On November 9, 2016, Washington, DC, woke to gloomy rain and the news that a political outsider, Donald J. Trump, would be the next president of the United States. Financial markets shuddered; futures contracts for major stock indexes traded 5 percent lower, and the price of oil fell. Gold, traditionally a haven in times of turbulence, ticked up. So did bitcoin, which rose 3 percent on news of Trump’s election. For bitcoin boosters, that small price jump would be the only good news about cryptocurrency to come out of Washington for the next three years.
On the other side of the country, David Utzke, a decorated special forces veteran based in California, was creating trouble for bitcoin. After serving overseas with the US Army and Navy, Utzke had sought a new way to serve his country when he got home. He found it with another fearsome organization: the Internal Revenue Service. Now forty-something, with perfect teeth and rigid posture, Utzke was scouring the globe for tax cheats.
Many people regard the IRS as an agency of gnomish bean counters who spend all day hunkered over tax returns. Fewer know that the agency also outfits a formidable law enforcement division that employs people like Utzke—accountants with badges and guns—who train at the same school as agents from the FBI and the DEA.
The IRS was one of the agencies that had quickly grasped the criminal potential of cryptocurrency. One of its special agents, Gary Alford, helped break open the federal investigation into the Silk Road crime bazaar. Alford has a strange habit—he always reads documents three times—but this idiosyncrasy paid off when, on one of his triple readings, he recognized a connection between a Gmail address and the Dread Pirate Roberts, the anonymous mastermind of the Silk Road. Alford’s discovery led the Justice Department to identify and convict Ross Ulbricht, aka the Dread Pirate.
Alford’s colleague Utzke had foreseen the rise of digital money way back in the 1980s and chose a novel concentration of studies in college—economics, forensic accounting, and computer science—in anticipation of something like bitcoin arriving one day. At the IRS, as the crypto markets picked up steam in early 2016, he embarked on an investigation of crypto tax evasion. This entailed an electronic search of all IRS returns between 2013 and 2015 to determine how many included a Form 8949—used to declare capital gains. Utzke then filtered those millions of filings to identify anyone who reported “property likely related to bitcoin.” He found only 802 such filings. That was the number of Americans who had reported gains or losses related to bitcoin the previous year.
That word property was key. In 2014, the IRS issued a statement designating cryptocurrencies like bitcoin as property, not currency. Owning bitcoin was just like owning a house or shares of Apple stock. If the price went up and the owner sold her shares, she would pay Uncle Sam under capital gains rules—typically about 10 percent of the profit. If the owner held onto the property for less than a year before selling it, it would be classified as a short-term gain and the resulting tax would be higher. Bitcoin’s legal status as property also meant that using it to buy anything, even a cup of coffee, could trigger a tax obligation. For someone like Olaf, who lived on bitcoin for several years, a strict interpretation of the IRS rules would result in an unending tax nightmare.
Utzke looked at his findings again. That number, 802, was shockingly small given that millions of US citizens reportedly owned bitcoin wallets and, according to his calculations, there had been over $10 billion in bitcoin transactions in 2015 alone. The more he looked into who was using bitcoin, the more sure he was that digital currency was a vector for tax evasion.
Utzke decided to squeeze a tax cheat who was already facing criminal charges to tell him more about bitcoin. This person had evaded taxes by using shell companies to funnel money into foreign brokerage accounts, and then back to the United States via withdrawals at ATMs. The tax dodger told Utzke this scheme had become a bother and that he found bitcoin provided an easier way to duck the IRS. Instead of sloshing money through different companies and accounts, he converted the cash into bitcoin, then bought cars, boats, and other items he could flip for dollars.
Utzke also discovered other bitcoin buyers who used less blatant but equally illegal ways to cheat. These included two companies whose accounts treated bitcoin purchases as technology expenses so as to classify them as tax deductions—the equivalent of trying to write off the purchase of gold bars or Euro notes as a business expense. When confronted, these two companies would be in for a world of hurt. And so would Coinbase. Utzke discovered, unsurprisingly, that the two organizations had bought their bitcoin through Coinbase.
