On Tuesday, the authorities in Spain, Costa Rica and New York arrested five people at the digital currency firm Liberty Reserve, including its founder Arthur Budovsky, and seized related bank accounts and Internet domains.
It was a further wake-up call for those involved in digital currencies, such as the most prominent, Bitcoin, that they need to comply with anti-money laundering rules or risk facing a crackdown.
They had already been put on notice – first by an April 2012 report from the U.S. Federal Bureau of Investigation that explained how Bitcoin was being used by criminals to secretly transfer money around the world, and then this March by the U.S. Treasury Department. Its anti-money laundering arm, the Financial Crimes and Enforcement Network (FinCEN) stated that digital currency firms needed to comply with the same anti-money laundering rules as other financial institutions, including monitoring customers and reporting suspicious activity to the government.
As regulators tighten the screws, businesses built around digital currencies are trying to satisfy new monitoring requirements without letting public enthusiasm for the technology-based concept slip away.
“I think the whole ecosystem is maturing very quickly and we have young companies that are just beginning to understand how to navigate the regulatory issues,” said David A. Johnston, co-founder and executive director of BitAngels, a new venture which only this week announced it had raised $6.7 million to fund startups tied to Bitcoin.
Digital currency is electronic money that can be passed between individuals without the use of the traditional banking or money transfer system.
Different currencies are structured in different ways. Some, like Liberty Reserve’s “LR” digital currency, use units of value that are tied to an existing hard currency, such as the U.S. dollar. By contrast, the value of Bitcoin, the best known virtual currency, fluctuates according to supply and demand.
Bitcoin, which has been embraced by a number of venture capitalists in Silicon Valley, exists through an open-source software program that any users with enough skill and computing power can access. It is not managed by a single company or government. Users can buy bitcoins through exchanges that convert real money into the virtual currency.
Liberty Reserve, which was closed last week, however, was a firm that U.S. prosecutors said created a platform that enabled criminal gangs to launder more than $6 billion.
Bitcoin’s supporters cite a host of legitimate reasons for using a digital currency: It can be transferred using less infrastructure than traditional currencies, and with fewer service fees. A virtual currency could also be safer than using a regular credit card for online purchases, because it is not attached directly to any bank account.
But law enforcement officials see Bitcoin as another vehicle for criminals to anonymously transfer money.
FinCEN’s statement in March set off a rush inside the community to learn about anti-money laundering rules and figure out how to comply with them. At the 2013 Bitcoin Conference in San Jose, California two weeks ago, discussion focused heavily on regulatory compliance – its intricacies and its costs.
“That was a big theme of the whole conference,” said Jerry Brito, director of the technology policy program at the Mercatus Center at George Mason University. Brito said businesses exchanging Bitcoins were coming to terms with the fact that they would now need to get licensed as money transmitters in 48 U.S. states, a process requiring in-person interviews in each state, thanks to FinCEN’s guidance.
“Everything I’m telling you, I’ve learned over the past couple of months as I’m racing to learn,” said Brito, who attended the Bitcoin Conference in San Jose. “I think that’s what the Bitcoin community is doing too.”
Charlie Shrem, chief executive of Bitcoin transfer firm BitInstant.com, told the conference about the importance of complying with the new rules.
“You have to know your customer,” he told the audience, according to a video posted on the Internet. “Whether or not you agree with the laws or not, you’ve got to follow them.”
The FinCEN statement means companies that exchange Bitcoins for hard currency must now hire full-time compliance officers to verify the identities of users, especially those looking to transfer Bitcoins out of the digital world and back into dollars or other hard currencies. Estimates vary on how much it costs to get compliant, but licensing and registration fees alone can total in the tens of thousands of dollars, an added heavy cost for small startup businesses.
Brito said the Bitcoin community is also trying to increase its contact with law enforcement and regulators. The Bitcoin Foundation, a Bitcoin advocacy group made up of Bitcoin-related business owners and software programmers, is looking to hire a full-time lawyer based in Washington to make its case to regulators and lawmakers.
Some members of the community are declining to discuss regulation. Jon Matonis, the Bitcoin Foundation’s secretary who is identified on the group’s website as one of two spokesmen for press inquiries, told Reuters: “I am electing to take a brief break from commenting on issues such as this.”
U.S. law enforcement officials are looking first and foremost to unmask criminals operating in cyberspace and arrest them, wherever they may be in the world, and they’re looking to digital currency businesses to help.
Ed Lowery, special agent in charge of the U.S. Secret Service’s criminal investigative division, said the agency is working “aggressively with our international partners” to pursue cyber crime and the companies that permit the misuse of digital currencies. He declined to comment specifically on Bitcoin.
Liberty Reserve has not been the only recent target for the authorities. The Tokyo-based firm Mt. Gox, the world’s largest exchanger of U.S. dollars with Bitcoins, had two accounts held by its U.S. subsidiary seized this month by agents from the Department of Homeland Security on the grounds that it was operating a money transmitting business without a license.
Mt. Gox on Thursday announced it would require all of its users accounts to be verified before allowing them to perform any more deposits or withdrawals. Its founder declined to comment for this story.
Other companies are simply trying to avoid having to comply with U.S. rules by keeping away from the country. Following FinCEN’s statement, two digital currency firms structured similarly to Liberty Reserve – Russia-based WebMoney and Panama-based Perfect Money – restricted access to their services from inside the United States.
Vyacheslav Andryushchenko, a spokesman for WebMoney in Russia, said each of the company’s 20 million users had to agree to prohibitions against money laundering and illegal trade when signing up for an account. Users who violate the rules are cut off, and all actions inside WebMoney’s system are recorded, the spokesman said. A user is blocked if there are any suspicions of anything illegal. In addition, the less personal information the user provides, the fewer services are available to him or her, the spokesman said.
Several messages on the listed number on Perfect Money’s website were not returned. The company’s address is an empty suite in an office block on the northwestern side of Panama City. A secretary in a neighboring office said she had never seen anyone go in or out.
This article was reported by Thomson Reuters and Compliance Complete Journalists. Reporting by Emily Flitter in New York and Brett Wolf in St.Louis.
This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.