Bitcoin and Illegal Activity: Silk Road Defendants Pled Guilty on September 4, 2014
On September 4, 2014 in the Southern District of New York, Charlie Shrem, the CEO of “Bitinstant.com,” a Bitcoin exchange company, and Robert Faiella, “Silk Road Dealer” pled guilty to operating an unlicensed money transmitting business. This federal charge carries a maximum sentence of five years in prison. Silk Road was an online black-market website focused on illicit and anonymous narcotics sales, until shut down by law enforcement in the fall 2013. Bitcoin, virtual currency, was the only form of payment accepted on the website. From December 2011 to October 2013, Shrem and Faiella exchanged approximately $1 Million in cash for Bitcoins for the website users so that those users can, in turn, buy and sell narcotics through the website. Faiella ran an underground Bitcoin exchange platform under the username “BTCKing.” Faiella used Shrem’s company to fill his orders and Schrem never filed a Suspicious Activity Report (SAR) with the Department of Treasury. Both men admitted to U.S. District Judge Jed S. Rakoff that they knew that the Bitcoins would be used for narcotics transactions. Their sentencing hearing is scheduled for January 20, 2015.
The currency landscape changed in 2009 with the emergence of Bitcoin, a virtual currency. Bitcoins are decentralized, unregulated, and anonymous by nature. Bitcoin is peer-to-peer traded currency and involves no middle man, i.e. banks. Coins are issued through “mining” to users who solve difficult mathematical problems. Supporters of Bitcoin view the new digital currency as an alternative form of payment free from government interference and manipulation. Critics of Bitcoin and other virtual currency argue that the digital money, due to its anonymous nature, is likely to be used for illicit activities. Director of National Intelligence, James Clapper, in his Worldwide Threat Assessment earlier this year, identified the risk of virtual currencies to be a vehicle for criminal financing. In the summer of 2014, the Department of Defense issued a statement that “virtual currency will likely shape threat finance and terrorist attacks.” Recently, in an ISIS (Islamic State of Iraq and the Levant) blog post suggested that the terrorist organization will begin to use Bitcoin to finance their terrorist activities.
Bitcoin and other virtual currency must be subjected to common sense regulation to ensure that it is being used in a lawful manner. The recent Silk Road prosecution is just the beginning of virtual currency/criminal use investigations and prosecutions. Until Silk Road, law enforcement was left in the dark as to how Bitcoin could be used in an illegal manner. Virtual currency is only going to grow and permeate our society in the future, but it will be inevitably changed to minimize the risk of illegitimate use. In March 2013, FinCEN, an arm of the Department of Treasury, issued a regulation requiring Bitcoin exchange companies to register as money service businesses under the Bank Secrecy Act. This exposes Bitcoin exchange companies to some of the same recordkeeping requirements imposed on banks and other financial institutions to detect and deter the flow of illicit funds. Bitcoin exchange companies are now required to file Suspicious Activity Reports (SAR). States are now joining the regulatory bandwagon and proposing their own regulations for virtual currency. In July 2014, the New York Department of Financial Services published their proposal, “BitLicense,” which establishes a regulatory framework for the operation of Bitcoin companies in New York. These regulations aim to prevent the use of Bitcoins for criminal and fraudulent activity by removing the layer of anonymity. In the coming next year, it will be interesting to see how states will begin to take the lead in proposing and implementing their own regulations on the virtual currency.