Coinbase, unlike most bitcoin sellers, had something the IRS wanted very much and few others in the bitcoin world had: a detailed profile of every one of its customers, including their name, home address, date of birth, and much more. These records would make it easy for the IRS to compare a list of Coinbase customers who had sold bitcoin against the agency’s own records to see who had failed to pay taxes.
From the outset, Brian had set out to make Coinbase the law-abiding good guy amid an industry rife with scams and scoundrels. Board member Chris Dixon had even taken to calling Coinbase “the white knight of crypto.” Now, ironically, the white knight’s decision to comply with “know your customer” laws had made it easy pickings for the IRS’s first major investigation into cryptocurrency—even as the more renegade exchanges, which operated in secrecy and skirted banking laws, avoided scrutiny.
Utzke’s investigation produced a subpoena that landed at Coinbase in late 2016 like a grenade. Company lawyers showed it to Fred shortly before he left Coinbase. Normally unflappable, Fred groaned, “Oh shit, this is serious.” There was no running through a brick wall built by the IRS. They brought the letter to Brian.
The subpoena was a nightmare they’d have had a hard time imagining but for the fact they were looking right at it. The IRS wasn’t after the account information of a few tax cheats it had been tracking. It wanted the identity of every Coinbase customer who had sold bitcoin—more than five hundred thousand of them—and every attendant piece of personally identifying information about them, including any email they might have sent to Coinbase as well as all power of attorney letters they executed with Coinbase. This was shaping up to be the Spanish Inquisition of tax investigations.
The subpoena meant hell two times over for Coinbase. First, the burden of rounding up and printing the details of half a millioncustomer records to send to the IRS would require Coinbase staff to burn hundreds—possibly thousands—of hours on paperwork rather than building out the company’s crypto services.
The second hell was the reputational scorching Coinbase would likely have to endure. From the start, Coinbase’s notion of centralizing keys and accounts had been problematic for the bitcoin purists, who viewed the tech as antiestablishment, anonymous, and a way to break power structures. Many of them had blamed Coinbase for betraying bitcoin’s libertarian values. Those values called on individuals to trust no central authority and rely instead on cryptographic private keys to guard their stashes. Their knock on Coinbase came in the form of a taunt—“not your keys, not your coins”—a dig at the company’s practice of storing its customers’ bitcoin for them. Now, if the government scooped up five hundred thousand Coinbase customer accounts, it would prove the critics right. Coinbase would be despised for selling out its users’ privacy. Given the vitriol, including death threats, hurled at the company during the block-size debates, it was hard to fathom how Coinbase would come through this.
Faced with crushing heaps of paperwork and a PR catastrophe, Brian did the only thing he thought he could do. He said no to the IRS. In a blog post, Brian said the likes of Citibank or PayPal or Charles Schwab would never go along with such a request from the IRS—and there was no way Coinbase would either. Bracing for millions in legal bills, the company filed to quash the subpoena as illegal and invasive.
“Asking for detailed transaction information on so many people, simply for using digital currency, is a violation of their privacy, and is not the best way for us to accomplish our mutual objective,” Brian wrote.
A two-year legal battle yielded some wins. Coinbase persuaded a judge to winnow down—though not quash—the subpoena. In the end, the IRS won the right to obtain limited records on more than thirteen thousand of Coinbase’s biggest customers—those who had done over $20,000 in business or conducted more than two hundred transactions in a year. Coinbase also provided 1099-K forms to large customers, a practice that mirrored what brokerages like Fidelity have long done. Neither Coinbase nor its customers were particularly happy with this outcome, but there was a silver lining: the legal fight would help bring Coinbase and other crypto companies closer to the world of mainstream financial institutions.
