The tax predicament of the encryption king in South Korea: The story of Do Kwon being chased for hundreds of billions in taxes

Author: TaxDAO

Do Kwon was once known as the ‘Cryptocurrency King’ of South 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 issued a 100 billion won (approximately $78 million) tax penalty to Do Kwon, co-founder and CEO of Terraform Labs, while as early as June 2021, Terraform Labs had come under scrutiny from the South Korean tax authorities for suspected tax evasion. Since being arrested in Montenegro, Do Kwon has been awaiting the final extradition decision. This article will discuss the former cryptocurrency tycoon, the once glorious Terraform Labs empire, and the massive tax penalties facing Do Kwon.

1. The ins and outs 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 earned a bachelor’s degree in computer science from Stanford University in 2015, and briefly worked as a software engineer at Microsoft and Apple. However, shortly after, he became disappointed with the lack of ambition in large companies and decided to start his own business. In January 2016, Kwon returned to Korea to establish his own startup, Anyfi. However, the success of Anyfi is not the story we are telling today. A true crypto legend began when he and his college friend Nicholas Platias started researching blockchain technology and eventually decided to establish Terraform Labs. Terraform Labs’ vision is to create a new monetary system, namely a decentralized stablecoin - Terra USD (UST). The birth of UST marked the rise of Do Kwon’s Terra empire. However, while 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., 1:1 exchange); similarly, when redeeming LUNA, users need to burn the corresponding amount of UST. At this point, there is arbitrage space between LUNA and UST, and traders can, based on the incentive, burn and mint when the price of UST or LUNA deviates from $1, thereby ensuring the stability of the UST price through price-supply-demand relationships. This also means that UST does not have external asset collateral support but maintains its price stability through market supply and demand dynamics and incentives. This is the key difference between UST and Tether, USDC, or DAI: UST is not backed by fiat currency or on-chain assets.

The Collapse of 1.2 UST and Do Kwon’s Escape

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 precisely because this mechanism failed to effectively stabilize the price of UST in the market panic. When whales sold UST and the market demand for UST sharply decreased, the price of UST began to deviate, and the system could not adjust the supply of LUNA in time, leading to a sharp decline in the price of LUNA. As a result, it was impossible to buy back enough UST with LUNA to keep the latter pegged to the US dollar. Ultimately, LUNA and UST entered into a death spiral of dual collapse, triggering a crash in the cryptocurrency market. LUNA fell from its historical high of $119.51 to almost zero, losing approximately $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 flourishing UST, but also left Do Kwon’s empire on the brink of collapse.

With the collapse of UST, Do Kwon began a 10-month-long fugitive life. During this period, South 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 forged documents. Upon learning of this news, 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 U.S. Department of Justice to request Montenegro to extradite him to the United States. In addition, South Korea and Singapore, 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 highest.

2. Tax Evasion Accusations and Potential Legal Liabilities Faced by Do Kwon

In addition to charges of fraud, Do Kwon and Terraform Labs also face allegations of massive tax evasion. In June 2021, the South Korean National Tax Service launched a special tax investigation into The Ancore Company, the parent company of Terraform Labs, and Terraform Labs itself, on suspicion of tax evasion. During the tax investigation, the South Korean National Tax Service found that Do Kwon held 92% of the shares of Terra Singapore, the Singaporean subsidiary of Terraform Labs. It was discovered that this Singaporean company secretly transferred a large amount of profits to the British Virgin Islands (BVI) in order to avoid taxes by taking advantage of BVI’s lenient tax policies. As the largest shareholder, Do Kwon was naturally the biggest beneficiary of this tax evasion. This tax evasion strategy is not uncommon as Lee Jae-yong, vice chairman of Samsung Electronics, was also summoned by South Korean prosecutors in 2021 for setting up a shell company in BVI to transfer profits. Such overseas tax evasion has always been a key target of the South Korean government’s crackdown.

The first step in determining tax evasion should be to clarify jurisdiction. In the case of Do Kwon, although Do Kwon has greatly reduced the actual tax burden by transferring most of the profits from encrypted assets to a BVI company through the design of the company’s equity structure, according to the actual operating principle adopted by South Korea, the company controlled by Do Kwon, although registered outside South Korea, is essentially still engaged in encrypted asset operations within South Korea, and therefore should pay relevant taxes in South Korea.

South Korea’s criteria for determining tax evasion are similar to commonly used criteria in other countries. The first point is to determine whether there is any tax evasion behavior, that is, not declaring or under-declaring income, property, or other taxable items. The second point is that the taxpayer knows that they are reducing or evading taxes and does so intentionally, as tax evasion is generally not caused by negligence, misunderstanding, or unconscious behavior. The third point is to reach a certain amount threshold. Based on the official disclosure of the case details, Do Kwon was aware of the company’s equity structure and tax arrangements, and although South Korea has not explicitly specified the specific amount threshold for tax evasion, Do Kwon’s tax evasion amount is considerable. Therefore, if the South Korean prosecutor can provide legal and sufficient factual evidence, it is almost certain that Do Kwon will be convicted of tax evasion, which means he will face a long imprisonment and be fined a huge amount of 100 billion Korean won. If the charges of financial fraud and other behaviors are also substantiated, Do Kwon will not only lose all his wealth but also spend the prime years of his life in prison.

3. Reflection on Do Kwon’s Tax Evasion Case: From Crypto King to Prisoner

In the world of cryptocurrency, the Do Kwon incident is like a heavy bomb, triggering a profound reflection on the regulation of cryptocurrency assets, especially tax compliance regulation, within the cryptocurrency industry. A more prominent contradiction lies in the fact that, on the one hand, the cryptocurrency industry is full of vitality, experiencing geometric growth despite the ups and downs, creating a rare and enormous wealth effect in human history. On the other hand, various governments and regulatory agencies have a relatively mature but traditional set of regulatory rules, attempting to place the cryptocurrency industry under their control. Faced with this emerging phenomenon of cryptocurrency assets, the regulatory measures of various governments undoubtedly consider maintaining financial order and economic stability, but they may affect the normal development of the cryptocurrency asset industry. As former U.S. President Trump criticized the former SEC chairman Gary Gensler, the strict regulatory measures of the SEC in the past may have continuously reduced the competitiveness of the United States in the global cryptocurrency and blockchain field. Perhaps for a new phenomenon, the most effective assistance is to watch and intervene cautiously.

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

Even though the tax rules regarding cryptocurrency assets may not be perfect, we still need to pay attention to current tax compliance issues before any changes are made to the tax rules to avoid unnecessary penalties and losses. In order to ensure trading compliance and avoid tax risks, investors in the cryptocurrency asset field should pay attention to:

First, improve the internal tax management system. For crypto companies, it is necessary to establish a comprehensive, systematic, and rigorous tax management framework. From the issuance and distribution of tokens to the accounting of various business revenues, and the monitoring of cross-border fund flows, every step should be considered in terms of tax compliance. By improving internal management systems and audit mechanisms, the accuracy and integrity 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 businesses must closely monitor the policy dynamics in the field of cryptocurrency taxation of various countries and international organizations, and timely understand the latest regulatory changes and supervision trends.

Third, actively leverage professional expertise to enhance compliance. 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 encrypted asset tax regulations is a wise move. These professionals can provide precise tax advisory services, tailor personalized tax compliance solutions based on the actual situation of enterprises or individuals, identify potential tax risks 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.