Written by: FinTax
2024 is the year when Bitcoin steps to the center of the world's financial stage, and it is also the year of carnival for meme coins. Relevant data shows that about 75% of meme coins were born this year. As of early December this year, the transaction of meme coins increased by more than 950%, and the total market value exceeded 140 billion US dollars. The popularity of meme coins not only brings a new round of heat to the crypto market, but also attracts more and more ordinary investors to the field of crypto assets.
The meme coin craze can't help but remind 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 hundreds of times and thousands of times returns emerged one after another, and billions of dollars poured into the ICO craze; and this year, a group of launch platforms represented by Pump.fun made issuing tokens simpler and fairer, and a meme coin storm that has continued to this day was set off in the circle. Although there are many differences between ICO and issuing meme coins in terms of technology and logic, the tax compliance risks faced by investors and project parties may be similar. In the last round of ICO craze, there was no shortage of investors and project parties facing ICO-related tax troubles. Today, as the meme coin craze continues, tax compliance issues will once 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, taking these two ICO-related tax evasion cases as examples to provide crypto investors with sober thinking about tax compliance during the meme coin craze.
1. Two typical ICO tax evasion cases
1.1 Oyster case: Sale of tokens income not reported, founder sentenced to four years in prison
The Oyster Protocol platform was initiated by Bruno Block (real name Amir Bruno Elmaani) in September 2017, aiming to provide decentralized data storage services. In October 2017, Oyster Protocol began its ICO, issuing a token named Pearl (PRL). Oyster Protocol claimed that the issuance of PRL was to create a win-win ecosystem where websites and users could benefit from data storage and achieve value exchange and incentive mechanisms through PRL. At the same time, founder Bruno Block also publicly promised that after the ICO, the supply of PRL would not increase, and the smart contract for creating PRL would be 'locked.'
Through ICO, Oyster Protocol initially raised about $3 million and used the funds to launch its mainnet, officially starting data storage services, turning Oyster Protocol from an idea into a usable product. However, the good times didn't last long. In October 2018, founder Bruno Block exploited a vulnerability in smart contracts to privately mint a large amount of new PRL and sell it on the market, resulting in a drastic drop in PRL's price, while Bruno Block personally made huge profits.
The drastic drop in PRL's price has attracted the attention of regulatory authorities. The SEC, IRS, FBI, and other relevant departments have launched investigations, ultimately leading the SEC to file a civil lawsuit regarding its fraud against investors, and the prosecutors to file a criminal lawsuit against Bruno Block for tax evasion. On tax matters, 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 he earned only about $15,000 from his 'patent design' business, did not file a tax return in 2018, nor report any income to the IRS, yet spent at least $12 million on properties, yachts, and more.
Ultimately, Oyster founder Bruno Block confessed to his tax evasion in court and signed a plea agreement in April 2023, sentenced to four years in prison and ordered to compensate tax authorities about $5.5 million to cover tax losses.
1.2 Bitqyck Case: ICO transfer of income not taxed, both 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 Bitcoin,' and conducted an ICO in 2016. Meanwhile, Bitqyck promised investors that each Bitqy coin included 1/10 of a share of Bitqyck common stock. However, in reality, the company’s shares were always held by founders Bise and Mendez, and the company never distributed the promised shares or corresponding profits to investors. Shortly after, Bitqyck launched a new cryptocurrency, BitqyM, 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 fact, such mining facilities did not exist. Through false promises, Bise and Mendez raised $24 million from over 13,000 investors through Bitqyck and used most of the funds for personal expenses.
In this regard, 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 its two founders jointly paying about $10.11 million in civil penalties to the SEC. Meanwhile, prosecutors continued to bring tax evasion charges against Bitqyck: from 2016 to 2018, Bise and Mendez earned at least $9.16 million through issuing Bitqy and Bitqy, 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 failed to submit any tax returns.
Ultimately, regarding tax issues, Bise and Mendez pleaded guilty in September and October 2021, respectively, each sentenced to 50 months in prison (a total of about eight years for both) and jointly liable for $1.6 million.
2. Detailed 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 income. In this emerging form of fundraising, some issuers obtain huge income through fraud or other improper means, underreporting their earnings or failing to file tax returns, leading to tax compliance issues.
2.1 How does U.S. law determine tax evasion?
In the U.S., tax evasion is a felony, defined as deliberately using illegal means to reduce tax liabilities, typically manifested as hiding income, falsely reporting expenses, failing to file or pay taxes on time, etc. According to Section 7201 of the Federal Tax Code (26 U.S.C. §7201), tax evasion is a federal crime, and once determined as 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.
