Silk Road shakedown: Feds arrest bitcoin exchange founders for alleged dark web money laundering

By Michael Carney , written on January 27, 2014

From The News Desk

Earlier today, news broke that Charlie Schrem, chief executive officer of the exchange, and Robert Faiella, operator of underground bitcoin exchange called BTCKing (alternatively BTC-KinG) were arrested and charged with conspiring to commit money laundering and operating an unlicensed money transmitting business. Schrem is also charged with violating the Bank Secrecy Act by “willfully failing to file any suspicious activity report regarding Faiella’s illegal transactions.” Notably Schrem is also a Vice Chairman of the Bitcoin Foundation, an unofficial bitcoin trade group that aims to “standardize, protect, and promote” use of the crypto-currency.

The charges against the two men stem from their dealings with Silk Road, which US Attorney Preet Bharara describes as “a dark web drug site.” In a press release issued by the US Attorney’s office, and stemming from a multi-agency investigation involving the Drug Enforcement Administration and the Internal Revenue Service, Schrem and Faiella are accused of:

...engaging in a scheme to sell over $1 million in Bitcoins to users of “Silk Road,” the underground website that enabled its users to buy and sell illegal drugs anonymously and beyond the reach of law enforcement.

Faiella allegedly was the one responsible for selling said bitcoins directly into Silk Road, while Schrem allegedly allowed Faiella to purchase bitcoins through his exchange with bulk fee discounts. According to the US Attorney’s statement, Schrem was not only aware of the ultimate destination of the bitcoins he provided, but also was a Silk Road customer, using the secret marketplace to purchase drugs for his own usage. The agencies write:

Shrem knowingly allowed Faiella to use the Company's services to buy Bitcoins for his Silk Road customers; personally processed Faiella's orders; gave Faiella discounts on his high-volume transactions; failed to file a single suspicious activity report with the United States Treasury Department about Faiella's illicit activity, as he was otherwise required to do in his role as the Company's Compliance Officer; and deliberately helped Faiella circumvent the Company's AML restrictions, even though it was Shrem's job to enforce them and even though the Company had registered with the Treasury Department as a money services business.

If convicted, 24-year-old Shrem could face a maximum sentence of 30 years, while 52-year-old Faiella could be looking at up to 25 years. Both men are expected to appear in court today. It’s not uncommon for law enforcement to use tax evasion and money laundering statutes to prosecute alleged drug dealers and participants in organized crime.

Silk Road was seized by the FBI in October 2013 and its alleged creator, Ross Ulbricht, aka Dread Pirate Roberts (DPR), arrested. The Feds seized a total of 174,000 bitcoins, worth more than $140 million as part of the raid and have announced plans to sell the first $25 million worth in the near future. Additional arrests stemming from this case have been widely anticipated, meaning that today's may not be the last. In a potentially related story, Wired reports that the FBI now has a full record of all email correspondence sent through the popular dark web email service TorMail, a favorite among Silk Road users. Whether that fact has any bearing on the case agains Schrem and Faiella remains to be seen.

New York-based BitInstant was at one time one of the largest bitcoin exchanges in the world, but has been plagued by legal issues of late. The company is currently the subject of a class action lawsuit filed in July by users who claim that the company misrepresented its services, specifically the speed of its services and their associated fees. The site has been unavailable, with messages reading that it’s closed for maintenance, since approximately July 13.

BitInstant raised $1.5 million in Seed funding from Winklevoss Capital Management, the fund of famed Facebook litigants Tyler and Cameron Winkelvoss, as well as angel investor David Azar. The Winklevosses, who are believed to be among the largest private holders of bitcoin wealth, issued the following statement to PandoDaily regarding today’s news:

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 Schrem, 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 founder of a prominent bitcoin company provided the following statement to PandoDaily on the condition on anonymity:

I don't know enough to comment too much on [the arrests]. It comes at a strange time with the NY hearings this week, but I think that [Fred Wilson] and [Jeremy Liew] are going to do a great job helping the regulatory bodies and media understand the difference between the bitcoin companies that are working with the government to bring technology that will improve peoples lives to the world, and the companies that are operating for political and ideological reasons without being mindful of the regulatory landscape.

As the founder notes, these arrests come at a pivotal time in bitcoin’s maturation. The perception and adoption of the digital currency and payment protocol has evolved from one of criminality and anti-establishment to that of a potentially world-changing financial innovation. And while many early adopters have resisted this ideological shift, it has coincided with a historic rise in bitcoin value. The last thing the bitcoin community needs is more headlines of impropriety, whether alleged or proven.

The case against Schrem and Faiella is just beginning. The two have yet to have their day in court or to share their sides of the story publicly. Until that happens, it’s prudent to reserve judgement. That said, public perception can be a cruel mistress, something the bitcoin community continues to learn the hard way.

[Image via antanacoins, Flickr]