The tax dilemma of the king of Korean Crypto Assets: The story of Do Kwon's pursuit of billions of taxes

Author: TaxDAO

Do Kwon was once hailed as the "Crypto King of Korea." However, with the collapse of UST and the subsequent legal accusations, this name has become associated with tax evasion and fraud. In May 2022, the South Korean National Tax Service imposed a 100 billion won (approximately $78 million) tax penalty on Do Kwon, the co-founder and CEO of Terraform Labs. As early as June 2021, Terraform Labs had attracted the attention of the South Korean tax authorities for suspected tax evasion. Since his arrest in Montenegro, Do Kwon has been awaiting the final extradition decision. This time, FinTax will discuss the former cryptocurrency tycoon, the once glorious Terraform Labs empire, and the enormous tax penalties faced by Do Kwon.

1. The background of the Do Kwon case

1.1 The Brilliance of Do Kwon and the Rise of Terraform Labs

Do Kwon was born in Seoul, South Korea in 1991. He obtained a Bachelor of Science in Computer Science from Stanford University in 2015 and briefly worked as a software engineer at Microsoft and Apple. However, not long into his job, Do Kwon became disappointed with the lack of 'ambition' in large companies and decided to start his own business. In January 2016, Kwon returned to South Korea and decided to establish his own startup, Anyfi. However, the success of Anyfi is not the story we are going to tell today. A true crypto legend began as he and his university friend Nicholas Platias started researching blockchain technology and eventually decided to establish Terraform Labs. The vision of Terraform Labs is to create a new monetary system, namely a decentralized stablecoin - Terra USD (UST). The birth of UST marks the rise of Do Kwon's Terra empire. However, when laying the foundation for the empire, the then Do Kwon harbored a simple idea: to create the 'most useful dollar possible'.

UST and LUNA are core components of the Terra ecosystem. UST is an algorithmic stablecoin pegged to the value of the US dollar. When minting UST, users need to burn an equivalent amount of LUNA (i.e., a 1:1 exchange). Similarly, when redeeming LUNA, users need to burn the corresponding amount of UST. There is an arbitrage opportunity between LUNA and UST, allowing traders to burn and mint based on the incentive for profit when the price of UST or LUNA deviates from $1. This ensures the stability of the UST price through the price-supply relationship. This also means that UST does not have collateral support from external assets, but maintains its price stability through market supply and demand dynamics and incentive mechanisms. This is the key difference between UST and Tether, USDC, or DAI: UST is not backed by fiat or on-chain assets.

The collapse of 1.2 UST and the escape of Do Kwon

In theory, the mechanism between LUNA and UST should be able to cope with various market fluctuations, but reality is often more complex and cruel. In 2022, the collapse of the Terra ecosystem was due to the failure of this mechanism to effectively stabilize the price of UST in the market panic. When whales dumped UST and the market demand for UST sharply decreased, the price of UST began to deviate from its peg, and the system failed to adjust the supply of LUNA in a timely manner, resulting in a sharp drop in the price of LUNA. As a result, it was not possible to buy back enough UST with LUNA to keep the latter pegged to the US dollar. Eventually, LUNA and UST entered a death spiral of dual collapse, triggering a cryptocurrency market crash. LUNA plummeted from its all-time high of $119.51 to almost zero, losing about $45 billion in market value in just one week. In South Korea alone, about 200,000 investors suffered huge losses, some even losing everything. This unforeseen collapse not only destroyed the once-promising UST, but also left Do Kwon's empire teetering on the edge.

With the collapse of UST, Do Kwon began a 10-month fugitive life. During this period, Korean prosecutors issued an arrest warrant against him in September 2022, and Interpol also issued a red notice. On March 23, 2023, the Montenegrin police detained Do Kwon at the airport for using fake documents. Upon learning of this, federal prosecutors in New York quickly charged him with fraud, including conspiracy to commit fraud, commodity fraud, securities fraud, wire fraud, and conspiracy to manipulate the market, prompting the US Department of Justice to request his extradition from Montenegro. In addition, South Korea and Singapore, both of which have legal jurisdiction, have also requested extradition. At present, although the Montenegrin court has not made a final decision, the possibility of Do Kwon being tried in South Korea is the greatest.

2. Do Kwon faces tax evasion accusations and potential legal responsibilities

In addition to the charge of fraud, Do Kwon and Terraform Labs also face substantial tax evasion accusations. In June 2021, the National Tax Service of Korea initiated a special tax investigation into The Ancore Company, the parent company of Terraform Labs, and Terraform Labs on suspicion of tax evasion. During the investigation, the National Tax Service of Korea discovered that Do Kwon owns 92% of the shares of Terra Singapore, the Singaporean legal entity of Terraform Labs. It was found that this Singaporean company secretly transferred a large amount of profits to the British Virgin Islands (BVI) in an attempt to take advantage of the favorable tax policies in BVI to evade taxes. As the largest shareholder, Do Kwon naturally became the biggest beneficiary of this tax evasion. This tax avoidance strategy is not uncommon. In 2021, Lee Jae-yong, Vice Chairman of Samsung Electronics, was summoned by the South Korean prosecutors for setting up a shell company in BVI to transfer profits, and such overseas tax evasion has always been a key target for the South Korean government to crack down on.

