Tax Risks in the Meme Coin Market Trend: A Look at Compliance of Encryption Assets from ICO Cases

In 2024, as Bitcoin made its debut on the world financial stage, it also witnessed the frenzy of meme coins. Data shows that approximately 75% of meme coins were created this year, and by early December, meme coin trading had increased by over 950%, with a total market capitalization exceeding 140 billion USD. This wave of enthusiasm not only brought a new round of heat to the encryption market but also attracted more ordinary investors into the field of encryption assets.

The rise of meme coins reminds people of the ICO boom around 2017. At that time, the emergence of the ERC-20 standard significantly lowered the threshold for issuing tokens, leading to a multitude of hundredfold and thousandfold projects, with billions of dollars pouring into the ICO market. Today, launch platforms represented by Pump.fun have made it even easier and fairer to issue tokens, sparking a meme coin frenzy that continues to this day.

Despite the many technical and logical differences between ICOs and meme coins, the tax compliance risks faced by investors and projects may be similar. During the last ICO boom, many investors and project parties encountered tax issues. Now, as the meme coin craze continues, tax compliance has once again become a core issue that cryptocurrency investors and meme coin issuers need to pay attention to.

This article will provide tax compliance considerations for cryptocurrency investors during the meme coin craze by reviewing the Oyster case and the Bitqyck case, both of which are tax evasion cases related to ICOs.

1. Two Typical ICO Tax Evasion Cases

1.1 Oyster case: Coin sale income not declared, founder sentenced to four years in prison

The Oyster Protocol platform was founded by Bruno Block in September 2017, aiming to provide decentralized data storage services. In October 2017, the platform conducted an ICO, issuing a token named Pearl (PRL). The founder 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 and achieved the launch of its mainnet. However, in October 2018, the founder exploited a smart contract vulnerability to privately mint a large amount of new PRL and sell it on the market, resulting in a sharp decline in PRL prices, while the founder personally gained substantial profits.

This incident has triggered an investigation by regulatory authorities. Regarding tax issues, prosecutors believe that the founder not only undermined investor trust but also violated tax obligations on millions of dollars in cryptocurrency profits. Between 2017 and 2018, the founder only submitted a tax return in 2017, claiming to have earned about $15,000 from "patent design" business, while no tax return was submitted in 2018, nor was any income reported to the tax authorities, yet at least $12 million was spent on acquiring properties, yachts, and other assets.

In the end, the founder of Oyster pleaded guilty in April 2023 to tax evasion and was sentenced to four years in prison, along with a compensation of approximately 5.5 million dollars 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 was founded by Bruce Bise and Samuel Mendez, who first launched Bitqy coin, claiming to provide an alternative way to wealth 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, in reality, the company's shares have always been held by the founders and the promised shares and corresponding profits were never allocated to investors.

Subsequently, Bitqyck launched the BitqyM coin, claiming that purchasing this coin would allow investors to join the "Bitcoin mining business," but in fact, there were no such facilities. Through false promises, the two founders raised $24 million from over 13,000 investors and used most of the funds for personal expenses.

In this regard, regulatory authorities filed a lawsuit against Bitqyck. In August 2019, Bitqyck reached a civil settlement with the regulatory authorities, with the company and its two founders jointly paying a fine of approximately $10.11 million. The prosecution also brought tax evasion charges against Bitqyck: from 2016 to 2018, the two founders earned at least $9.16 million by issuing 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 file any tax returns.

Eventually, the two founders pleaded guilty in September and October 2021, respectively, and were each sentenced to 50 months in prison for tax evasion, along with a joint liability of $1.6 million.

2. Analysis 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 method, 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 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, usually manifested as concealing income, falsely reporting 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 a fine of up to $250,000, while entities may face a fine of up to $500,000.

To constitute tax evasion, the following must be met: ( failure to pay a large amount of taxes; ) engaging in active tax evasion behavior; ( existence of subjective intent to evade taxes. Investigations into tax evasion typically involve tracing and analyzing financial transactions, sources of income, and asset flows. In the field of encryption currency, tax evasion is more likely to occur due to its anonymity and decentralized characteristics.

) 2.2 Tax-related behaviors in the two cases

In the United States, each stage of an ICO may involve tax obligations, with project teams and investors bearing different tax responsibilities at different stages. Project teams must comply with tax compliance requirements when raising funds through an ICO. Funds raised through an ICO can be regarded as sales revenue or capital fundraising. Investors also have tax obligations after obtaining tokens through an ICO, especially when receiving rewards or airdrops, which will be considered capital gains and subject to corresponding taxes.

(# 2.2.1 Tax Evasion in the Oyster Case

In the Oyster case, the founder exploited a vulnerability in the smart contract to privately mint a large amount of PRL and sell it for profit, but failed to fulfill relevant tax obligations, violating U.S. tax laws.

This case involves a special situation, namely that the founder engaged in minting activities before selling Pearl. There is currently no definitive conclusion on whether the minting of tokens should be taxed. Some opinions suggest that minting tokens is similar to mining and should be taxed. However, 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 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 will have market value, and the income from minting should be regarded as taxable income.

)# 2.2.2 The tax evasion behavior of the Bitqyck case

The tax evasion behavior in the Bitqyck case involves false promises to investors and illegal transfer of raised funds. The founders did not fulfill the promised investment returns and used 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 benefits.

According to U.S. law, both legal and illegal income are considered taxable income. U.S. citizens must report illegal gains as income when filing their annual tax returns. The founders of the Bitqyck case failed to report illegal income transferred from funds raised through the ICO as required, which directly violated tax law regulations and ultimately resulted in criminal liability.

3. Tips and Suggestions

With the meme coin craze, 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 tax Compliance, which is a key issue.

First, understand the tax responsibilities of issuing meme coins to avoid legal risks. Although issuing meme coins does not directly generate income through fundraising like an ICO, the issuer and early investors should still pay capital gains tax when selling after the meme coin appreciates. Even though anyone can anonymously issue meme coins on the blockchain, this does not mean they can evade tax audits. Complying with tax laws is the best way to avoid risks.

Secondly, pay attention to the trading process of meme coins and ensure that transaction records are transparent. Due to the high speculation in the meme coin market and the continuous emergence of new projects, investors' transactions may be very frequent. Cryptocurrency investors should keep detailed transaction records, especially by using professional cryptocurrency asset management and tax reporting software, to ensure that all purchases, transfers, and profits are traceable, and are accurately classified during tax reporting to avoid potential tax disputes.

Finally, keep track of tax law dynamics and collaborate with professional tax advisors. The tax law systems for encryption assets in various countries are still in their infancy and may undergo frequent adjustments, with key changes potentially directly affecting the actual tax burden. Therefore, meme coin investors and issuers should closely monitor the changes in tax laws in their respective countries and seek professional tax advice when necessary to make optimal tax decisions.

In conclusion, while the meme coin market has a significant wealth effect, it also comes with new legal challenges and compliance risks. Issuers and investors need to fully understand the associated tax risks, remain cautious and vigilant in a complex and ever-changing market, and minimize unnecessary risks and losses.