Tax Concerns Under the Meme Coin Craze: Compliance Risks of Encryption Assets from ICO Cases

In 2024, Bitcoin welcomed a new highlight moment, while the meme coin market also showed unprecedented prosperity. Data shows that about 75% of meme coins were created this year, and by early December, meme coin trading increased by over 950%, with a total market cap surpassing 140 billion USD. This boom not only brought a new wave of enthusiasm to the encryption market but also attracted more ordinary investors into the encryption asset field.

The popularity 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, with projects yielding hundreds and thousands of times returns emerging one after another, and tens of billions of dollars flooding into the ICO market. Today, a group of launch platforms represented by Pump.fun has once again simplified the token issuance process, sparking a meme coin storm that continues to this day. Although ICOs and meme coins differ in terms of technology and logic, the tax compliance risks faced by investors and projects may be similar.

In the previous round of the ICO boom, many investors and project parties encountered tax issues. Now, with the continued surge of meme coins, tax compliance has once again become a key concern for both cryptocurrency investors and meme coin issuers. This article will review the Oyster case and the Bitqyck case as examples of two tax evasion cases related to ICOs, providing insights into tax compliance for cryptocurrency investors during the meme coin boom.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster Case: Coin sale income not reported, founder sentenced to four years in prison

The Oyster Protocol platform was founded by Amir Bruno Elmaani (pseudonym Bruno Block) 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 to establish a win-win ecosystem, allowing both websites and users to benefit from data storage. The founder also publicly promised that the supply of PRL would not increase after the ICO, and the smart contract would be "locked."

Through the ICO, Oyster Protocol raised approximately $3 million in its early stage and launched its mainnet. However, in October 2018, the founder exploited a smart contract vulnerability to privately mint a large amount of new PRL and sold it on the market, leading to a drastic drop in the price of PRL, while personally gaining enormous profits.

This event has attracted the attention of regulatory authorities. Ultimately, the regulatory agency filed a civil lawsuit against its fraudulent behavior towards investors, while the prosecution initiated a criminal lawsuit regarding tax evasion issues. The prosecution believes that the founder not only undermined investor trust but also violated the tax obligations on millions of dollars in encryption profits.

Between 2017 and 2018, the founder only submitted one tax return in 2017, stating that he earned approximately $15,000 from the "patent design" business. In 2018, he did not submit a tax return and did not report any income to the tax authorities, yet spent at least $12 million on acquiring property, yachts, and other items.

Ultimately, the founder of Oyster confessed to the fact of tax evasion and signed a plea agreement in April 2023, being sentenced to four years in prison and ordered to compensate the tax authorities approximately $5.5 million.

1.2 Bitqyck case: ICO transfer income not taxed, 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 wealth opportunity for those who "missed out on Bitcoin," and conducted an ICO in 2016. The company promised investors that each Bitqy coin would come with 1/10 of a share of Bitqyck common stock. However, the company's shares have always been held by the founders and have never been allocated to investors as promised along with the corresponding profits.

Subsequently, Bitqyck launched the BitqyM coin, claiming that purchasing this coin would allow investors to participate in the "Bitcoin mining business" by paying to power its Bitcoin mining facility in Washington State, but in reality, such a facility does 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.

Regulators have filed a civil lawsuit against Bitqyck for 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 civil penalties. The prosecution has 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 BitqyM but underreported relevant income to the tax authorities, 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 (a total of about eight years) for tax evasion, and each assumed joint liability of $1.6 million.

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

One of the core issues in the cases of Oyster and Bitqyck is the tax compliance of ICO revenues. In this emerging fundraising form, some issuers obtain substantial income through fraudulent means against investors or other improper methods, yet underreport their earnings or fail to file tax returns, raising tax compliance issues.

How does American law determine tax evasion?

In the United States, tax evasion is regarded as a felony, referring to the deliberate use of illegal means to reduce tax liability, typically manifested as concealing income, inflating expenses, failing to report or pay taxes on time, among other actions. According to Section 7201 of the Federal Tax Code, tax evasion is a federal crime, and if convicted, 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 tax evasion.

