Funny Money

01.28.14

A Bitcoin Boss’s Bust Spotlights the Cryptocurrency’s Link to Online Drug Sales

A big player in the Bitcoin world was arrested Monday signaling that the Feds don’t view cryptocurrency the same way online users do—especially when it comes to drug sales.

It’s been a rough 24 hours for drug users, Bitcoin aficionados, and multi-millionaire twins played by Armey Hammer in Social Network. In a move heard round the Internet, the well-respected CEO of a Bitcoin exchange, along with a 52-year-old co-conspirator who went by the name “BTCKing,” were arrested and charged with money laundering, as well as operating an unlicensed money transmitting business.

It’s a crime that would have been impossible five years ago, when Bitcoin was just a twinkle in Satoshi Nakamoto’s eye. But today, we live in a brave new world of online drug markets, government-free currencies, and investment opportunities that have the potential to turn 24-year-olds into millionaires--or felons. Here’s what you need to know:

Charlie Shrem is a 24-year-old from Brooklyn who was building a cryptocurrency empire before he had his Bachelor’s. He’s currently the vice chairman of the Bitcoin Foundation--though that will probably change, depending on how his legal problems play out--and a prominent member of the cryptocurrency community.

Quick interpolation on the cryptocurrency community: Bitcoin is an online peer-to-peer based currency that doesn’t have any state backing. As a result, its value can change rapidly. And last year, it skyrocketed. Now there are dozens of competing cryptocurrencies, as well as enormous online (and real-life) spaces for their users to meet and socialize. Shrem was a prime mover in these circles. The Bitcoin exchange he headed, called BitInstant, had enough prominence to draw the eyes and investment dollars of the Winkelvoss twins. Shrem isn’t some troll living in his mom’s basement; he’s the real deal.

And that’s why his arrest is so shocking--imagine if Grover Norquist was locked up for tax fraud. Sam Patterson, author of Bitcoin Beginner: A Step-by-Step Guide to Buying, Selling, and Investing in Bitcoins, explains that Shrem was one of the original Bitcoin pioneers.

“He’s in some ways been an evangelist for Bitcoin,” Patterson adds.

The case is a bit complicated. It goes roughly as follows: The Manhattan U.S. Attorney’s office says Shrem and a co-conspirator are charged with “conspiring to commit money laundering, and operating an unlicensed money transmitting business.” Assuming the federal allegations are correct--and that’s a big assumption, but let’s make it for the sake of argument--this is what happened: Shrem worked in tandem with a 52-year-old from Cape Coral, Fla., named Robert Faiella (alias “BTCKing”) to set up a system that sold Bitcoins to Silk Road users, who then used the currency to buy illegal drugs. If it sounds like something out of The Big Lebowski, that’s because it might as well be.

A bigger question here, though, is how all this will affect Bitcoin’s future.

Silk Road, by the way, is a now-defunct (or, as far as I know, now-defunct) online marketplace that was essentially the eBay of illegal drugs. Users used an IP anonymizer to visit the website, where dealers hawked their wares--just about any narcotic imaginable--which they sold for Bitcoin. Silk Road played an integral role in the development of the currency, since Bitcoin allowed for transactions that were virtually anonymous.

But “virtually” is the operative word in that sentence, as Shrem (allegedly) learned the hard way. The two (still allegedly) sold more than $1 million in Bitcoin to users for drug-procuring purposes. And a press release from the U.S. Attorney’s Office of New York says Shrem also bought drugs on the site, though it doesn’t look like they’re charging him with that as of now.

“Even if people think they’re really covering their tracks and being super secretive, who knows?” says Chuck Grimmett, a web developer and Bitcoin investor who (full disclosure) is a close friend who first told me about the currency.

That’s one of the big takeaways from the Shrem arrest. Bitcoin lets users make transactions with comparatively unparalleled anonymity. But that doesn’t mean it sets Internet denizens up for perfect crimes. Patterson says that though Silk Road was shut down a few months ago, lots of clone sites using the same model have sprung up in its wake. And that raises an interesting legal question: Shrem seems to have believed that just selling Bitcoins on Silk Road wasn’t illegal. He didn’t think it was totally above-board, per Patterson--but he seems to have felt that he was operating in a legal gray area. It looks like the Feds disagree.

“If you were to sell shoes on Silk Road, is that something you’d go to jail for?” asks Patterson. And depending on how this case plays out, that could be a serious query.

A bigger question here, though, is how all this will affect Bitcoin’s future. Its value went down a bit today, but not by an outsize margin; Bitcoin is very volatile, and dips aren’t unusual. The biggest threat to the currency is that users will worry other exchanges are in danger of federal crackdowns if their managers have ties to online drug rings--think of it as the Bitcoin equivalent of a bank run. That wouldn’t be good.

But that seems to be an unlikely result. Based on testimony at a recent Senate hearing, federal law enforcement agents seem to think they have the legal tools necessary to go after people using Bitcoin to sell drugs online. So at the moment, it’s doubtful onerous regulations will hit users. And Grimmett adds that the structure of the case is in Bitcoin’s favor; it’s a hit on online drug rings, he says, rather than a generic Bitcoin investigation looking for a crime.

In a weird way, this story has everything: celebrities, Internet celebrities, drug money, and a Florida Man. How it plays out could have significant ramifications for the future of online currency. The Internet is watching, and—maybe--the future of money and drug crime is waiting.