Written by: FinTax
2024 is a year when Bitcoin moves to the center of the global financial stage and also a carnival year for meme coins. Relevant data shows that about 75% of meme coins were created this year, and by early December this year, meme coin trading increased by over 950%, with a total market value exceeding $140 billion. The popularity of meme coins has not only brought a new wave of heat to the crypto market but also attracted an increasing number of ordinary investors into the crypto asset field.
The meme coin craze inevitably reminds one of the ICO boom around 2017. In 2017, with the emergence of the ERC-20 standard, the cost of issuing tokens was significantly reduced, leading to numerous projects multiplying hundreds or thousands of times, with billions of dollars flooding into the ICO frenzy; this year, platforms like Pump.fun have made token issuance simpler and fairer, igniting a meme coin storm that continues to this day. Although there are many technical and logical differences between ICOs and issuing meme coins, the tax compliance risks faced by investors and project parties may be similar. In the previous ICO boom, many investors and project parties faced tax troubles related to ICOs. Now, as the meme coin craze continues, tax compliance issues will once again become a core concern for crypto asset investors and meme coin issuers. In this issue, FinTax will review the Oyster and Bitqyck cases, using these two tax evasion cases related to ICOs as examples to provide crypto investors with cold reflections on tax compliance amid the meme coin boom.
1. Two Typical ICO Tax Evasion Cases
1.1 Oyster Case: Unreported Sale Revenue, Founder Sentenced to Four Years
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 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 to realize value exchange and incentive mechanisms through PRL. Meanwhile, founder Bruno Block also publicly promised that after the ICO, the supply of PRL would not increase, and the smart contract creating PRL would be 'locked.'
Through the ICO, Oyster Protocol initially raised approximately $3 million, using these funds to launch its mainnet and officially start data storage services, turning Oyster Protocol from a concept into a usable product. However, the good times did not last long; in October 2018, founder Bruno Block exploited a vulnerability in the smart contract to privately mint a large amount of new PRL and sold it on the market, leading to a collapse in PRL prices, while Bruno Block personally gained huge profits from this.
The collapse in PRL prices attracted the attention of regulators, leading to investigations by the SEC, IRS, FBI, and other related departments. Ultimately, the SEC filed a civil lawsuit against him for defrauding investors, while prosecutors initiated a criminal lawsuit against Bruno Block regarding tax evasion. In tax matters, prosecutors argued that Bruno Block not only harmed the trust of investors but also violated the obligation to report taxes on millions of dollars in cryptocurrency profits. During the period from 2017 to 2018, Bruno Block only submitted one tax return in 2017, claiming to have earned approximately $15,000 from 'patent design' and did not submit any tax returns in 2018, nor report any income to the IRS, despite spending at least $12 million on properties, yachts, and other purchases.
Ultimately, Oyster founder Bruno Block admitted his tax evasion in court and signed a plea agreement in April 2023, receiving a four-year prison sentence and ordered to pay approximately $5.5 million to the tax authorities to cover tax losses.
1.2 Bitqyck Case: Unreported ICO Transfer Income, Two 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 an alternative path to wealth for 'those who missed Bitcoin' and conducted an ICO in 2016. Meanwhile, Bitqyck promised investors that each Bitqy coin was accompanied by 1/10 of a share of Bitqyck common stock. In reality, the company shares were always held by founders Bise and Mendez, and the company never allocated the promised shares and corresponding profits to investors. Shortly thereafter, Bitqyck introduced 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 such mining facilities did not exist. Through false promises, Bise and Mendez raised $24 million from over 13,000 investors and used most of the funds for 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 the company and its two founders paying approximately $10.11 million in civil penalties to the SEC. Meanwhile, prosecutors continued to pursue 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 file 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 (totaling about eight years), and jointly liable for $1.6 million.
2. Detailed Analysis of the Tax Issues Involved in the Two Cases
In both the Oyster and Bitqyck cases, one of the core issues is the tax compliance of ICO revenues. In this emerging fundraising format, some issuers have obtained huge revenues through defrauding investors or other improper means, yet underreport their earnings or fail to file tax returns, leading to tax compliance issues.
