IRS Seizure of Crypto Records Sets Up Privacy Rights Showdown
An appeals court will decide whether investors have a reasonable expectation of privacy for information they provide to a cryptocurrency-exchange platform.
An investor’s challenge to the Internal Revenue Service’s (IRS’s) seizure of his cryptocurrency-exchange records has teed up a showdown with the government at the U.S. Court of Appeals for the First Circuit over privacy rights and how the “third-party doctrine” applies in the digital age.
The Boston-based appeals court will consider a question-of-first-impression next month about whether the IRS violated a crypto trader’s Fourth Amendment rights by obtaining his financial information from Coinbase without a warrant. The outcome could affect the government’s ability to tax cryptocurrency profits.
Reed Smith partner Daniel H. Ahn said the case seeks to build on a landmark 2018 U.S. Supreme Court decision, U.S. v. Carpenter. There, the justices said the third-party doctrine—which holds that people have no reasonable expectation of privacy in information they give to banks or other third parties—doesn’t apply when the government accesses cell phone location data without a search warrant.
“The Supreme Court did not apply the third-party doctrine and instead said that doctrine shouldn’t extend to this modern digital age,” said Ahn, a former supervisory federal prosecutor. “How does that all apply here in the crypto context? That’s the issue before the First Circuit.”
Cell Phone Data vs. Exchange Records
The case before the First Circuit was brought by investor James Harper, whose financial records the IRS obtained through a judicially enforced “John Doe summons” asking Coinbase to turn over information on thousands of account holders. John Doe summons, which don’t require a showing of probable cause, direct a third party to surrender information about taxpayers whose identities are unknown to the IRS.
The summons was part of an IRS investigation into Coinbase users underreporting gains in their tax filings between 2013 and 2015. Through it, the government received 14,000 users’ taxpayer ID numbers, addresses, transaction logs, and other information.
Harper filed a lawsuit challenging the IRS’s possession of his records, but a district judge found Harper had no reasonable expectation of privacy when he voluntarily gave his information to Coinbase. On appeal, Harper argues that Carpenter applies.
Cory Flashner, a member at Mintz, said the First Circuit will press Harper’s counsel on whether crypto exchange information reveals a similar level of detail about a person’s life as cell phone data does, and why it’s not akin to bank records that have long fallen under the third-party doctrine.
“A cell phone … has all sorts of information. This [exchange] information just contains financial transactions. It’s not someone’s life. It’s not where they go, where they travel, and what they’re doing,” said Flashner, who is not involved in the First Circuit case. “That’s the distinction that’s gonna be a hard one for [Harper] to get around.”
In Carpenter, the high court noted that cell phones log a person’s location “without any affirmative act on the user’s part beyond powering up” and track “a detailed chronicle of a person’s physical presence.”
Harper argues in briefs that the financial records the IRS obtained are “similarly sensitive and revealing” and private by nature due to how blockchain technology works.
Each cryptocurrency transaction is posted on a public ledger called the blockchain, and the details are confidential because individuals use unique pseudonyms, the brief states. But getting Coinbase transaction logs allows the IRS to learn pseudonyms and gather information about all of a user’s cryptocurrency transactions, even beyond the three-year period covered by the summons, Harper stated in his reply brief.
“In one fell swoop, the IRS effectively collected all cryptocurrency transactions linked to Coinbase transactions, past and future, for Harper and over 14,000 others,” states the brief written by his attorneys with the New Civil Liberties Alliance.
The IRS argues that Coinbase records are no different from bank deposit slips or monthly statements covered by the third-party doctrine, and the confidentiality intrinsic to blockchain technology does not alter the legal analysis.
The two sides disagree on the relevance of a Fifth Circuit ruling from 2020 that touched on the issue. There, federal agents served a subpoena to obtain information from Coinbase about customers who sent cryptocurrency to bitcoin addresses associated with a child pornography website that was under investigation. Richard Gratkowski challenged the government’s use of evidence gathered from the subpoena in charging him with possession of child porn. The Fifth Circuit said Gratkowski had no reasonable expectation of privacy and that the exchange information was not comparable to cell phone data.
Harper argues that the IRS summons is different because it targeted thousands of Coinbase users, while the subpoena in Gratkowski’s case “focused on a single suspect’s transactions with an illegal website.”
The government, in its brief, pushed back against that point, writing: “[Harper] does not explain how the number of persons to which a summons relates has any bearing on the third-party doctrine, given its ‘primary rationales’ of the nature of the information sought and the voluntariness of the exposure of that information to third parties.”
Data Collection Policies
At stake in the case is the government’s ability to quickly identify and tax the profits someone makes off cryptocurrency, said Flashner. But even more broadly, the appeal showcases the continuing struggle courts have had in applying Fourth Amendment precedent to new technologies, he added.
“There’s a difference between a cell phone in your pocket and a notebook in your pocket,” Flashner said. “And there’s a difference between cryptocurrency, which is on a public blockchain ledger, and in learning my pseudonyms and being able to follow those back and understand that public ledger in a much more broad sense. So the law struggles when it has to apply traditional methodologies to emerging technologies.”
Ahn said he expects Harper’s case to partly turn on the facts developed at the district court level about Coinbase’s data collection policies and other information the company asks users for that may differ from what banks gather.
For example, Coinbase’s policy states that the company collects cookies, which are often used to track a person’s browsing history, Ahn said. If the IRS obtained that type of information through its summons, the court may view that as too invasive, added Ahn, who is not involved in Harper’s case.
Ahn said many crypto exchanges also generate analytic profiles about each customer, asking for example what the sources of their funds are for purchasing and trading cryptocurrency or the purpose of the transaction.
“If the IRS’s summons asked for five years worth of information and everything under the sun that the crypto exchange has—including cookies and the risk profile and the source of funds and the purpose of the transaction—then I think we’re maybe in a Carpenter world, where a court will say, ‘This shouldn’t be controlled by the third-party doctrine,’” Ahn added.
From: National Law Journal