Friday, February 7, 2014
That development follows late January 2014 reports that New York State plans to regulate bitcoin as a result of the indictment and arrest of two individuals in New York who allegedly employed the cryptocurrency to facilitate the purchase of illicit drugs. All these circumstances underscore the potential hazards of offering bitcoin payments when the ecosystem for it remains volatile and unregulated.
On Feb. 7, 2014, Mt. Gox stopped users from making withdrawals because of a technical malfunction. Only the previous day, Russia had pronounced bitcoin and other virtual currencies illegal.
The resulting 8 percent drop in bitcoin's value mirrors the 40 percent plummet in the value of bitcoin following the early December 2013 decision by China to not allow its network of banks to deal in the cryptocurrency. However, bitcoin's value subsequently bounced back 30 percent.
It was only on Jan. 16, 2014, that the attorney general's office in the southern district of New York reported it had seized millions of dollars in bitcoin from the illicit drug trafficking website known as Silk Road. Additionally, authorities confiscated the personal stash of bitcoin from Silk Road's owner and operator, Ross William Ulbricht.
According to the attorney general, Preet Bharara, about 29,655 bitcoin units (worth approximately $28 million) were seized and an additional 144,336 of the virtual currency (worth over $130 million) were taken from Ulbricht's personal computer hardware.
The bitcoin seizures came in connection with a Sept. 30, 2013, civil action in which all of Silk Road's assets were forfeited to the government, including the website, where only bitcoin was accepted as payment for alleged drug purchases, purportedly because bitcoin users can buy and sell the currency anonymously. Ulbricht is contesting the forfeiture of his personal batch of bitcoin.
On Jan. 24, 2014, Bharara posted criminal indictments against Robert M. Faiella, an alleged underground bitcoin exchanger, and Charlie Shrem, Chief Executive Officer and Compliance Officer of bitcoin exchange company BitInstant. The attorney general said Faiella ran his operation via the Silk Road website from about December 2011 to October 2013, where he allegedly exchanged over $1 million worth of bitcoin in the trafficking of narcotics.
Faiella reportedly employed Shrem's New York City-based company to exchange bitcoin for U.S. dollars. The attorney general said Shrem knew that Faiella's bitcoin transactions were drug related, but did not alert authorities because the high-dollar transactions were lucrative for the company.
Shrem, who was also an executive at bitcoin advocacy group Bitcoin Foundation, was furthermore charged with failing to file suspicious activity reports (SARs) against Faiella's activities.
The Bank Secrecy Act mandates that money transmitters, such as banks, credit unions and money transfer businesses, file SARs to the Financial Crimes Enforcement Network (FinCEN). In March 2013, FinCEN clarified that individuals who mine bitcoin and transact using the cryptocurrency are not subject to the BSA's AML regulations. However, any enterprise whose business involves the exchange of bitcoin is considered a money transmitter by FinCEN and is required to follow its AML policies, including the filing of SARs.
Four days after the attorney general charged Faiella and Shrem, New York State's Superintendent of Financial Services, Benjamin Lawsky, announced that New York would seek to regulate bitcoin service providers, and be the first state to do so. But Internet entrepreneurs Cameron and Tyler Winklevoss, who were investors in BitInstant, released a statement that over regulation of the nascent bitcoin marketplace could cripple the development of the ecosystem for the alternative currency.
An alternative school of thought holds that the nature of bitcoin, as a mathematical value rather than a monetary one, makes it highly resilient to whatever regulations are imposed on it. "The innovative impact of bitcoin is in the protocol that drives it," said Tom Waters, Director of Sales at Bank Associates Merchant Services. "It is a mathematical solution to a logic problem. The driving force behind the growth of the bitcoin ecosystem is not traced to any one person, corporation or political agenda."
Because bitcoin is decentralized, the virtual currency will flourish wherever it is not regulated. "If the innovators who build new technologies around this protocol are prohibitively regulated or policed, the economic progress surrounding bitcoin development will simply shift to less regulated nations," Waters said. "Progress might be delayed, but it will be virtually impossible to stifle or kill altogether."
These characteristics of bitcoin also attract criminals to its use as a money laundering instrument. ISOs interested in offering the bitcoin payment option for merchants must weigh the potential profits from providing bitcoin functionality with its increasingly documented risks.
"Bitcoin is a relatively new technology with many young companies sprouting from its innovative capacity," Waters said. "As time progresses and these new companies demonstrate that they can be trusted, there will be a lot less risk in promoting it as a product. At the very least, ISOs should begin to understand the function and value it provides so they can be prepared to adopt it as part of their suite of services."
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