No. It is not illegal. Here is an excerpt from my manual discussing this:
There is always the question of “Isn’t that illegal, to deface coins?” The law states:
Federal statute 18 USC 331 “whoever fraudulently alters, defaces, mutilates, impairs, diminishes, falsifies, scales, or lightens any of the coins coined at the mints of the United States … shall be fined under this title or imprisoned not more than five years, or both.”
The key word is fraudulent. Because we are not defacing to defraud, there is no concern of legality. We are merely making jewelry, not gold plating a nickel and trying to pass it off as a five dollar gold piece, that is illegal (if gold and silver were still considered money by the Government). Also, by using pre 1965 U.S. silver coins, or foreign coins, there is not a concern due to the ability of melting down these coins for their metal value. An immeasurable amount of U.S. silver coins have been melted down in the past few decades to get to their silver content.