An Analysis of The Charlie Shrem Arrest: What’s Next For Bitcoin

Monday was certainly not a happy day in the world of virtual currency, Bitcoin in particular.  Bitcoin champion, Charlie Shrem, was arrested at JFK Airport in New York on a criminal complaint charging him in a money laundering conspiracy stemming out of his company’s alleged involvement in exchanging cash for bitcoin, ultimately to be used to purchase illegal drugs on the ill-fated Silk Road website.

What follows are my thoughts and analysis of the government’s case based on what I know at the moment, and my commentary on what Shrem’s prosecution might mean for bitcoin in general.  Perhaps a few might find my analysis and commentary somewhat helpful, given the fact that I am an attorney, a former federal law enforcement official, a virtual currency anti-money laundering specialist /consultant, as well as a college professor of legal studies and criminal justice.

Though Charlie Shrem is certainly presumed “not guilty” until proven otherwise, the criminal complaint is nightmarish from the perspective of anyone that wants to see bitcoin thrive and to be shown in the best light possible.  The government’s unsealed criminal complaint is a far cry from the Charlie Shrem portrayed as a conscientious entrepreneur, co-founder, and AML/BSA compliance officer of a successful and well-known bitcoin exchange.  Instead, the government portrays Shrem as a bad actor, one who consistently and repetitively evaded his responsibilities under the BSA through such unlawful activities as advising a co-defendant how to structure deposits to avoid triggering AML reporting requirements. Not a pretty picture.

Herein lies a question.  If, in fact, Shrem knowingly broke the law, then he should be found guilty and face punishment.  However, where are the money laundering  prosecutions of the Wells Fargos (Wachovia) and the HSBCs of the world?  Where are the prosecutions of the bank officials that facilitated the illegal transactions on behalf of these financial institutions?  I haven’t seen any.  Sure, the government initiated formal proceedings against the banks in those cases; however, all too often they have been disposed of through tidy deferred prosecution agreements and consent decrees.  Certainly, no bank officials to my knowledge have felt the cold steel of the handcuffs and none of them have personally faced criminal prosecution.

Let’s see, how much money did Wachovia launder?  Was it $150 million?  What about HSBC? Billions.  HSBC’s fine, after all, was $1.9 billion.  How much did Shrem allegedly assist in laundering?  According to the criminal complaint, “over $1 million.”  Is this selective prosecution?  Though Shrem’s prosecution smacks of selectively targeting the “little guy” (relative, at least, to the billion dollar banker-criminals), based on the facts presented, the selective prosecution moniker does not pass muster jurisprudentially. Usually for such a defense to be raised successfully, the defendant must show that he was singled-out for prosecution based on a protected status under the 14th Amendment such as race, religion, or gender.  Too bad for us bitcoiners that “Bitcoin entrepreneur” is not included on the list.

From my perch, it looks like just more of the same old government behavior, i.e. get the low-hanging fruit, target industries and individuals with relatively little money and political clout while leaving the big boys to their own devices, wreaking havoc and misery across the planet and its economies while they’re at it.

Now, what does this mean for bitcoin and the overall virtual currency space?  The Shrem arrest and prosecution is certainly not good for bitcoin from the standpoint of convincing legislators and regulators that the industry is prepared to play by the rules.  Sure, cash is utilized in criminal activities everyday and no one is arguing it should be banned or regulated out of existence.  However, that’s not really the issue.  Cash is a known entity.  Let’s face it; though Bitcoin has made tremendous strides and is gaining acceptance by many in the business world, it is still a relatively unknown entity,  High profile arrests like this one do not serve to minimize already existing knee-jerk impulses to relegate bitcoin to relative obscurity through government bans or over-regulation.

Could this prosecution impact the fate of regulations that might be currently under consideration?  Absolutely.  Regulators might well be keen to hear how the industry plans to police itself since one of its own leaders is alleged not to have been so fastidious about following the law.

Banks and Bitcoin…At Odds…Really?