• • •
While the IRS had declared bitcoin was property, officials at the SEC were deliberating over whether it was technically a security, a tradeable financial asset. Meanwhile, at the Treasury Department, the Financial Crimes Enforcement Network treated it as a currency. And yet another agency, the CFTC (Commodity Futures Trading Commission), said bitcoin was a commodity, which would mean it was a good or a service. These technicalities could be mind-numbing, but they also meant a legal minefield for the emerging crypto industry.
Ironically, in the course of trying to classify and put checks on bitcoin, the US government also become one of the biggest owners of it. As a result of the Silk Road takedown, the FBI had seized around 150,000 bitcoin from the site’s mastermind and then sold them off for millions of dollars in a series of auctions run by the US Marshals Service. Meanwhile, the Bureau of Alcohol, Tobacco, Firearms and Explosives, the Drug Enforcement Agency, the Secret Service, and others began confiscating crypto in the course of their investigations. Some of the bitcoin ended up in the hands of the Marshals, while other stashes simply went missing. The US government couldn’t keep track of its own bitcoin—even as it was creating a regulatory ordeal for everyone else who touched the currency.
And that was just the feds. State regulators wanted a say too. The New York Department of Financial Services, jealously guarding its role as watchdog of Wall Street, dumped another load of paperwork on the crypto sector in the form of licensure. Any company that wanted to deal crypto in the Empire State would have to obtain a so-called Bit License—a process that cost over $100,000 and could take years to complete. This bureaucratic hellhole stank of revolving-door politics. The powerful official who created the license, Benjamin Lawsky, soon quit the Department of Financial Services and created a consultancy that specialized in—what else?—helping firms navigate crypto regulation. For bitcoin ideologues, Lawsky’s stunt simply reaffirmed their belief about the tyrannical nature of government. “New York is that abusive, controlling ex you broke up with three years ago, but they keep stalking you,” snarled Jesse Powell, the libertarian CEO of the Kraken exchange.
Another influential figure in bitcoin, Erik Voorhees, was even less impressed. Voorhees had developed one of the first bitcoin applications, a gambling game called Satoshi Dice, and ran a company called ShapeShift that let customers exchange one type of crypto for another. Even by libertarian standards, Voorhees was a radical. His political passions included the Free State movement, a campaign to persuade tens of thousands of people to move to New Hampshire. Their influx into that low-population state, the Free Staters hoped, would allow them to create a stronghold for antigovernment zealots. Many in the movement also promoted bitcoin as a way to subvert the state’s control over the money supply. Voorhees watched what was unfolding in New York with dismay. “Bit License is officially law in New York today,” he tweeted. “Shed a tear for freedom, capitalism and innovation. Then comply, citizen.”
Not everyone in crypto circles shared Voorhees’s views, of course. Many others, including Brian, hoped thoughtful, careful regulation could bring stability to the crypto markets and help it become even more mainstream.
Unfortunately, the emerging US regulatory regime for cryptocurrency was not providing stability, but instead wrapping it in red tape. Multiple agencies were still arguing over whether this stuff was money or property or a commodity like frozen orange juice. Rules began to multiply from state to state. Navigating the knots of red tape was making markets less stable and slowing crypto’s legitimacy.
Meanwhile, other countries were carving out safe harbors from the US regulatory storms where crypto firms could operate under relative calm. The state of Zug in Switzerland, for instance, created a “Crypto Valley” where firms could experiment with new business models without stepping into a regulatory bear trap. American entrepreneurs and investors began to warn that a generation of crypto innovation could decamp to foreign shores if the United States didn’t dispel its regulatory haze.
Blame could not be put entirely at the feet of the regulators. The IRS and other agencies were simply using the tools they had—and nearly all those tools had been created before bitcoin existed. The regulators were trying to stuff crypto, a new technology, into old legal boxes designed for an earlier era of finance. The situation wasn’t much different from when cars began appearing on American roads. Lacking laws to regulate automobiles, governments in the early twentieth century did their best by adapting rules designed for horses and carriages. In the long run, of course, this proved impractical, and new laws were required to regulate cars.