Under the provisions of Section 7201, to constitute tax evasion, the following must be met: (1) a substantial amount of taxes owed; (2) active evasion behavior; (3) subjective intent to evade taxes. Investigations into tax evasion generally involve tracing and analyzing financial transactions, sources of income, asset flows, etc. Particularly in the cryptocurrency field, due to its anonymity and decentralized nature, tax evasion behaviors are more likely to occur.
2.2 Tax-related actions in the two cases
In the U.S., 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 comply with tax compliance requirements when raising funds through ICO. The funds raised through ICO can be seen as sales revenue or capital fundraising. For example, if the funds raised are used for company operating expenses, developing new technologies, or expanding business, then these funds should be considered company income and taxed accordingly. On the other hand, investors also have tax obligations after obtaining tokens through ICO. Especially when rewards or airdrops are received through tokens acquired in ICO, these rewards will be considered capital gains and subject to capital gains tax. In the U.S., the value of airdropped and rewarded tokens is usually calculated based on their market value and reported for tax purposes. When investors hold tokens for a period and then sell them for profit, those profits will also be considered capital gains and taxed.
Objectively speaking, whether from the Oyster case or the Bitqyck case, the actions of the parties not only infringed on the interests of investors, constituting fraud, but also indeed violated U.S. tax laws to varying degrees. Of course, the tax evasion behaviors in the two cases are not the same, and will be analyzed in detail later.
2.2.1 Tax evasion in the Oyster case
Specifically regarding the Oyster case, after the PRL ICO, the founder of Oyster Protocol, Bruno Block, exploited a vulnerability in the smart contract to privately mint a large amount of PRL and sold it, obtaining huge profits. Bruno quickly accumulated wealth through the sale of PRL, but failed to fulfill related tax obligations. This behavior violated Section 7201 of the Federal Tax Code.
However, in this case, Bruno Block's actions were special because he minted Pearl before selling it. It goes without saying that capital gains tax should be paid on the income from the sale of tokens, while whether IRS should tax the act of minting tokens remains undecided. Some argue that minting tokens is akin to mining, creating new digital assets through computation, and therefore should also be taxed. FinTax believes that 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, the value of minted tokens is difficult to determine, making it impossible to clearly calculate income; however, if the market has a certain liquidity, these tokens have market value, and the income from minting should be considered taxable income.
2.2.2 Tax evasion 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 raised funds. After successfully raising funds through ICO, Bitqyck's founders Bise and Mendez did not fulfill their promised returns to investors but instead used most of the funds for personal expenses. This transfer of funds essentially amounts to converting investors' funds into personal income, rather than being used for project development or fulfilling investor interests. Unlike the direct sale of tokens during the ICO process, the key tax issue in the Bitqyck case is the illegal transfer of funds raised through ICO and unreported income.
According to relevant provisions of the U.S. Internal Revenue Code, both legal and illegal income are included in 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 these taxpayers usually do not report such income because reporting illegal income could trigger investigations into their illegal activities. Bise and Mendez failed to report the illegal income transferred from the funds raised through ICO as required, directly violating relevant tax law provisions and ultimately facing criminal liability for this.
3. FinTax's tips and recommendations
With the boom of meme coins, many in the crypto industry have gained huge returns from them. However, as previously indicated by ICO tax evasion cases, in a meme coin market where wealth myths are created daily, we need to pay attention not only to technological innovations and market opportunities, but also 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 directly generate income like an ICO, when the tokens early purchasers buy appreciate, they should still pay capital gains tax upon sale. At the same time, although anyone can anonymously issue meme coins on-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 on-chain anonymous methods.
Second, pay attention to meme coin trading processes and ensure transparent transaction records. Due to the more speculative nature of the meme coin market and the constant emergence of new projects, investors may engage in meme coin transactions very frequently, resulting in numerous transaction records. Crypto asset investors need to maintain detailed records of a series of transactions, especially by using professional crypto asset management and tax reporting software, to ensure that all buying, selling, transfers, and profits are traceable, and that they receive correct tax law classification during tax reporting to avoid potential tax disputes.
Third, keep up with tax law dynamics and collaborate with professional tax personnel. The tax law systems regarding crypto assets in various countries are still in their infancy and subject to frequent adjustments, with key changes potentially directly affecting actual tax burdens. 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 personnel when necessary to assist in making optimal tax decisions.
In summary, the meme coin market, which has reached $140 billion, has a huge wealth effect, but this wealth also comes with a new round of legal challenges and compliance risks. Issuers and investors need to fully understand the relevant tax risks, remain cautious and sharp in the unpredictable market, and reduce unnecessary risks and losses.