According to the WSJ’s Paul Vigna, Bitcoin faces three major challenges in 2014. “Bitcoin’s Three Key Challenges in 2014,” The identified challenges or “buckets,” as the article refers to them, are regulation, adoption and volatility.  At NCFPS, we are most concerned with regulation. With regard to regulation, though government regulators at the state and federal level are listening closely to Bitcoin advocates and their tone toward Bitcoin, to date, has largely not been hostile and even hopeful, perhaps because, according to a knowledgeable insider quoted in the article, that “Bitcoin really isn’t competition for national currencies-at least not for quite a while.  It can be competition here-and-now for national banking systems.” Therefore, regulators of bitcoin might see an upside to having bitcoin come into its own as a facilitator of payments.  That’s all well and good and could represent a huge boon to the overall economy, while not posing a threat to national currencies–a win-win situation, right?  However, what about the bitcoin can be “competition here-and-now for national banking systems” part of the quote?

Well, an innovative and open mind could rightfully speculate that bitcoin might potentially offer an innovative mechanism through which banks could streamline and integrate payment systems, thus attracting to national banking systems a new type of entrepreneurial clientele and those currently outside the banking system. Right? Not so fast.

Enter J.P. Morgan’s Jamie Dimon. According to the January 23, 2014, WSJ article, “Dimon Disses Bitcoin, and Bitcoiners Diss Back,” Dimon was downright negative about Bitcoin stating the following: “It’s a terrible store of value…[i]t could be replicated over and over.”  The article also notes that Dimon suggested that bitcoin “doesn’t have government backing, and it’s been used by, yes, drug traffickers.” Dimon parted with a salvo that suggested that the end of bitcoin will come when government regulations applicable to virtual currencies are enacted.

If one takes Dimon’s statements to their “logical” conclusion, the government should ban cash (as its commonly utilized by drug traffickers) as well as all types of various and sundry other everyday items that might be used for illegal purposes.  While we are at it, why not get rid of banks? After all, banks do serve as a major conduit for money laundering.

Preposterous? Of course it is.

Equally preposterous, however, is Dimon’s notion that regulation will be the end of bitcoin.  If bitcoin is to ultimately thrive, regulation is what must happen. With regulation comes the legitimacy that would-be financial backers look for.  With regulation comes, at least a sense of, predictability.  Admittedly, when bitcoin regulation begins to appear, the dust will not immediately settle.  Actually, the dust is likely to start flying.  Many new questions will arise precisely because of the regulations.  This, of course, is expected and certainly would be in accordance with the experience in other newly regulated arenas.

Perhaps, regulation is what scares Dimon and his ilk.  London Whale anyone?

Sacramento Kings Crown Bitcoin and the Winkelvoss Twins Court the SEC

Lots of new developments in the bitcoin space hitting the news!  Bitcoin continues, it would seem, almost on a daily basis to be achieving growing acceptance among merchants in a variety of industries.  The other day, it was  Today its the National Basketball Association’s (“the NBA”) Sacramento Kings.  The Wall Street Journal reports that the Kings are poised to begin accepting bitcoin “in return for its products, marking a symbolically important step in the virtual currency’s bid to achieve mainstream acceptance.” “Sacramento Kings to Accept Bitcoin,”

The move by the NBA franchise marks the team as the “…first major professional franchise to accept bitcoin…”  Kings owner, Vivek Ranadive, understands the implications of his move, stating “…bitcoin had reached a tipping point where it had crossed from being a curiosity to becoming a legitimate form of doing commerce.”  Ranadive, “gets it.”  Others in the business world seem to be “getting it” with even greater frequency as days and weeks pass.  My question is does the U.S. government get it, yet?

I’ll be the first to admit that I do not have a special relationship with Capitol Hill and therefore, my finger is not exactly on the pulse of Washington, DC, particularly since I live on the West Coast.  However, following the “Bitcoin hearings” held in Washington late last year, when legislators and regulators listened attentively to virtual currency experts, I have read scant commentary on what might be under consideration, specifically, what may be in store as far as AML/BSA regulatory compliance in the virtual currency space is concerned.

My considered opinion is that only when legislation and regulations are promulgated, specifically directed towards the virtual currency space, will wholesale acceptance among broad swaths of the business community occur.

With that said, Singapore has grabbed the bull by the horns and has set forth some realistic guidance and regulation regarding the taxation of bitcoin in that country. “Indian Bitcoin Operators Resume Services With Caution” Instead of issuing unrealistic outright edicts banning banks from handling bitcoin transactions by third-party payment processors and exchanges (China), or issuing ill-conceived advisories highlighting the risks of Bitcoin (India), Singapore issued an advisory that, according to the article, states that businesses in the business of “buying and selling of the virtual currency will be subject to taxation on the gains made on the sale.  However, if the Bitcoins form part of the business‘ investment portfolio, the tax authority considers the gains from any sale to be capital in nature and not subject to taxation.”  Well, though I’m no tax attorney, this sounds like guidance to me.  True, the guidance itself may raise more than a few more new questions.  That’s ok, as an effort is being made to recognize the validity and reality of bitcoin.  In other words, it is a beginning. Guidance and an overall regulatory blueprint is what must be formulated by governments if bitcoin and virtual currencies are to thrive.

