The Internal Revenue Service has dropped the ball on bitcoin and left users with little choice but noncompliance. Agency officials may have been in denial for the past few years, but the weight of criticism from both government and independent watchdogs appears to have jolted them into action.

Their knee-jerk response, however, is thin on introspection and does zero to facilitate legal use of the cryptocurrency. To make up for lost time and cast fear into the hearts of bitcoin users across the country, the IRS is demanding to know the transaction records and identities of every single client from 2013 to 2015 of the largest bitcoin trading platform in the United States.

As reported by Cryptocoins News, Coinbase and its 4.8 million clients are under the gun and staring down a case filed with the California Northern District Court. Senior Revenue Agent David Utzke filed the “John Doe” case, which does not identify a specific suspect, on November 17, and now it is before Judge Jacqueline Scott Corley in San Franciso, where Coinbase has its home office.

“[I am] assigned to investigate tax non-compliance connected with the use of virtual currencies,” Utzke writes. “Although [my Offshore Compliance Initiatives] program typically involves abusive offshore transactions and financial arrangements, the virtual currency issues I have been working on are not limited to offshore activities.”

While other bitcoin exchanges have shied away from the United States, given regulatory concerns, Coinbase readily accepts US customers and has attracted $117 million in startup capital. With ID verification, Coinbase connects the platform to users’ domestic credit cards and bank accounts, so they can buy and trade bitcoin and ethereum, a competing cryptocurrency. Each day, Coinbase customers purchase about $3 million worth of bitcoin.

Although Coinbase has yet to respond with a statement on its website, one of the company’s representatives posted to the bitcoin thread of Reddit, a popular social-media platform:

“We take user privacy very seriously and will work to protect the privacy of our users in broad information requests. We are taking a very careful look at this petition and the scope of the government’s authority as it relates to this request.”

They added with a comment to Politico that although their “general practice is to cooperate with law enforcement, [they] are very concerned with the indiscriminate breadth of the government’s request.”

That has done little to quell fears among Coinbase users, and prominent bitcoin-analyst Tone Vays says that he warned people against ever connecting government identification to bitcoin usage.

Juan Llanos, a cryptocurrency compliance advisor, believes the IRS is very likely to prevail in the case: “It’s been almost three years since the IRS came out with its policy on virtual currencies … plus they were recently slapped on the wrist for their failure to enforce tax compliance”

He foresees two probable consequences, both spelling bad news for Coinbase and “bound to adversely affect the industry”:

The IRS will harvest the data to enable audits of individuals holding cryptocurrencies. The IRS will scrutinize Coinbase until it finds record-keeping errors, and then subject them to a Bank Secrecy Act investigation.

Llanos says he is not entirely sure if “a broad request such as this one will fly” and adds that “information requests need to be based on probable cause or an underlying existing investigation.” However, he notes an awkward crossover that may tilt in the IRS’s favor: “[The agency] is both the tax watchdog and the enforcement arm of the Financial Crimes Enforcement Network, the US anti-money laundering and [counterterrorism] financing regulator.”

What makes this case so egregious is that it goes after people that the IRS knows are innocent. In the very words of the IRS agent in the court document (PDF), bitcoin users often “have a lack of knowledge of tax requirements and uncertainty over how to report virtual currency transactions.… It may be difficult for individuals receiving income from virtual currencies to determine their tax basis for calculating gains because they may have trouble determining the value of the virtual currency when they first obtained it or in maintaining documentation to determine their tax basis.”

Back in 2014, the IRS released a six-page document (Notice 2014-21), but that was incomplete and did not permit bitcoin to have currency status for tax purposes. The American Institute of CPAs, Coin Center, the Tax Revolution Institute, and most recently the Treasury Inspector General for Tax Administration have all sought clarification and pointed out the many problems with the status quo.

Meanwhile, the technology has continued to prove useful as a medium of exchange, and the market value of bitcoin in circulation is now $12 billion. The industry is maturing, and the IRS acknowledges that in January there were “more than 100,000 merchants globally … accepting bitcoin payments with businesses such as Overstock.com, Home Depot, DirectTV, Dell, Microsoft, Amazon, and Expedia topping the list.”

The IRS may be able to win a battle against Coinbase and its clients, but it will lose the war against bitcoin. As Llanos recently stated on the Gold Newsletter Podcast, the “genie is out of the bottle.” This technology has already proved its worth and is in widespread, decentralized use around the globe, so there is no single head honcho to take down.

The responsibility is thus on the US Congress and the IRS to apply a tax regime that users can comply with. This latest attempt to make an example of Coinbase, if it proceeds without reform, will just foment black-market usage and divert customers to rogue exchanges.