On October 10, 2014, Arthur Budovsky was extradited from Spain to face charges related to his operation of Liberty Reserve, a digital currency platform that was allegedly used by cybercriminals around the world to launder the proceeds of illegal activity. Mr. Budovsky’s extradition and prosecution spotlight an ongoing trend in a world of advancing technology, inter-web dealings, and digital transactions. With new forms of digital currency, such as ApplePay and Bitcoin, popping up at an incredible rate, individuals now find themselves stuck between the need for increased privacy and safety while also looking for protection from the over-criminalization and regulation of our online transactions.
In general, digital currency operates just as its name indicates — it is an online platform or medium for two parties to exchange money directly for goods and services offered. Primarily, consumers can receive Bitcoins in exchange for goods or services, or purchase them through different exchanges. Bitcoins, and other forms of digital currency, can be converted into cash when deposited into special accounts.
Consumers enjoy digital currency because of its faster and debatably more secure characteristics than that of a regular credit card. On the other hand, for merchants and service providers, digital currency directly impacts the bottom line of their business because these transactions bypass the fees generally associated with credit card companies or other payment services (i.e., PayPal, or the standard 2.75% that a credit card company charges a merchant per transaction). Additionally, in terms of security, digital currencies do not tie in personal information to virtual transactions, and thus this system is less susceptible to identity theft or fraud. This last point is one advocates consider the greatest advantage to digital currency marketplaces in light of recent scandals such as the NSA monitoring program.[1] With new technology budding—mainly through smartphone mediums such as ApplePay—supporters of digital currency platforms have a legitimate interest in using a marketplace that disconnects personal information from the actual virtual transaction.
To the contrary, some within the digital currency world have used the latitude and freedom associated with virtual currencies to foster potentially illegal activity. In one of the more notable examples, federal prosecutors focused in on the laundering of digital currency through the Silk Road, an online “black market” for many distinct forms of contraband. A high profile matter is currently underway in the Southern District of New York, where Ross Ulbricht—the alleged founder of the Silk Road—faces charges for, among others, money laundering, computer hacking, and conspiracy to traffic narcotics. In relation to the Silk Road case, the FBI has claimed to recover about 174,000 Bitcoins, equivalent to over $45 billion.
The question of how to regulate digital currencies is a new one, and much will depend on how the government classifies these digital platforms: as currencies, investment securities, or commodities.
At the federal level, the Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) has clarified that digital currencies are subject to laws against money laundering,[2] and that virtual currency exchanges are required to register with the Department. Thus, by not registering with the Department, these platforms may be seen as fostering crime for the purpose of concealing certain unlawful activity from the government, and its operators may be found liable.
The Internal Revenue Services announced that it would treat Bitcoins as property, rather than as a currency, for federal taxing purposes. This effectively requires those transferring and in possession of virtual currencies to legally claim such activity on the appropriate tax forms, in which case the IRS can evaluate the legitimacy of such transactions and the goods or services acquired.
So far, many states have been considering digital currencies as payment systems. This means they are likely going to be governed by states’ money transmission laws (such as those covering both electronic transfer services like PayPal and more traditional mediums like wire transfers). New York has become the first state to propose a set of rules specifically geared towards the regulation of digital exchanges. The proposed rules would require such exchanges, and companies that accept such currencies, to obtain a “BitLicense.” Customers and merchants that simply accept digital currencies would not have to obtain licenses. The proposed rules would also require virtual currency firms to hold as much virtual currency as they owe to customers, hold a bond or trust account in U.S. dollars, provide receipts with every transaction, and comply with anti-money laundering provisions.
The New York Bitlicense campaign was launched earlier this year by the New York Department of Financial Services. The Department has made it clear that it does not intend to request more than one license for digital currency businesses and, in most cases, they will not have to obtain money transmitter licenses. Furthermore, individual Bitcoin or digital currency users will not be affected by the regulation. The comment period on the Bitlicense proposal has officially ended, and the NYDFS plans to issue a new proposal, which will be accompanied by a new comment period that will allow for more feedback from the industry and community.
Mr. Budovsky—having been extradited from Spain—has recently pled not guilty to all three charges: conspiracy to commit money-laundering, conspiracy to operate an unlicensed money transferring business, and operation of an unlicensed money transmitting business.[3] Specifically, federal prosecutors allege that Mr. Budovsky’s Liberty Reserve laundered more than $6 billion for criminals between 2006 and 2013. Essentially, the indictments accuse Budovsky of creating a firm that portrayed a convenient, legitimate, and private money transfer system. Prosecutors say the digital currency laundered the proceeds of credit card fraud, identity theft, investment fraud, computer hacking, child pornography and narcotics trafficking.
Thus, should the government continue forward with the current charges,[4] it will have the burden of proving the elements of the abovementioned crimes. Money laundering—governed by 18 U.S.C. § 1956—requires the government to show that the individual, “knowing that the property involved in a financial transaction represents the proceeds of some form of unlawful activity,” conducts (with intent or knowledge of concealment) the financial transaction which in fact involves the proceeds of specified unlawful activity.
Regarding operation of an unlicensed money transmitting business, 18 U.S.C. § 1960 provides that whoever “knowingly conducts, controls, manages, supervises, directs, or owns all or part of an unlicensed money transmitting business, shall be fined in accordance with this title or imprisoned not more than 5 years, or both.”
As seen with both the money-laundering and conspiracy charges, the government is given the burden of showing that the individual charged acted with the requisite mental state for culpability. Accordingly, one difficulty for enforcement and prosecution of cases involving digital currency platforms—such as Mr. Budovsky’s—will be proving that these defendants were aware that these (potentially massive) platforms were harboring the proceeds of unlawful activity. While the federal government and many of the states consider how to regulate the inevitable technological advancements of the digital age—and specifically those involving digital currency platforms—cases such as that of Mr. Budovsky’s and Mr. Ulbricht’s will provide helpful guidance into the government’s strategy for enforcing and proving that such enterprises were operating for unlawful purposes.
[1] In early 2013, it was leaked to the public that the U.S. National Security Agency has been potentially monitoring everything from emails, videos, photos, stored data, file transfers, login activity and other personal, sensitive online information.
[2] Money laundering is defined as knowingly engaging in a financial transaction with the proceeds of a crime for the purpose of concealing or disguising the illicit origin of the property from governments.
[3] At this time, four of Liberty Reserve’s former employees (seven total were named in the indictment)—Vladimir Kats, Azzeddine el Amine, Mark Marmilev, and Maxim Chukharev—have pled guilty to this conspiracy charge.
[4] The trial against Mr. Budovsky is currently set for fall 2015.
