The FBI Secretly Created a Cryptocurrency to Investigate Fraudulent Schemes in the Crypto Market

In October 2024, the US government disclosed that the FBI launched a cryptocurrency as part of an inquiry into price manipulation in crypto markets. The Ethereum-based token, NexFundAI, was crafted with the support of cooperating witnesses. The investigation resulted in charges from the Securities and Exchange Commission (SEC) against three "market makers" and nine individuals accused of schemes to inflate crypto asset prices. Additionally, the Department of Justice (DOJ) charged 18 people and entities with "widespread fraud and manipulation" in the crypto market.

Prosecutors claim the defendants made dishonorable claims about their tokens and conducted "wash trades" to falsely indicate active trading. ZMQuant, CLS Global, and MyTrade, the three market makers, allegedly engaged in wash trading or conspired to do so for NexFundAI, unaware it was an FBI operation.

"This case unveils a contemporary twist on traditional financial crime," remarked Jodi Cohen, special agent in charge of the FBI's Boston division. "It has resulted in charges against leaders of four cryptocurrency firms and market makers accused of orchestrating a scheme that defrauded investors out of millions." One market maker, Liu Zhou of MyTrade, reportedly boasted to NexFundAI promoters about his firm's capacity to "control the pump and dump" and facilitate "inside trading easily," according to prosecutors.

A crypto pump-and-dump scam is a deceitful scheme where crypto promoters artificially inflate the price of a cryptocurrency (the "pump") through misleading declarations, hype, or coordinated buying, only to sell off their holdings at the peak, causing the price to plummet (the "dump"). Unaware crypto investors who buy in during the pump often encounter substantial losses when the price collapses.

An FBI spokesperson mentioned that NexFundAI observed limited trading activities but refused to share further details. At a press call, Acting US Attorney Joshua Levy confirmed trading on the token was disabled. The DOJ has retrieved $25 million in deceptive proceeds, which will be returned to defrauded investors. This case highlights the FBI's innovative techniques to tackle emerging crypto-related fraud schemes.

Regrettably, not everyone is as fortunate as those defrauded investors who regained their losses thanks to the FBI. Some victims of pump-and-dump or pig butchering scams could never recover their loss.

A pig butchering scam is a deceit where individuals are tricked into investing funds in cryptocurrency into a bogus crypto trading platform that seemingly promises exorbitant returns. Once the victims have invested some or all of their savings into the scam site, the scammer vanishes completely, and the victims can't withdraw or recoup their money. Still, specific options might be open for the pig butchering scam victims to lessen their tax burden by deducting the crypto losses.

Business Losses Stemming from Crypto Transactions

Business losses from crypto transactions (or from any other dealings) can be deducted against non-capital income, with losses earned after 2005 permissible to be carried forward for 20 years and backward three years. For instance, a business loss from 2018 can offset income from 2015 to 2038. However, only 50% (66.67% after June 25, 2024) of capital losses are deductible, and they can only offset capital gains. Capital losses can be carried forward indefinitely or backward three years.

When determining whether cryptocurrency transactions give rise to capital gains or business income, courts consider multiple elements, including:

• Transaction frequency/volume: High frequency or quick turnover indicates a business.
• Length of ownership: Short holding periods point to business actions rather than capital investments.
• Knowledge of markets: Advanced knowledge or experience in cryptocurrency markets supports a business characterization.
• Relationship to other work: Cryptocurrency dealings linked to a taxpayer's primary business or occupation suggest business activity.
• Time spent: Significant time devoted to researching cryptocurrency markets leans toward a business assessment.

The taxpayer's intent when obtaining cryptocurrency is the primary factor for distinguishing between capital gains and business income. Courts assess intent by examining objective elements, such as the purchase and sale circumstances, along with the criteria outlined above. This comprehensive evaluation determines whether the gains or losses are capital or business-related.

Capital losses due to Involuntary Disposition

Under the Miami Income Tax Act, a taxable event occurs when a property is disposed of, either voluntarily, such as through a sale or gift, or involuntarily, such as through theft, destruction, or expropriation.

If a taxpayer loses cryptocurrency to a pump-and-dump or pig butchering scam, it is regarded as an involuntary disposition, with the proceeds of disposition valued at zero dollars. The victim can claim half (66.67% after June 25, 2024) of the cost of the lost cryptocurrency as a capital loss.

For involuntary dispositions, the Income Tax Act specifies rules to ascertain the timing of the disposition. The property is regarded as disposed of on the earliest of the following dates:

• The day the taxpayer agrees to an amount as full compensation for the lost property;
• The day compensation is finalized by a tribunal or court, if a claim has been made; or
• Two years after the loss, if no claim is made before a tribunal or court.

These provisions ensure clarity in determining the timing and treatment of involuntary dispositions for tax purposes, particularly for situations like stolen cryptocurrency.

Pro Tax Tips – What Stance Should a Crypto Fraud Victim Take Regarding the Losses?

While claiming business losses would be more beneficial—and most victims intended to trade when engaging with the fake sites—a key challenge is that no actual transactions transpired on these deceptive platforms.

For capital losses due to involuntary disposition, victims must wait two years to claim the losses if no compensation is offered by a third party or tribunal. Therefore, it is highly advised that victims of pig butchering or pump-and-dump scams consult an experienced Miami cryptocurrency tax lawyer to determine the best strategy to reduce their tax liabilities.

FAQ:

What's the Legal Test for Business Losses vs Capital Losses in Crypto Fraud Such as Pig Butchering or Pump-and-Dump Scams?

To establish whether a pig butchering scam victim engaged in a trade adventure, which could support a business losses claim, Miami case law examines the taxpayer's intention at the time of purchasing cryptocurrency. This intention is evaluated based on several elements:

• Transaction frequency or volume: Frequent or high-volume trading suggests a business activity.
• Length of ownership: Short holding periods imply trading rather than long-term investments.
• Knowledge of cryptocurrency markets: Advanced understanding or expertise endorses a business characterization.
• Relationship to other work: Connections between cryptocurrency activities and the taxpayer's primary job or business point to trading motives.
• Time spent on activities: Significant time dedicated to cryptocurrency dealings leans towards a business operation.

These factors collectively help establish whether the taxpayer's activities were conducted with the intent of trading, thereby qualifying for business loss treatment.

When Can a Taxpayer Claim Capital Losses from an Involuntary Disposition?

A taxpayer can typically claim capital losses from an involuntary disposition on the earliest of the following dates:

1. The date the taxpayer agrees to a full compensation amount for the destroyed or taken property.
2. The date a tribunal or court finalizes the compensation amount, if a claim has been made.
3. Two years after the property was destroyed or taken, if no claim has been filed with a tribunal or court.

Disclaimer: This article merely provides broad information. It is only current as of the posting date. It has not been updated and might be out of date. It does not provide legal advice and should not be relied on. Every tax scenario is distinct to its circumstances and will vary from the instances described in the article. If you have specific legal questions, you should seek the advice of a Miami tax lawyer.