To constitute tax evasion, the following must be met: (1) a significant amount of unpaid taxes; (2) engaging in active tax evasion behaviors; (3) the presence of subjective intent to evade taxes. Tax evasion investigations typically involve tracing and analyzing financial transactions, sources of income, and asset flows. In the field of encryption currency, due to its anonymity and decentralization features, tax evasion behaviors are more likely to occur.

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. The project parties must comply with tax compliance requirements when raising funds through the ICO. The funds raised in the ICO can be viewed as sales revenue or capital fundraising. For example, if used to pay for company operating expenses, develop new technologies, or expand the business, these funds should be considered company income and taxed accordingly.

Investors have a tax obligation after obtaining tokens through an ICO. Especially when the tokens obtained through the ICO bring rewards or airdrops, these rewards will be considered capital gains and subject to capital gains tax. In the United States, the value of airdropped and rewarded tokens is usually calculated at market value for tax reporting. After holding the tokens for a period, the profits obtained from selling them will also be considered capital gains for taxation.

Objectively speaking, whether it is the Oyster case or the Bitqyck case, the actions of the parties not only violated the interests of investors and constituted fraud but also violated U.S. tax laws to varying degrees. The tax evasion behaviors in the two cases are different, and a detailed analysis will follow.

2.2.1 Tax evasion in the Oyster case

In the Oyster case, after the PRL ICO, the platform's founder exploited a vulnerability in the smart contract to privately mint a large amount of PRL and sell it, gaining huge profits. The founder quickly accumulated wealth by selling PRL, but failed to fulfill tax obligations, violating the provisions of Section 7201 of the Federal Tax Code.

In this case, the founder's behavior is special because he had the act of minting Pearl before selling it. It goes without saying that capital gains tax should be paid on the proceeds from the sale of the tokens, but there is no conclusion yet on whether the act of minting tokens should be taxed by the tax authorities. Some argue that minting tokens is similar to mining, as both activities create new digital assets through computation; hence, the income from minting tokens should also be taxed.

Whether the income from minting is taxable 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, making it impossible to clearly calculate the income; however, if the market has a certain level of liquidity, these tokens then have 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 Bitqyck case involved tax evasion through false promises to investors and the illegal transfer of raised funds. After successfully raising funds through an ICO, the founders of Bitqyck failed to deliver on their promised returns to investors, instead using most of the funds for personal expenses. This transfer of funds is essentially equivalent to converting investors' funds into personal income, rather than being used for project development or fulfilling investor interests. The key tax issue in the Bitqyck case lies in the illegal transfer of funds raised through the ICO and unreported income.

According to the relevant provisions of the U.S. Internal Revenue Code, both legal and illegal income are included in taxable income. The U.S. Supreme Court also 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 such taxpayers typically do not report this income because reporting illegal income may trigger investigations by relevant authorities into their illegal activities. In the Bitqyck case, the founders failed to report illegal gains transferred from ICO fundraising as required, directly violating the relevant provisions of tax law, and ultimately bore criminal responsibility for this.

3. Tax Tips and Advice

With the popularity of meme coins, many people in the encryption industry have gained huge returns. However, as shown by previous ICO tax evasion cases, in the meme coin market, 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 directly generate revenue through fundraising like an ICO, when the tokens of meme coin issuers and early investors appreciate, they should still pay tax on the related capital gains upon sale. Although anyone can issue meme coins anonymously 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 means of anonymity on the chain.

Second, pay attention to the trading process of meme coins and ensure that the transaction records are transparent. Due to the speculative nature of the meme coin market, new projects continue to emerge, and investors' meme coin transactions may be very frequent, resulting in numerous transaction records. Cryptocurrency investors need to keep a detailed record of a series of transactions, 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 legal classification for tax reporting, thereby avoiding potential tax disputes.

Third, keep up with tax law developments and collaborate with professional tax advisors. The tax systems for encryption assets in various countries are still in their infancy and are subject to frequent adjustments, with key changes potentially directly affecting the actual tax burden. Therefore, investors and issuers of meme coins should maintain a high level of attention to the tax law dynamics in their respective countries and, if necessary, seek the advice of professional tax advisors to assist in making optimal tax decisions.

In summary, the meme coin market, which has reached as high as $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 understand the associated tax risks and remain cautious and sharp in this complex and ever-changing market to minimize unnecessary risks and losses.