2.1 How U.S. Law Determines Tax Evasion?
In the United States, tax evasion is a felony, defined as deliberately taking illegal means to reduce tax liabilities, typically manifested as concealing income, inflating expenses, failing to report or pay taxes on time, etc. According to Section 7201 of the United States Federal Tax Code (26 U.S.C. §7201), tax evasion is a federal crime. Once found guilty of tax evasion, individuals may face up to five 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 Section 7201, tax evasion requires meeting three criteria: (1) owing a substantial amount of tax; (2) engaging in affirmative acts of evasion; (3) having subjective intent to evade tax. Investigations into tax evasion typically involve tracing and analyzing financial transactions, income sources, and asset flows. Particularly in the cryptocurrency space, 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 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. Funds raised through the ICO can be viewed as sales revenue or capital fundraising. For example, if the funds raised are used to pay for company operating expenses, develop new technology, or expand the business, these funds should be considered company income and taxed accordingly. On the other hand, investors also have tax obligations upon obtaining tokens through the ICO. Particularly when the tokens obtained through the ICO generate rewards or airdrops, 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 generally calculated based on their market value for tax reporting. Profits obtained from selling these tokens after holding them for a period will also be considered capital gains for taxation.
Objectively speaking, both the Oyster and Bitqyck cases involve actions that not only infringe on investor interests, constituting fraud, but also indeed violate U.S. tax laws to varying degrees. Of course, the tax evasion behaviors in the two cases are not identical, which will be analyzed in detail in the following text.
2.2.1 Tax Evasion in the Oyster Case
Specifically regarding the Oyster case, after conducting an ICO for PRL, Oyster Protocol platform founder Bruno Block exploited a smart contract vulnerability to privately mint a large amount of PRL and sold it for enormous profits. Bruno quickly accumulated wealth through the sale of PRL, but did not fulfill his tax obligations. This behavior violated Section 7201 of the Federal Tax Code.
However, Bruno Block's actions in this case had special circumstances, as he minted Pearl before selling it. It goes without saying that capital gains tax should be paid on the proceeds from the sale of tokens, but it's still undetermined whether the IRS should tax the act of minting tokens. Some opinions argue that minting tokens is similar to mining, as both involve creating new digital assets through computation, therefore the income from minting tokens should also be taxed. FinTax believes that whether income from minting should be taxed depends on the market liquidity of the tokens. If the market has not yet formed liquidity, the value of minted tokens is difficult to determine, making it impossible to calculate income; however, if the market has a certain degree of liquidity, these tokens will 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 in the Bitqyck case involved false promises to investors and illegal transfers of raised funds. After successfully raising funds through the ICO, Bitqyck founders Bise and Mendez failed to fulfill their investment return commitments, instead using most of the funds for personal expenses. This act of fund transfer essentially equated 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 lies in the illegal transfer of funds raised through the ICO and unreported income.
According to relevant provisions of the 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 annual tax returns, but these taxpayers typically do not report such income because reporting illegal income may trigger investigations into their illegal activities. Bise and Mendez failed to report the illegal income transferred from the ICO funds as required, directly violating tax laws, and ultimately bore criminal responsibility for this.
3. FinTax's Tips and Recommendations
With the popularity of meme coins, many people in the crypto industry have gained huge returns. However, as indicated by previous ICO tax evasion cases, in a meme coin market where wealth myths emerge daily, we need to focus not only on technological innovations and market opportunities but also on the important matter of tax compliance.
First, understand the tax responsibilities associated with issuing meme coins to avoid legal risks. Although issuing meme coins may not yield direct income like an ICO, when the tokens purchased early by meme coin issuers and investors appreciate, they should still pay taxes on the relevant capital gains at the time of sale. Additionally, while 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 anonymity methods.
Second, focus on the meme coin trading process to ensure transparent transaction records. Given the speculative nature of the meme coin market and the continuous emergence of various new projects, investors may engage in meme coin trading very frequently, leading to numerous transaction records. Crypto asset investors need to keep detailed records of a series of transactions, particularly using professional crypto asset management and tax reporting software to ensure that all buys, sells, transfers, and profits are traceable, and to obtain correct tax law characterizations during tax reporting to avoid potential tax disputes.
Third, keep up with tax law developments and collaborate with professional tax advisors. Tax laws regarding crypto assets are still in their infancy and are subject to frequent adjustments, with key changes potentially impacting actual tax burdens directly. Therefore, both investors and issuers of meme coins should remain highly attentive to the tax law dynamics in their countries and seek professional tax advice when necessary to make optimal tax decisions.
In summary, the meme coin market, which has reached $140 billion, has a significant wealth effect, but this wealth also comes with a new round of legal challenges and compliance risks. Issuers and investors need to fully recognize the related tax risks, remain cautious and alert in the ever-changing market, and minimize unnecessary risks and losses.