Written by: FinTax
2024 is the year when Bitcoin takes center stage in the global financial arena, and it is also the year of the meme coin frenzy. Relevant data shows that about 75% of meme coins were born this year, and as of early December this year, the trading volume of meme coins has increased by more than 950%, with a total market value of over $140 billion. The popularity of meme coins has not only brought a new round of heat to the crypto market, but has also attracted more and more ordinary investors to the crypto asset field.
The meme coin craze inevitably reminds people of the ICO craze around 2017. In 2017, with the emergence of the ERC-20 standard, the cost of issuing tokens was greatly reduced, and projects with hundredfold or thousandfold returns emerged one after another, with tens of billions of dollars flowing into the ICO craze; this year, a batch of launch platforms represented by Pump.fun have made the issuance of tokens simpler and fairer, and have sparked a meme coin storm that continues to this day. Although ICOs and the issuance of meme coins differ in terms of technology, logic, etc., the tax compliance risks faced by investors and project parties may be similar. In the previous ICO craze, there was no shortage of investors and project parties facing tax troubles related to ICOs. Now, with the continued meme coin craze, tax compliance issues will again become a core issue that crypto asset investors and meme coin issuers need to pay attention to. In this issue, FinTax will review the Oyster case and the Bitqyck case, and use these two tax evasion cases related to ICOs as examples to provide crypto investors with some cold thoughts on tax compliance in the meme coin craze.
1. Two Typical ICO Tax Evasion Cases
1.1 Oyster Case: Unreported Coin Sale Revenue, Founder Sentenced to Four Years in Prison
The Oyster Protocol platform was launched in September 2017 by Bruno Block (real name Amir Bruno Elmaani) with the aim of providing decentralized data storage services. In October 2017, Oyster Protocol began its ICO, issuing a token called Pearl (PRL). Oyster Protocol claimed that the issuance of PRL was to create a win-win ecosystem where both websites and users could benefit from data storage, and value exchange and incentive mechanisms could be realized through PRL. At the same time, the founder Bruno Block also publicly promised that the supply of PRL would not increase after the ICO, and the smart contract for creating PRL would be "locked".
Through the ICO, Oyster Protocol raised about $3 million in the initial stage, and with this funding, it realized the mainnet launch and officially launched the data storage service, turning Oyster Protocol from an idea into a usable product. But the good times did not last long. In October 2018, the founder Bruno Block used a loophole in the smart contract to secretly mint a large number of new PRLs and sell them on the market, causing the PRL price to plummet, but Bruno Block personally gained huge profits from this.
The plunge in the PRL price caught the attention of the regulators, and the U.S. Securities and Exchange Commission (SEC), the Internal Revenue Service (IRS), the Federal Bureau of Investigation (FBI), and other relevant departments launched an investigation. Eventually, the SEC filed a civil lawsuit against him for defrauding investors, and the prosecution brought criminal charges against Bruno Block for tax evasion. On the tax issue, the prosecutor argued that Bruno Block not only undermined investor trust, but also violated the obligation to pay taxes on hundreds of millions of dollars in crypto currency profits. Bruno Block only filed a tax return in 2017, claiming he earned about $15,000 from "patent design" business, and did not file a tax return in 2018, nor did he report any income to the IRS, but spent at least $12 million to purchase real estate, yachts and other assets.
Ultimately, Oyster founder Bruno Block admitted the facts of his tax evasion in court, signed a plea agreement in April 2023, and was sentenced to four years in prison and ordered to pay the tax authorities about $5.5 million in restitution to make up for the tax loss.
1.2 Bitqyck Case: Unreported ICO Revenue, Two Founders Sentenced to a Total of Eight Years
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 get rich for those who missed out on Bitcoin, and conducted an ICO in 2016. At the same time, Bitqyck promised investors that each Bitqy coin would come with 1/10 share of Bitqyck common stock. However, the company shares were always held by the founders Bise and Mendez, and the company never distributed the promised shares and corresponding profits to investors. Soon after, Bitqyck launched a new cryptocurrency called BitqyM, claiming that buying this coin would allow investors to join the "Bitcoin mining business" by paying to power Bitqyck's Bitcoin mining facilities in Washington state, but in fact such mining facilities did not exist. Through false promises, Bise and Mendez raised $24 million from more than 13,000 investors through Bitqyck, and used most of the funds for their personal expenses.
In response, the SEC filed a civil lawsuit against Bitqyck for defrauding investors. In August 2019, Bitqyck admitted the facts and reached a civil settlement, with Bitqyck and the two founders jointly paying the SEC about $10.11 million in civil penalties. The prosecution then 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 Bitqy, but underreported the relevant income to the IRS, causing a tax loss of over $1.6 million; in 2018, Bitqyck earned at least $3.5 million from investors, but did not file any tax returns.
Ultimately, on the tax issue, Bise and Mendez pleaded guilty separately in September and October 2021, and were sentenced to 50 months in prison each (a total of about eight years) on tax evasion charges, and each took on $1.6 million in joint and several liability.
2. Explanation of the Tax Issues Involved in the Two Cases
In the Oyster and Bitqyck cases, one of the core issues is the tax compliance of ICO revenue. In this new form of fundraising, some issuers have obtained huge revenues through fraud or other improper means, but have underreported their earnings or failed to file tax returns, leading to tax compliance issues.
2.1 How Does U.S. Law Judge Tax Evasion?
In the U.S., tax evasion is a felony, which means intentionally using illegal means to reduce the taxes owed, usually manifested as concealing income, falsely reporting expenses, failing to file or pay taxes on time. According to Section 7201 of the U.S. Internal Revenue Code (26 U.S.C. §7201), tax evasion is a federal crime, and once judged as a tax evader, an individual may face up to 5 years in prison and a fine of up to $250,000, while an entity may face a fine of up to $500,000, with the specific punishment depending on the amount and nature of the tax evasion.
