On Monday, January 27, 2013, Charlie Shrem, the 24 year old CEO of BitInstant and Vice Chairman of the Bitcoin Foundation, was arrested for his role operating a Bitcoin exchange service popular among users of Silk Road. Before being seized and shut down by the United States government in October 2013, Silk Road was a hugely popular online black market which allowed users to buy and sell illegal drugs using Bitcoin as the primary medium of exchange. As described in the Complaint against Mr. Shrem, available here, “[t]he illegal nature of the commerce hosted on Silk Road was readily apparent to anyone visiting the site. The vast majority of the goods for sale consisted of illegal drugs of nearly every variety, openly advertised on the site as such and prominently visible on the home page.”
The Complaint against Mr. Shrem presents the underlying facts in excruciating detail. First, the Complaint makes clear that Shrem was the CEO and Chief Compliance Officer for BitInstant, referred to throughout the Complaint as simply “the Company.” Using his position at BitInstant, the Complaint also makes clear that Shrem helped a third party – Robert M. Faiella, a/k/a BTCKing – acquire Bitcoins for purposes of selling them to his own (Faiella’s) customers on Silk Road. The Complaint also alleges, primarily by quoting email exchanges between Shrem and Faiella, that Shrem knew that the Bitcoins he made available to Faiella would be used for unlawful purposes, and moreover that he circumvented the BitInstant anti-money laundering protocols he was responsible for controlling in order to sell Bitcoins to Faiella without raising any red flags.
Unfortunately, there is nothing new about the Shrem case, and at least as far as the technicalities of the legal case is concerned, not at all surprising. Indeed, given the allegations described above, the actual charges make perfect sense. Count One against Mr. Shrem is a violation of 18 U.S.C. § 1960, for operating an unlicensed money transmitting business. § 1960 proscribes the operation of an “unlicensed money transmitting business,” which is defined as:
…a money transmitting business which affects interstate or foreign commerce in any manner or degree and—
(A) is operated without an appropriate money transmitting license in a State where such operation is punishable as a misdemeanor or a felony under State law, whether or not the defendant knew that the operation was required to be licensed or that the operation was so punishable;
(B) fails to comply with the money transmitting business registration requirements under section 5330 of title 31, United States Code, or regulations prescribed under such section; or
(C) otherwise involves the transportation or transmission of funds that are known to the defendant to have been derived from a criminal offense or are intended to be used to promote or support unlawful activity;
18 U.S.C. § 1960(b)(1)(A)-(C).
Although BitInstant had registered with FinCEN is required by section (b)(1)(B) and other provisions of federal law, BitInstant was not licensed by any state, and thus the government likely could have brought charges under § 1960(b)(1)(A). However, such a charge would have raised questions about whether BitInstant was required to become licensed and, if so, in which state(s), so the government appears to have taken the easier approach and pursued its case under § 1960(b)(1)(C). The Government’s § 1960 charge against Shrem describes that the Bitcoins Shrem made available to Faiella were “known to Shrem to have been intended to be used to promote and support unlawful activity, to wit, the operation of an unlicensed money transmitting business on Silk Road…and ultimately narcotics trafficking…”
The question of whether a Bitcoin exchange service like BitInstant can be labelled a money transmitting business may one day prove to be an interesting legal question. For now, the basis of the charge is derived from FinCEN’s March 18, 2013 Guidance Document, “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies.” In FinCEN’s Guidance, FinCEN does not mention Bitcoin by name, but does include a discussion of “De-Centralized Virtual Currencies” which explains as follows:
A final type of convertible virtual currency activity involves a de-centralized convertible virtual currency (1) that has no central repository and no single administrator, and (2) that persons may obtain by their own computing or manufacturing effort.
A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter. By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter. In addition, a person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.
To the extent that Mr. Shrem may ever challenge the § 1960 allegation against him, he may argue that the FinCEN guidance document is not binding or legally enforceable and therefore should not be used in the government’s case against him. He may also argue that the allegation – which turns an exchange service into a transmitter without the presence of a third party recipient of funds – should be dismissed as a matter of law. Whether Shrem will pursue any defenses in court remains to be seen.