Enter the Winkelvoss Twins. “Lawyer for Winkelvoss Twins‘ Bitcoin ETF Says SEC Review Going Smoothly.” Commenting on their efforts before the SEC to establish a exchange-traded fund and the need for some certainties built into the process, Evan Greebel, the attorney for the Twins states that “Ambiguity is the worst thing,” [quoting from the article] “…noting that it’s one of the factors that’s keeping institutional investors away and that’s making banks reluctant to provide accounts to businesses operating in the bitcoin industry.  He said the Trust is making the case that bitcoin – often referred to as a digital currency – should be treated as a capital asset rather than, say, a currency or a commodity. That means bitcoin investments should be subject to capital gains taxes. Although some of the early enthusiasts for bitcoin might be put off by the arrival of a taxation regime, big institutions will welcome clarity on the taxation status for the new technology, Mr. Greebel said.”

Bitcoin and…the…Mundane?

According to the Wall Street Journal article, “Where’s Bitcoin Going in 2014, and Beyond?,”, dated January 13, 2014, “…bitcoin’s value lies more in its ability to be a mundane facility for people’s daily needs than some spectacular modern gold rush.”  Not only is this true, I would suggest that this is the linchpin that those lobbying in Washington promoting bitcoin and other crypto-currencies should hang their hats on.

Yes, bitcoin is “new.”  Yes, bitcoin is an amazing innovation.  Yes, bitcoin can be misused by money launderers; however, so can cash.  No one on Capitol Hill ever suggests, even under their breath, the prospect of banning cash.  Why?  Because cash is mundane and cash facilitates our existence.  Sure, some of us have a lot more of it than others.  Some of us use it for good, and others use it for nefarious purposes.  One thing is certain, nearly all of us use it.  Most of us use it for perfectly mundane and routine purposes.  One of the major long-term advantages that bitcoin has is that it represents an inexpensive method of facilitating the efficiency of payments and facilitating transactions.  The sooner regulators and those on Capitol Hill are convinced of this fact, the sooner workable AML regulations that are tailored to the realities of the virtual currency environment can be enacted.

New York State To Hold Hearings On Digital Currency Regulations

According to the CoinDesk Blog, “[o]ver-regulation, including a requirement for many digital currency businesses to register as money transmitters separately in all 50 states, is seen as a barrier to entrepreneurship in the US and many of the world’s largest bitcoin businesses are located elsewhere.”  There is no truer statement.  This single regulatory nugget has the potential to significantly stifle innovation in bitcoin, as well as in the cryptocurrency space overall, in the United States.

With that said, I am heartened by the fact that New York State is preparing to hold hearings on bitcoin and the regulation of digital currencies in general.  It is important that New York take a leadership role in the development of digital currency regulations that promote innovation, or, at the very least, do not affirmatively stifle it.

In November, the New York State Department of Financial Services released the following statement about the upcoming hearings:

“Our public hearing will review the interconnection between money transmission regulations and virtual currencies. Additionally, the hearing is also expected to consider the possibility and feasibility of NYDFS issuing a ‘BitLicense’ specific to virtual currency transactions and activities, which would include anti-money laundering and consumer protection requirements for licensed entities.”

Hopefully, New York will ultimately prove to be a leader in fashioning a digital currency regulatory scheme that makes sense and promotes innovation in the cryptocurrency space. We will be following these hearings closely.

Bitcoin Lobbyists Hard At Work

According to Bloomberg, “Bitcoin Woos Washington To Ensure Lawmakers Don’t Kill It,”, lobbyists are out in full force bending politicians’ ears to make sure they understand that the benefits of Bitcoin outweigh any negatives, and that the negatives can be minimized and controlled through a proper regulatory scheme.

Politicians should listen very closely.  If they fail to enact appropriate regulations and,instead, attempt to “kill” Bitcoin, they will be unsuccessful and will only ensure its survival as an underground currency eagerly partaken in by organized criminal organizations and their cohorts.