Tax Risks Behind the Meme Coin Craze: Compliance Challenges in the $140 Billion Market from ICO Cases

The year 2024 witnessed the rise of Bitcoin on the global financial stage, while also becoming a year of meme coin frenzy. Data shows that about 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 exceeding $140 billion. This wave not only injected new vitality into the crypto market but also attracted more ordinary investors into the crypto asset sector.

This wave of meme coins inevitably reminds people of the ICO boom around 2017. At that time, the emergence of the ERC-20 standard greatly lowered the threshold for issuing tokens, leading to a surge of projects with hundredfold and thousandfold returns, with billions of dollars pouring into the ICO market. This year, technology represented by certain launch platforms has made it even simpler 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.

In the last round of the ICO boom, many investors and project parties encountered tax issues. Now, with the ongoing surge of meme coins, tax compliance has once again become a key issue that crypto asset investors and meme coin issuers need to focus on. This article will provide insights on tax compliance for crypto investors in the meme coin boom by reviewing the Oyster case and the Bitqyck case, both of which are related to tax evasion in ICOs.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster case: The coin sales revenue was not reported, and the founder was 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). The Oyster Protocol claims that the issuance of PRL is to establish a win-win ecosystem, allowing both websites and users to benefit from data storage, and to achieve value exchange and incentive mechanisms through PRL. At the same time, founder Bruno Block 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 and used these funds to launch its mainnet and officially start data storage services. However, in October 2018, founder Bruno Block exploited a vulnerability in the smart contract to mint a large amount of new PRL privately and sold it on the market, resulting in a sharp decline in the price of PRL, while Bruno Block personally gained substantial profits.

The sharp decline in PRL prices has attracted the attention of regulatory authorities, who have launched an investigation into the matter. Regarding tax issues, prosecutors believe that Bruno Block not only undermined investors' trust but also violated his tax obligations on millions of dollars in cryptocurrency profits. Between 2017 and 2018, Bruno Block submitted only one tax return in 2017, claiming he earned about $15,000 from his "patent design" business, and did not submit a tax return for 2018 or report any income to the IRS, yet spent at least $12 million on properties, yachts, and more.

Ultimately, Bruno Block admitted to the tax evasion in court and signed a plea agreement in April 2023, being sentenced to four years in prison and ordered to pay approximately $5.5 million to the tax authorities to cover the tax loss.

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 was accompanied by 1/10 share of Bitqyck common stock. However, in reality, the company’s shares have always been held by founders Bise and Mendez, and the company never allocated the promised shares and corresponding profits to investors. Soon after, Bitqyck introduced a new cryptocurrency called BitqyM coin, claiming that purchasing 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 reality, such mining facilities do not exist. Through these false promises, Bise and Mendez raised $24 million from over 13,000 investors through Bitqyck, and most of the funds were used for their personal expenses.

In this regard, a regulatory agency has filed a civil lawsuit against Bitqyck for defrauding investors. In August 2019, Bitqyck admitted the facts and reached a civil settlement, with Bitqyck and its two founders jointly paying approximately $10.11 million in civil fines. Meanwhile, the prosecution continued to accuse Bitqyck of tax evasion: from 2016 to 2018, Bise and Mendez earned at least $9.16 million by issuing Bitqy and Bitqy, but underreported the relevant income to the tax authorities, resulting in a tax loss of over $1.6 million; in 2018, Bitqyck earned at least $3.5 million from investors but failed to file any tax returns.

Finally, regarding the tax issues, 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 for both), and they each bear joint liability of 1.6 million dollars.

2. Detailed Explanation of the Tax Issues Involved in the Two Cases

In the cases of Oyster and Bitqyck, one of the core issues is the tax compliance problem related to ICO revenue. In this emerging form of fundraising, some issuers have obtained substantial income through fraudulent means against investors or other improper methods, yet report lower earnings or fail to file tax declarations, leading to tax compliance issues.

How does U.S. law determine tax evasion?

In the United States, tax evasion is a felony, referring to the intentional use of illegal means to reduce tax liability, typically manifested through actions such as concealing income, inflating expenses, failing to report, or not paying taxes on time. According to relevant U.S. legal provisions, tax evasion is a federal crime, and once determined to be a tax evader, individuals may face up to 5 years in prison and fines of up to $250,000, while entities may face fines of up to $500,000, with specific penalties depending on the amount and nature of the evasion.