Under the provisions of Section 7201, to constitute tax evasion, the following must be met: (1) a large amount of taxes owed; (2) the implementation of active tax evasion measures; (3) the subjective intent to evade taxes. The investigation of tax evasion usually involves tracing and analyzing financial transactions, sources of income, and asset flows. Especially in the crypto currency field, due to its anonymity and decentralized nature, tax evasion is more likely to occur.
2.2 Tax-related Behaviors in the Two Cases
In the United States, various aspects of an ICO may involve tax obligations, with project parties and investors bearing different tax responsibilities at different stages. On the one hand, project parties must comply with tax compliance requirements when raising funds through an ICO. The funds raised through an ICO can be treated as sales revenue or capital raising. For example, if the funds raised through an ICO are used to pay for the company's operating expenses, develop new technologies, or expand the business, these funds should be treated as the company's income and taxed accordingly. On the other hand, investors who obtain tokens through an ICO also have tax obligations. Particularly when the tokens obtained through an ICO bring rewards or Airdrops, these rewards will be treated as capital gains and subject to capital gains tax. In the United States, the value of Airdrops and reward tokens is usually calculated based on their market value and reported for tax purposes. When investors hold the tokens for a period of time and then sell them for a profit, the profits will also be treated as capital gains and taxed accordingly.
Objectively speaking, from both the Oyster case and the Bitqyck case, the actions of the parties not only infringed on the interests of investors and constituted fraud, but also violated the tax laws of the United States to varying degrees, although the tax evasion behaviors in the two cases were not exactly the same, which will be analyzed in detail later.
2.2.1 Tax Evasion Behavior in the Oyster Case
Specifically in the Oyster case, after the PRL ICO, Oyster Protocol platform founder Bruno Block used a smart contract vulnerability to secretly mint a large amount of PRL and sell it, gaining huge profits. Through the sale of PRL, Bruno quickly accumulated wealth, but failed to fulfill the relevant tax obligations. This behavior violated the relevant provisions of Section 7201 of the Internal Revenue Code.
However, Bruno Block's behavior in this case has a special aspect, because he minted Pearl before selling it. The need to pay capital gains tax on the proceeds from the sale of the tokens goes without saying, but the IRS has not yet reached a conclusion on whether the minting of tokens should be taxed. Some believe that minting tokens, like mining, is the creation of new digital assets through computation, and therefore the income from minting tokens should also be taxed. FinTax believes that whether the income from minting should 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 the income cannot be clearly calculated; but if the market already has a certain degree of liquidity, these tokens have market value, and the income from minting should be treated as taxable income.
2.2.2 Tax Evasion Behavior in the Bitqyck Case
Unlike the Oyster case, the tax evasion behavior in the Bitqyck case involves false promises to investors and the illegal transfer of funds raised. After successfully raising funds through the ICO, Bitqyck's founders Bise and Mendez did not fulfill the promised investment returns as planned, but instead used most of the funds for personal expenses. This fund transfer behavior is essentially equivalent to converting the investors' funds into personal income, without using them for project development or fulfilling the interests of investors. Unlike the direct sale of tokens in the ICO process, the key tax issue in the Bitqyck case lies in the illegal transfer of ICO-raised funds and the failure to report income.
According to the relevant provisions of the U.S. Internal Revenue Code, both legal income and illegal income are included in taxable income. The U.S. Supreme Court has also confirmed this rule in the case of James v. United States (1961). U.S. citizens must report illegal income as income when filing their annual tax returns, but such taxpayers usually do not report this type of income, as reporting illegal income may lead to an investigation by the relevant authorities into their illegal activities. Bise and Mendez failed to report the illegal income from the transfer of ICO-raised funds as income as required, directly violating the relevant tax law provisions, and ultimately bore criminal responsibility for this.
3. FinTax's Reminders and Suggestions
With the popularity of meme coins, many crypto industry practitioners have gained huge returns from them. However, as the previous ICO tax evasion cases have shown, in the meme coin market where wealth myths emerge every day, we not only need to focus on technological innovation and market opportunities, but also on the important 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 income through fundraising like an ICO, when the tokens purchased by the meme coin issuer and investors at an early stage appreciate in value, they should still pay capital gains tax when sold. At the same time, although anyone can anonymously issue meme coins on the chain, this does not mean that the issuer can avoid tax audits. The best way to avoid tax law risks is to comply with tax laws, rather than seeking more effective on-chain anonymity measures.
Second, pay attention to the meme coin trading process and ensure transaction transparency. Due to the stronger speculative nature of the meme coin market and the constant emergence of new projects, investors' meme coin transactions may be very frequent, resulting in a large number of transaction records. Crypto asset investors need to keep detailed records of a series of transactions, especially using professional crypto asset management and tax reporting software, to ensure that all buying, selling, transfers, and profits have a traceable record, and are correctly characterized for tax purposes, thereby avoiding potential tax disputes.
Third, keep up with tax law dynamics and collaborate with professional tax experts. The tax systems for crypto assets in various countries are still in the initial stage and may undergo frequent adjustments, and key changes in them may directly affect the actual tax burden. Therefore, meme coin investors and issuers should keep a close eye on the tax law dynamics in their jurisdictions, and seek the advice of professional tax experts when necessary to assist in making the most optimal tax decisions.
In summary, the meme coin market, which has reached a staggering $140 billion, has a huge wealth effect, but this wealth also comes with a new round of legal challenges and compliance risks. Both issuers and investors need to fully recognize the relevant tax risks, maintain caution and acuity in the volatile market, and reduce unnecessary risks and losses.
