How Lawful are Bitcoins?

By on January 28, 2014
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Bitcoin’s development as a legitimate currency is being hamstrung by burdonsome regulations, claims New York Superintendant of Financial Services Benjamin Lawsky at the same time as Bitcoin entrepreneur Charlie Shrem faces charges that his invention is linked to the drugs exchange Silk Road and is nothing more than a money-laundering, drug purchase facilitator.

Shrem, the chief executive of the bitcoin company BitInstant and vice chairman of the Bitcoin Foundation, was arrested Sunday at John F. Kennedy International Airport and also arrested was Robert M. Faiella, an underground bitcoin exchanger known as “BTCKing.”

Bitcoin, a cryptocurrency, has been embraced by venture capitalists as much or more than drug dealers and money launderers, however.  They want a digital currency but the law, it appears, is well behind the eight ball on the issue.

Benjamin Lawsky made it clear that some sort of state regulatory guidelines are on the way this year, he told a New York public hearing about the currency on Tuesday.  The hearing is part of a fact-finding investigation started last August “and will allow us to put forth a proposed regulatory framework for virtual currency firms. We believe we’ll be the first state to do that,” Lawsky said.

New York US Attorney Preet Bharara slammed the currency’s use, saying in a statement:
“Truly innovative business models don’t need to resort to old-fashioned law-breaking, and when Bitcoins, like any traditional currency, are laundered and used to fuel criminal activity, law enforcement has no choice but to act.”

The MarketWatch blog reported that Shrem and Faiella were allegedly involved in a scheme to sell more than $1 million in bitcoin to users of the bitcoin-only drug market Silk Road, which was seized by authorities in October. Charges include conspiring to commit money laundering and operating an unlicensed money transmitting business. Shrem, 24, was additionally charged with violating the Bank Secrecy Act, as he allegedly failed to report suspicious activity regarding Faiella’s illegal transactions through his company. The complaint doesn’t list BitInstant by name.

“We are surprised and shocked by the news today. As a foundation, we take these allegations seriously and do not condone illegal activity,” said a spokesperson for the Bitcoin Foundation in an email.

Shrem’s arrest illustrates a tug-of-war between the old and new proponents of bitcoin. Bitcoin is a virtual currency that its proponents have also described as a way to revolutionize payments. The concept was first circulated on a mailing list in 2008. In its early years, bitcoin was often associated activities such as buying banned drugs on the Internet through the website Silk Road. But interest in bitcoin, along with its price, surged in 2013 as bitcoin companies attracted funds from prominent investors, some of whom were involved in early Internet companies. The Senate held its first hearing on bitcoin and other virtual currencies in November that was described as pretty positive for bitcoin, propelling prices above $1,000 in the wake of the event.

The virtual currency isn’t created by a central bank, but instead relies on a process called mining that pits computers against each other in a race to solve cryptographic problems. The correct winners — computers often band together to mine as a group — are awarded a block of bitcoin. The first block of bitcoin was mined in January 2009.

Shrem co-founded BitInstant in 2011 with a $10,000 investment from his mother. Since then, BitInstant raised $1.5 million in a seed round led by Cameron and Tyler Winklevoss in May 2013. Shrem is also the co-owner of the New York City bar EVR, which accepts bitcoins.

Cameron and Tyler Winklevoss issued a statement in the wake of the arrest:

“When we invested in BitInstant in the fall of 2012, its management made a commitment to us that they would abide by all applicable laws – including money laundering laws – and we expected nothing less.  Although BitInstant is not named in today’s indictment of Charlie Shrem, we are obviously deeply concerned about his arrest.  We were passive investors in BitInstant and will do everything we can to help law enforcement officials. We fully support any and all governmental efforts to ensure that money laundering requirements are enforced, and look forward to clearer regulation being implemented on the purchase and sale of bitcoins.”

The New York Department of Financial Services (NYDFS) has already announced that its inquiry might lead to the issuance of a “BitLicense” for virtual currencies. So far, virtual currency exchanges and companies have not officially been deemed by states to be transmitters of money, and have not been required to obtain licenses.

Government officials, however, have argued that the fluctuations in value and the anonymous nature of the virtual currency pose risks.

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