) engaging in active tax evasion behaviors; ( having subjective intent to evade taxes. Investigations into tax evasion usually involve tracing and analyzing financial transactions, sources of income, and asset flows. In the cryptocurrency field, due to its anonymity and decentralized characteristics, tax evasion is more likely to occur.

) 2.2 Specific tax-related behaviors in the two cases

In the United States, each stage of an ICO may involve tax obligations, and project parties and investors bear different tax responsibilities at different stages. Project parties must comply with tax Compliance requirements when raising funds during an ICO, and the funds raised can be viewed as sales income or capital raised. For example, if the ICO funds are used to pay for company operating expenses, develop new technologies, or expand business, they should be regarded as company income and taxed accordingly.

Investors have tax obligations after obtaining tokens through an ICO. When the tokens obtained by investors through an ICO 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 usually calculated at market value for tax reporting. Profits obtained from selling tokens held by investors for a period of time will also be considered capital gains for tax purposes.

(# 2.2.1 Tax evasion in the Oyster case

In the Oyster case, Bruno Block exploited a smart contract vulnerability to privately mint a large amount of PRL and sold it for profit, but failed to fulfill relevant tax obligations, violating Section 7201 of the Federal Tax Code.

It is worth noting that Bruno Block had minting activities before selling Pearl. There is no dispute that capital gains tax should be paid on the proceeds from the sale of the tokens, but the IRS has not yet reached a conclusion on whether 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 needs to be taxed depends 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, and it is 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 behavior of the Bitqyck case

The tax evasion behavior in the Bitqyck case involves false promises to investors and the illegal transfer of raised funds. After successfully raising funds through an ICO, the founders of Bitqyck did not fulfill their promised returns on investment, but instead used the majority of the funds for personal expenses. This behavior is essentially equivalent to converting investors' funds into personal income, rather than being used for project development or realizing investor benefits.

According to the U.S. Internal Revenue Code, both legal and illegal income are considered 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 submitting their annual tax returns, but such taxpayers often do not report this income, as it may trigger investigations by relevant authorities into illegal activities. Bise and Mendez did not report illegal gains transferred from ICO fundraising as income, directly violating tax laws and ultimately facing criminal liability.

3. Tips and Suggestions for Participants in the Meme Coin Market

As the meme coin market booms, many people in the crypto industry have gained huge returns. However, as 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 crucial issue of tax Compliance.

First, fully 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 the meme coin issuers and early investors appreciate, they should still pay taxes on the relevant capital gains when sold. Although anyone can issue meme coins anonymously on the chain, this does not mean that issuers can evade tax audits. Compliance with tax laws is the best way to avoid risks, rather than seeking more effective on-chain anonymity measures.

Second, closely monitor the trading process of meme coins to ensure that transaction records are transparent. Due to the speculative nature of the meme coin market, new projects are constantly emerging, and investors may engage in very frequent trading, resulting in a multitude of transaction records. Cryptocurrency investors need to properly maintain detailed records of all transactions and are advised to use professional cryptocurrency management and tax reporting software to ensure that all buys, transfers, and profits are traceable, and to obtain correct tax characterization during tax reporting, thereby avoiding potential tax disputes.

Third, keep up with the dynamics of tax laws and collaborate with professional tax advisors. The tax law systems regarding cryptocurrency assets in various countries are still in their infancy and may be frequently adjusted, with key changes potentially directly affecting the actual tax burden. 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 advisors when necessary to make optimal tax decisions.

In summary, the meme coin market, which has reached a scale of $140 billion, contains a huge wealth effect, but this wealth is also accompanied by a new round of legal challenges and Compliance risks. Both issuers and investors need to fully understand the relevant tax risks and remain cautious and alert in this rapidly changing market to reduce unnecessary risks and losses.