Behind the Meme Coin Frenzy: Tax Risks in a $140 Billion Market

2024 witnessed Bitcoin taking center stage in the world of finance, while also becoming a year of frenzy for meme coins. Data shows that approximately 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 of enthusiasm not only injected new vitality into the crypto market but also attracted more ordinary investors into the realm of crypto assets.

This wave of meme coins inevitably reminds people of the ICO craze around 2017. At that time, the emergence of the ERC-20 standard significantly lowered the threshold for issuing tokens, leading to a plethora of projects with hundredfold or even thousandfold returns, with billions of dollars flooding into the ICO market. This year, platforms like Pump.fun have made it even easier and fairer to issue tokens, igniting 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.

In the last round of the ICO boom, many investors and project parties encountered tax issues. Now, with the continued craze for meme coins, tax compliance issues have once again become a key concern for cryptocurrency investors and meme coin issuers. This article will review the Oyster case and the Bitqyck case, two tax evasion cases related to ICOs, to provide cryptocurrency investors with insights on tax compliance during the meme coin boom.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster case: Unreported coin sales income, 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 called Pearl (PRL). Oyster Protocol claims that the issuance of PRL is intended to establish a win-win ecosystem, allowing websites and users to benefit from data storage, and to achieve value exchange and incentive mechanisms through PRL. Founder Bruno Block publicly pledged that he would not increase the supply of PRL after the ICO, and that the smart contract would be 'locked'.

Through the ICO, the Oyster Protocol initially raised about $3 million, successfully launching its mainnet and officially starting its data storage services. However, in October 2018, Bruno Block exploited a vulnerability in the smart contract to mint a large number of new PRL privately and sold them on the market, causing the price of PRL to plummet, while he personally gained huge profits.

The sharp drop in PRL prices has attracted the attention of regulatory authorities, and relevant departments have launched an investigation. Ultimately, the SEC filed a civil lawsuit regarding fraudulent investment issues, while the prosecutor's office filed a criminal lawsuit for tax evasion. Prosecutors believe that Bruno Block not only damaged investor trust but also violated tax obligations on cryptocurrency profits amounting to millions of dollars. Between 2017 and 2018, he submitted only one tax return in 2017, claiming to have earned approximately $15,000 from "patent design" business, while in 2018 he did not submit any tax return or report any income to the IRS, yet spent at least $12 million on properties, yachts, and other expenditures.

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 in restitution to the tax authorities.

1.2 Bitqyck Case: ICO revenue transfer not taxed, both founders sentenced to eight years.

Bitqyck is a cryptocurrency company founded by Bruce Bise and Samuel Mendez. The company first launched the Bitqy coin, claiming to provide another opportunity for "those who missed Bitcoin" to get rich, 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 as promised.

Soon after, Bitqyck launched BitqyM coin, claiming that purchasing the coin would allow investors to participate in the "Bitcoin mining business" by powering Bitqyck's Bitcoin mining facilities in Washington State, but in reality, such facilities do not exist. Through 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 against Bitqyck, accusing it of defrauding investors. 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 fines to the SEC. Subsequently, the prosecution brought 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 related 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 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 they each bear joint liability of 1.6 million dollars.

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. In this emerging form of fundraising, some issuers obtain huge revenues by defrauding investors or through other improper means, yet underreport their earnings or fail to file tax returns, leading to tax compliance issues.

How does US law determine tax evasion?

In the United States, tax evasion is considered a felony, referring to the deliberate use of illegal means to reduce the amount of tax owed, typically manifested in behaviors such as concealing income, inflating 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 up to $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 conditions must be met: ( a large amount of tax owed; ) engaging in active tax evasion behavior; ( having a subjective intention to evade taxes. Tax evasion investigations usually 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 behaviors in the two cases

In the United States, each stage of an ICO may involve tax obligations, with project parties and investors assuming different tax responsibilities at various stages. The project party must comply with tax regulations when raising funds during the ICO. The funds raised in the ICO can be considered sales revenue or capital raised. For example, funds used to pay for company operating expenses, develop new technologies, or expand the business should be regarded as company income and taxed accordingly. Investors also have tax obligations after obtaining tokens through the ICO, especially when receiving rewards or airdrops, as these gains will be considered capital gains and subject to capital gains tax.

(# 2.2.1 Tax Evasion in the Oyster Case

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

In this case, Bruno Block's actions are unique because he had a minting activity before selling Pearl. The proceeds from the sale of tokens should be subject to capital gains tax, but there is currently no conclusion on whether minting tokens is taxable. Some viewpoints argue that minting tokens is similar to mining, as both create new digital assets through computation, and therefore should also be taxed. In fact, whether the income from minting is taxable should depend on the market liquidity of the tokens. When the token market has not yet formed liquidity, it is difficult to determine the value of the minted tokens and thus 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 The 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. After the successful ICO, founders Bise and Mendez failed to fulfill their investment return commitments and instead used most of the funds for personal expenses. This kind of fund transfer behavior is essentially equivalent to converting investor funds into personal income, rather than being used 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 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 they often do not do so due to the potential for investigations by relevant authorities into illegal activities. Bise and Mendez did not report the illegal income transferred from funds raised through the ICO as income, directly violating tax law provisions, and ultimately faced criminal liability.

3. Tips and Suggestions

With the popularity of meme coins, many people in the cryptocurrency industry have gained huge returns. However, as previous ICO tax evasion cases have shown, in the meme coin market, we should not only focus on technological innovation and market opportunities, but also place great importance on tax compliance as a key issue.

First, 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 meme coin appreciates, the issuer and early investors should still pay capital gains tax upon selling. While anyone can anonymously issue meme coins on the blockchain, this does not mean they can evade tax audits. The best way to avoid tax law risks is to comply with tax laws rather than seek more effective on-chain anonymity methods.

Secondly, pay attention to the trading process of meme coins and ensure that transaction records are transparent. Due to the strong speculation in the meme coin market, new projects are constantly emerging, and investors may trade very frequently. Cryptocurrency investors need to keep detailed transaction records, especially by using professional cryptocurrency management and tax reporting software, to ensure that all purchases, transfers, and profits are traceable, and to obtain the correct tax qualification during tax reporting to avoid potential tax disputes.

Finally, keep track of tax law developments and collaborate with professional tax advisors. Tax regulations regarding crypto assets in various countries are still in the early stages and may be frequently adjusted; key changes could directly affect the actual tax burden. Therefore, meme coin investors and issuers should closely monitor the tax law developments in their respective countries and seek professional tax advice when necessary to make optimal tax decisions.

In summary, the meme coin market, which has reached 140 billion USD, has a significant wealth effect, but this wealth is also accompanied by a new round of legal challenges and compliance risks. Issuers and investors must fully recognize the relevant tax risks, maintain caution and sensitivity in the complex and changing market, and reduce unnecessary risks and losses.