The first step in determining tax evasion should be to clarify jurisdiction. In the case of Do Kwon, although he transferred most of the profits from encrypted assets to a BVI company through the design of the company's equity structure, which greatly reduced the actual tax burden, according to the actual operation principle adopted by South Korea, the company controlled by Do Kwon, although registered overseas, is still engaged in encrypted asset operation activities within the territory of South Korea, and therefore should pay relevant taxes in South Korea.

The criteria for determining tax evasion in South Korea are similar to those commonly used in other countries. The first point is to determine whether there is any tax evasion, that is, failure to declare or underreport income, property or other taxable items; the second point is that the taxpayer knows that they are reducing or evading tax and does so intentionally, because tax evasion is generally not caused by negligence, misunderstanding, or unconscious behavior; the third point is that a certain amount of money must be reached. Based on the details of the case disclosed by the authorities, Do Kwon was aware of the company's equity structure and tax arrangements, and although South Korea has not clearly defined the specific amount of tax evasion, Do Kwon's amount of tax evasion is considerable. Therefore, if the South Korean prosecution can cite legal and sufficient factual evidence, it is almost certain that Do Kwon will be convicted of tax evasion, which means he will face long-term imprisonment and be fined a huge tax penalty of about 100 billion won. If the charges of financial fraud and other behaviors are also proven, Do Kwon will not only be bankrupt, but also spend the most energetic time of his life in prison.

3. Reflection on Do Kwon's Tax Evasion Case: From Crypto King to Convict

In the world of cryptocurrency, the Do Kwon incident is like a bombshell that has triggered a profound reflection on the regulation of cryptocurrency assets, especially tax compliance regulation, in the cryptocurrency industry. A prominent contradiction lies in the fact that, on the one hand, the cryptocurrency industry is full of vitality and has been growing exponentially through bull and bear cycles, creating a tremendous wealth effect that is rare in human history; on the other hand, governments and regulatory agencies of various countries have a relatively mature but traditional set of regulatory rules, attempting to control the cryptocurrency industry. Faced with the emerging phenomenon of cryptocurrency assets, the regulatory measures taken by governments undoubtedly consider maintaining financial order and economic stability, but they may also affect the normal development of the cryptocurrency asset industry. As President Trump criticized former SEC Chairman Gary Gensler, the strict regulatory measures taken by the SEC in the past may have led to a continuous decline in the competitiveness of the United States in the global cryptocurrency and blockchain field. Perhaps for a nascent phenomenon, the most effective help is to observe its changes and intervene cautiously.

From the perspective of tax administration, the tax rules for cryptocurrency assets are not clear enough in various countries, and the continuous innovation in the field of cryptocurrency assets makes the application of relevant rules ambiguous. This objectively increases the tax burden of the cryptocurrency industry, making it imperative to establish a tax framework that is in line with the characteristics of the cryptocurrency industry and is transparent and stable. In fact, Do Kwon is indeed dissatisfied with the South Korean tax system, believing that he bears a heavy tax burden under South Korean tax law. In comparison, transferring profits and wealth to the BVI, known for its zero tax rate, is obviously a more economical choice. However, Do Kwon still overestimates his ability to evade taxes and the investigation level of tax authorities in various countries. In other words, regardless of whether UST collapses, Do Kwon will inevitably be investigated for tax evasion, and the collapse only accelerates the arrival of tax charges. In a sense, for Do Kwon and countless other cryptocurrency tycoons, cryptocurrency assets are not just a symbol of wealth and status, but also a potential restraint. Once they decide to evade taxes or violate other regulatory requirements, these restraints will become real shackles.

Although the tax rules regarding cryptocurrencies are not yet perfect, we still need to pay attention to the current tax compliance issues before the tax rules change to avoid unnecessary penalties and losses. In order to ensure transaction compliance and avoid tax risks, investors in the cryptocurrency field should pay attention to:

First, improve the internal tax management system. For cryptocurrency enterprises, it is imperative to establish a comprehensive, systematic, and rigorous tax management framework. Every aspect, from token issuance and distribution to accounting for various business revenues and monitoring cross-border fund flows, should be considered in terms of tax compliance. By improving internal management systems and audit mechanisms, the accuracy and completeness of tax information can be ensured, effectively preventing potential tax risks.

Second, keen insight into policy dynamics and flexible adjustment of strategies. The cryptocurrency industry is still in its early stages of development, with frequent changes in tax policies and significant regional differences. Investors and enterprises must closely monitor policy dynamics in the field of cryptocurrency taxation by various countries and international organizations, and stay informed of the latest regulatory changes and regulatory trends.

Third, actively leverage professional expertise to enhance compliance levels. The tax issues of encrypted assets are highly specialized and complex. At this time, seeking cooperation with professional lawyers, accountants, or tax advisors familiar with the tax regulations of encrypted assets is a wise choice. These professionals can provide precise tax advisory services, develop personalized tax compliance solutions based on the actual situation of enterprises or individuals, identify potential tax risk points in advance, and provide effective response strategies. At the same time, professional encrypted asset tax declaration software can be used for assistance. This type of software can efficiently and accurately process a large amount of complex transaction data, greatly improving the efficiency and accuracy of tax declaration, effectively avoiding tax risks caused by human errors.