To constitute a tax evasion crime, the following conditions must be met: (1) a large amount of tax is owed; (2) active tax evasion behavior has been implemented; (3) there is subjective intent to evade tax. Investigations into tax evasion typically involve tracing and analyzing financial transactions, sources of income, and asset flows. Especially in the field of cryptocurrency, tax evasion is more likely to occur due to its anonymity and decentralization characteristics.

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. On one hand, project parties must adhere to tax compliance requirements when raising funds through an ICO. The funds raised in an ICO can be considered as sales revenue or capital raised. For example, if the funds raised in the ICO are used to pay for company operating expenses, develop new technologies, or expand business, then these funds should be regarded as company income and taxed accordingly. On the other hand, investors also have tax obligations when obtaining tokens through an ICO. Particularly, when the tokens obtained by investors through an ICO bring rewards or airdrops, these rewards will be considered as capital gains and subject to capital gains tax. In the United States, the value of airdropped and rewarded tokens is usually calculated based on their market value for tax reporting purposes. When investors hold the tokens for a period and then sell them for profit, these profits will also be regarded as capital gains for taxation.

Objectively speaking, both in the Oyster case and the Bitqyck case, the actions of the parties not only infringed upon the interests of investors and constituted fraud, but also indeed violated U.S. tax laws to varying degrees. Of course, the tax evasion behaviors in the two cases are not entirely the same, and this will be analyzed in detail later.

2.2.1 Tax evasion in the Oyster case

Specifically regarding the Oyster case, after the ICO of PRL, the founder of the Oyster Protocol platform, Bruno Block, exploited a vulnerability in the smart contract to privately mint a large amount of PRL and sold it off, reaping huge profits. Bruno quickly accumulated wealth through the sale of PRL, but he failed to fulfill his tax obligations. Such behavior violates relevant legal provisions.

However, there are special circumstances regarding Bruno Block's behavior in this case, as he engaged in the minting of Pearl before selling it. It goes without saying that capital gains tax should be paid on the proceeds from the sale of tokens, but there is still no conclusion on whether the minting of tokens should be taxed by tax authorities. Some argue that minting tokens and mining both create new digital assets through computation, thus the income from minting tokens should also be taxed. Others believe that whether the income from minting tokens needs to be taxed should depend on the market liquidity of the tokens. When the token market has not yet formed liquidity, the value of minted tokens is difficult to determine, making it impossible to clearly calculate the income; however, if the market already has a certain degree of liquidity, these tokens possess market value, and the income from minting should be considered taxable income.

2.2.2 The tax evasion behavior of 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 raised funds. After successfully raising funds through the ICO, Bitqyck's founders Bise and Mendez failed to fulfill the promised investment returns, instead using a large portion of the funds for personal expenses. This transfer of funds is essentially equivalent to converting investors' money into personal income, rather than being used for project development or the realization of investor benefits. Unlike the direct sale of tokens during the ICO process, the key tax issue in the Bitqyck case lies in the illegal transfer of funds raised through the ICO and unreported income.

According to relevant U.S. laws, both legal and illegal income are included as taxable income. The U.S. Supreme Court has also confirmed this rule in related cases. U.S. citizens must report illegal gains as income when submitting 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 the funds raised in the ICO as required, directly violating the relevant provisions of tax law, and ultimately bore criminal responsibility for this.

3. Tips and Suggestions

With the popularity of meme coins, many people in the cryptocurrency industry have gained huge returns from it. However, as previously indicated by the ICO tax evasion cases, in the meme coin market where wealth myths emerge daily, 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 responsibilities of issuing meme coins to avoid legal risks. Although issuing meme coins does not generate revenue directly through fundraising like an ICO, the meme coin issuers and investors should still pay taxes on the relevant capital gains when the tokens purchased early appreciate in value upon sale. At the same time, although anyone can anonymously issue meme coins on the chain, 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 anonymous methods on the chain.

Second, pay attention to the trading process of meme coins and ensure that the transaction records are transparent. Due to the higher speculation in the meme coin market, along with the continuous emergence of various new projects, investors may engage in meme coin transactions very frequently, resulting in a multitude of transaction records. Cryptocurrency investors need to keep a detailed record of a series of transactions, especially by using professional cryptocurrency asset management and tax reporting software, to ensure that all buys, transfers, and profits are traceable, and receive correct legal classification during tax reporting, thus avoiding potential tax disputes.

Third, keep up with tax law dynamics and collaborate with professional tax personnel.