Coinbase has many of the same backers as Airbnb, Uber, and other Silicon Valley companies that built their business on what some call “regulatory arbitrage”—exploiting regulatory loopholes while also unleashing feel-good PR that includes fluffy phrases like “the sharing economy.” The strategy had worked well for those other startups, letting them grow big enough to fight every court battle and curry favor with politicians. But Brian knew that for the crypto industry to catch a break, it would need new laws. And that meant going to Congress to help lawmakers make good ones. It was time for Brian to go to Washington.
• • •
While Wall Street and the Valley are very different places—as Adam White found out when he met with Cantor Fitzgerald—they do share a zest for free markets and cosmopolitan culture that makes them oddball distant cousins. The Valley and Washington, on the other hand, are about as closely related as a hamster to a hippopotamus. Most people in the Capitol regard the Valley with hostility and suspicion, while most California tech geeks possess a nearly physical aversion to the politics and lobbying that permeate DC (though tech giants like Google and Facebook eventually become adept at the lobbying game themselves).
The Coinbase crew had already made several forays into Washington over the years in an effort to win over lawmakers to the potential of crypto. What they encountered did little to improve their opinion. Juan Suarez, the company’s longtime lawyer, had tried and failed to educate lawmakers about cryptocurrency. “I tried to explain bitcoin to people in DC, but all they would do was ask about Olaf’s eccentric blog posts from three years earlier,” he said, referring to rambling essays written by his former colleague.
Brian had little time for DC-style politics. What was the point of engaging with pols when, in his view, he could use Coinbase to bring economic freedom to a billion people? One exception, however, was his hometown congresswoman, the powerful Speaker of the House and Democratic leader Nancy Pelosi. During a meeting in her San Francisco office, she did not raise her liberal priorities, but instead piled on the charm, telling Brian how much she respected and admired entrepreneurs. Brian could handle someone like Pelosi on Coinbase’s home turf on the West Coast. It was the city of Washington, DC—populated with partisans inflamed by narrow issues and often ignorant of tech—he could do without.
Regardless of Brian’s ease with Pelosi, the IRS investigation and the gathering regulatory storm meant Coinbase had to double down on its political efforts. Brian hired Mike Lempres, a political fixer who had served as associate attorney general of the Justice Department in the 1990s and had worked with President Donald Trump’s future Attorney General William Barr as well as Robert Mueller, who would lead a high-profile investigation into Russian interference in American elections. A fifth-generation son of San Francisco, Lempres has a fluff of white hair around a growing bald spot, but he still projects youth and vigor. At Coinbase, he drew a tough assignment: sell Brian on Washington, DC. After all, if the company wanted to notch a political win for cryptocurrency, sending its CEO as an emissary could be key to its strategy. “I told him, ‘Brian, I hope you like it.’ I want you to be here at least twice a year,” said Lempres, adding ruefully, “he didn’t like it.”
Their joint visit stirred little in Brian besides a strong urge to go back to California. The city’s heat and humidity were oppressive. The DC schmoozing culture annoyed him. He liked people who built things rather than just bloviated about them. This included the US senators he met. One of them, a stalwart of the Democrats, he declared to his Coinbase colleagues, was a “complete and total ass.”
About the only thing he liked about DC was the underground train that whisks members of Congress between different places on Capitol Hill. Other than that, the trip was a bust. Lempres’s hopes of imparting to Brian the ways of Washington went nowhere. On their way back, Lempres recalls, “Brian wanted to solve the whole problem with the SEC on our return flight. He thought it was time to go back to first principles and rethink the whole agency. The thing is that there’s a hundred years of SEC law out there, and they’re not about to change it for him.”
With or without Brian, policy would be made. Slowly, glacially, Washington grappled with cryptocurrency, lumbering toward a plan. Meanwhile, the thriving world of crypto investors was not going to wait for the feds. As Congress dithered, one of the most outrageous financial bubbles in modern history was swelling faster than a new celebrity’s ego.