As the price of bitcoin leaps and lurches toward new highs, it seems fitting that the legal regime surrounding it and other virtual currencies is similarly unpredictable. With bitcoin edging its way into mainstream finance, and Coinbase, one of the world’s largest exchanges of bitcoin and other cryptocurrencies, currently holding the top spot on Apple’s free apps chart, U.S. regulators have begun to grapple with how to bring cryptocurrencies and those who use them into compliance with existing and new laws. Though some agencies, like the Securities and Exchange Commission, have chosen a soft entry into regulation by first issuing proactive guidance, others, including the Internal Revenue Service (IRS), have opted to go directly into enforcement actions. A recent decision by the U.S. District Court for the Northern District of California on these actions has brought issues of cryptocurrency account holders’ privacy, anonymity and tax liability onto center stage.

In November 2016, the IRS launched an investigation into underreported tax liabilities for gains from virtual currency. As part of that investigation, the agency served a “John Doe” summons on Coinbase Inc., a Silicon Valley-based crypto exchange that boasts upward of 10 million users and more than $50 billion in digital currency exchange. The sweeping summons, based on what appeared to be only three confirmed cases of tax avoidance, commanded the virtual currency giant to turn over all “information regarding United States persons who at any time during the period January 1, 2013 through December 31, 2015 conducted transactions in a virtual currency as defined in IRS Notice 2014-21.” The IRS specifically requested complete user profiles, addresses, transaction logs, Know Your Customer due diligence records and some third-party communications. When Coinbase refused to comply, the IRS moved to enforce the summons in the U.S. District Court for the Northern District of California.

Under IRS Notice 2014-21 – the only virtual currency guidance the agency has issued to date – virtual currency is treated as “property,” and therefore holders are required to report certain transactions and gains under federal tax laws. After searching its electronic filings for 2015, the IRS learned that only 802 people had declared bitcoin-related gains or losses that year, despite significant appreciation in bitcoin’s value. In issuing the summons, the IRS pointed to the significant discrepancy between the high number of Coinbase users and the low number of tax filings. It argued that Coinbase’s production of its user information was necessary because it “may be relevant to the underlying IRS investigation into the identity and correct federal income tax liability of U.S. persons who conducted transactions in a convertible virtual currency.”

After several rounds in court, the IRS eventually agreed to limit its demand to include only those users who bought, sent, sold or received at least $20,000 through their accounts in any given year in the period between 2013 and 2015. Coinbase, however, argued that even the narrower IRS summons represented an overbroad, illegal intrusion into its customers’ privacy.

In an order issued on Nov. 28, 2017, a magistrate judge further narrowed the summons and ordered Coinbase to comply. Though the court noted that the proposed summons was “broader than necessary,” it permitted the IRS to collect the names, addresses, birth dates, taxpayer IDs and transaction histories of all users meeting the narrowed criteria – a number that Coinbase estimates will exceed 14,000 accounts. While the order concluded that the summons satisfied a “legitimate purpose” and (mostly) sought “information relevant to that purpose” under the Powell test (United States v. Powell, 379 U.S. 48, 57-58 (1964)), questions remain as to the propriety of the process and resulting privacy implications.

Forceful amicus briefs, submitted by Coin Center, the Competitive Enterprise Institute (CEI) and the Digital Currency & Ledger Defense Coalition, challenged the summons on the grounds of privacy, bad faith and improper breadth. Coin Center’s filing argued that while the IRS could scrutinize people holding baseball cards, works of art or any other form of valuable property and find tax evasion, the fact that it chose to target the virtual currency market revealed that the IRS either is embarking on an impermissible “fishing expedition” or believes “all or most convertible virtual currency transactions are made to evade taxes.” The brief also chided the IRS for failing to provide more specific tax guidance, implying that the summons was a desperate attempt to make up for IRS’ own lagging regulations. Further, while the order did not address any countervailing privacy arguments, CEI argued that the disclosure of such information could threaten user autonomy, undermine the security of user PII, chill the freedom of users to transact as they wish, and potentially reveal privileged relationships between users and third parties.

In a company blog post, Coinbase expressed both its disappointment at not being able to “entirely defeat the summons” and its pride in having fought for the rights of its customers, but did not address whether the company would appeal the ruling. If the ruling stands, questions remain as to how other exchanges might be impacted and whether other government agencies might be emboldened to take similarly aggressive action in the cryptocurrency sphere. Given that a major force behind the inception of cryptocurrencies was their decentralized nature, user anonymity and lack of regulation, it remains to be seen whether increasing government pressure toward regulation and disclosure will dampen the appeal of bitcoin and other digital currencies. As bitcoin’s valuation soars, it appears that many users may be willing to trade anonymity for profits. One thing appears certain: As virtual currency and blockchain technology enter mainstream commerce, legal fights over user rights and regulatory compliance are just beginning.