Behind the Meme Coin Craze: Tax Risks Hidden in a $140 Billion Market

In 2024, Bitcoin took center stage in the world of finance, while also witnessing the frenzy of meme coins. Data shows that about 75% of meme coins were created this year, and by early December, the trading volume of meme coins had increased by over 950%, with a total market capitalization surpassing $140 billion. This wave not only brought new vitality to the crypto market but also attracted more ordinary investors into the field of crypto assets.

This wave of meme coin frenzy inevitably reminds people of the ICO boom around 2017. At that time, the emergence of the ERC-20 standard significantly reduced the cost of issuing tokens, leading to a plethora of hundredfold and thousandfold projects, with billions of dollars flooding into the ICO market. This year, a group of launch platforms represented by Pump.fun has made token issuance even simpler and fairer, triggering a meme coin storm that continues to this day. Although there are many differences between ICOs and meme coins in terms of technology and logic, the tax compliance risks faced by investors and projects may have similarities.

In the previous ICO craze, many investors and project parties encountered tax issues related to ICOs. Now, with the ongoing meme coin boom, tax compliance has once again become a core issue that crypto asset investors and meme coin issuers need to closely monitor. This article will provide thoughts on tax compliance for crypto investors during the meme coin boom by reviewing the Oyster case and the Bitqyck case, two tax evasion cases related to ICOs.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster case: Unreported coin sales income, founder 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). Oyster Protocol claims that the purpose of PRL is to create a win-win ecosystem where both websites and users can benefit from data storage. Bruno Block publicly promised that the supply of PRL would not increase after the ICO, and the smart contract would be "locked."

Through ICO, the Oyster Protocol initially raised about $3 million, achieving the launch of the mainnet and the initiation of data storage services. However, in October 2018, Bruno Block exploited a smart contract vulnerability to mint a large number of new PRL privately and sold them on the market, causing the price of PRL to plummet, but he personally made a huge profit.

This incident has drawn the attention of regulatory authorities, ultimately leading the SEC to file a civil lawsuit regarding the issue of defrauded investors, while the prosecutor's office has initiated a criminal lawsuit against Bruno Block related to tax evasion. The prosecutor believes that Bruno Block not only undermined investor trust but also violated tax obligations on cryptocurrency profits amounting to millions of dollars.

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

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 Bitqy coin, claiming to provide an alternative wealth opportunity for those who "missed out on Bitcoin," and conducted an ICO in 2016. Bitqyck promised investors that each Bitqy coin would come with 1/10 of a share of the company's common stock. However, the company shares have always been held by the founders and have never been allocated to investors as promised, along with the corresponding profits.

Soon after, Bitqyck launched the BitqyM coin, claiming that buyers could participate in the "Bitcoin mining business" by powering Bitcoin mining facilities in Washington State, but in reality, such facilities do not exist. Through these false promises, Bise and Mendez raised $24 million from over 13,000 investors, most of which was used for personal expenses.

The SEC filed a civil lawsuit against Bitqyck, which reached a settlement in August 2019, with the company and its two founders collectively paying approximately $10.11 million in civil penalties to the SEC. The prosecution continues 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 the related income, resulting in over $1.6 million in tax losses; in 2018, Bitqyck earned at least $3.5 million from investors but did not submit 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 was held jointly liable for $1.6 million.

2. Detailed Explanation of 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 revenue. In this emerging fundraising model, some issuers obtain huge revenues through fraudulent means against investors or other improper methods, yet underreport their earnings or fail to file tax returns, leading to tax compliance issues.

How does American law determine tax evasion?

In the United States, tax evasion is a felony that refers to the intentional use of illegal means to reduce the tax owed, typically manifested in actions such as concealing income, falsifying expenses, failing to file, or failing to pay taxes on time. According to Section 7201 of the U.S. Federal Tax Code, tax evasion is a federal crime, and individuals may face up to 5 years in prison and fines up to $250,000, while entities may face fines up to $500,000, with specific penalties depending on the amount and nature of the tax evasion.

To constitute tax evasion, the following conditions must be met: (1) a large amount of tax owed; (2) active tax evasion behavior; (3) the existence of subjective intent to evade taxes. Tax evasion investigations typically involve the tracing and analysis of financial transactions, income sources, asset flows, etc. In the field of cryptocurrency, 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, various stages of an ICO may involve tax obligations, and both project parties and investors bear different tax responsibilities at different stages. The project party 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 raising. Investors also have tax obligations after obtaining tokens through the ICO, especially when receiving rewards or airdrops, which will be considered capital gains and subject to capital gains tax.

2.2.1 Tax evasion in the Oyster case

In the Oyster case, Bruno Block privately minted a large amount of PRL after the ICO on PRL by exploiting a smart contract vulnerability and sold it, reaping huge profits. He quickly accumulated wealth through the sale of PRL but failed to fulfill related tax obligations, violating Section 7201 of the Federal Tax Code.

It is worth noting that Bruno Block's actions include minting and selling Pearl. The proceeds from the sale of tokens are subject to capital gains tax, but the IRS has yet to reach a conclusion on whether the act of minting tokens should be taxed. Some believe that minting tokens is similar to mining, as both involve creating new digital assets through computation, and thus should also be taxable. Whether the income from minting is taxable may depend on the market liquidity of the tokens. When the 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 has a certain level of liquidity, these tokens have market value, and the income from minting should be considered taxable income.

2.2.2 The tax evasion behavior of Bitqyck 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, Bise and Mendez did not fulfill their promised investment returns, 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 using it for project development or fulfilling investors' interests.

According to 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 filing their annual tax returns. Bise and Mendez failed to report the illegal income transferred from the funds raised through the ICO as required, directly violating relevant tax laws, and ultimately facing criminal liability.

3. Suggestions for Participants in the Meme Coin Market

With the meme coin craze, many people in the crypto industry have gained huge returns. However, as indicated by the previous ICO tax evasion cases, in the meme coin market, we not only need to focus on technological innovation and market opportunities but also pay attention to tax compliance.

First, understand the tax responsibilities of issuing meme coins to avoid legal risks. Although issuing meme coins does not directly generate profits through fundraising like an ICO, both issuers and early investors should still pay capital gains tax when selling after the meme coins appreciate. While anyone can anonymously issue meme coins on the blockchain, this does not mean that they 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-chain.

Second, focus on the trading process of meme coins and ensure the transparency of transaction records. Due to the high speculation in the meme coin market, new projects are constantly emerging, and investors trade frequently, resulting in numerous transaction records. Cryptocurrency investors need to keep detailed trading records and use professional cryptocurrency asset management and tax reporting software to ensure that all purchases, transfers, and profits are traceable, and to obtain the correct tax classification when filing taxes to avoid potential tax disputes.

Third, keep up with tax law developments and collaborate with professional tax experts. Tax systems for crypto assets in various countries are still in their early stages and will undergo regular adjustments. Key changes may directly affect the actual tax burden. Meme coin investors and issuers should maintain a high level of attention to the tax law developments in their respective countries and seek advice from professional tax experts when necessary to assist in making optimal tax decisions.

In conclusion, the meme coin market, which has reached $140 billion, has a huge wealth effect, but this wealth is also accompanied by a new round of legal challenges and compliance risks. Both issuers and investors need to fully understand the associated tax risks, remain cautious and alert in the complex and ever-changing market, and reduce unnecessary risks and losses.