Mr. Shrem was also charged for participating with Faiella in a conspiracy to commit money laundering in violation of 18 U.S.C. § 1956(a)(2)(A), which provides that “(2) Whoever transports, transmits, or transfers, or attempts to transport, transmit, or transfer a monetary instrument or funds from a place in the United States to or through a place outside the United States or to a place in the United States from or through a place outside the United States — (A) with the intent to promote the carrying on of specified unlawful activity” is subject to inter alia a twenty year prison term. This provision of the federal money laundering statute requires an international movement of money, and the government’s complaint therefore alleges that when Faiella ordered Bitcoins from BitInstant, Shrem “filled the orders by causing funds to be transferred to an account that Faiella controlled” at Mt. Gox in Japan. This will be a very difficult allegation for Mr. Shrem to defeat.
Finally, Mr. Shrem – BitInstant’s Chief of Compliance – was also charged with wilfully failing to file suspicious activity reports in violation of 31 U.S.C. § 5318(g) and 5322(a), and 31 C.F.R. § 1022.320. Again, given his position at BitInstant and his understanding of Silk Road, we see this as a very difficult allegation to defeat. Worse, with all of these charges, given Shrem’s sophistication and the manner by which he made use of that sophistication, the Federal Sentencing Guidelines do not play in his favor. Mr. Shrem will likely do real prison time here.
When the news about Mt. Gox broke in May of last year, we wrote not only about the case itself (which was primarily based on Mt. Gox’s alleged deception of its U.S. bank, Wells Fargo), we also discussed the widespread media attention it received. Seemingly within minutes of the government executing the Mt. Gox seizure warrant, the story was picked up by Gawker, CNN, PC World, the Financial Times, and a host of underground websites. We commented at the time as follows: “Tragically for this upstart currency, the mainstream will learn of Bitcoin for the first time as a fringe currency under attack by the federal government. Whether Bitcoin will survive this attack and shed itself of the stigma associated with this seizure is a matter for another day and another article. We certainly hope that it does.”
Those who had never heard of Bitcoin before Charlie Shrem was arrested have certainly heard of it now. Once again, seemingly within minutes following his arrest, the Shrem case was picked up by virtually every major news outlet, from Time, to the New York Times, the Wall Street Journal, the Los Angeles Times, the Washington Post, Bloomberg, the International Business Times, Reuters, Wired, and literally hundreds of others. If the mainstream had not heard of Bitcoin after the Mt. Gox story broke or after Silk Road was shut down, it has heard about it now, and the context is terrible.
That said, our concerns about this stigma potentially destroying Bitcoin are different today than when we commented last May. Indeed, in the intervening months, we have spoken with (and in many cases, represented) numerous players in the Bitcoin space and educated ourselves about some of the emerging technology. For instance, we attended the North American Bitcoin Conference last week in Miami Beach and had the opportunity to hear Vitalik Buterin speak about Ethereum, described by Wired as: “an online service that lets you build practically anything in the image of bitcoin and run it across a worldwide network of machines. At its core, bitcoin is a way of reliably storing and moving digital objects or pieces of information. Today, it stores and moves money, but Buterin believes the same basic system could give rise to a new breed of social networks, data storage systems and securities markets — all operated without the help of a central authority.” In other words, Ethereum borrows the concept of the Bitcoin blockchain, but allows users to interact with one another ways that are far more advanced than a typical Bitcoin transaction. We see Ethereum as a “Web 3.0” of sorts, and Buterin’s lecture in Miami Beach was simply mindblowing. We frankly had no idea that the technology – or even the vision of what the technology might someday be – was as far along as it apparently is.
For Buterin’s discussion, we sat next to Jay Postma with MSB Compliance Inc.. Buterin ended his discussion to a standing ovation, and Jay turned to us and said, “this is the future.” We agree. Our chief concern when the Mt. Gox story broke, and even more so when the Silk Road story broke, was that the stigma could prevent Bitcoin from ever being used on a mass scale. But after hearing Buterin speak, we had to change our perspective in two critical ways. First, we need to stop looking at Bitcoin solely as an underground medium of exchange. It is so much more than that. Yes, it is a medicum of exchange, but it is also a cultural movement and radical technological development based upon the idea that people should be able to communicate directly with one another – in customizable language – with neither the involvement nor interference of anyone. And second, we need to stop looking at Bitcoin as meek and vulnerable to the taint that comes with stories like Mt. Gox, Silk Road, and Charlie Shrem. Bitcoin – as a medium of exchange but much more importantly as a totally radical idea of direct communication – is not going anywhere. We need to embrace it and take it very, very seriously.