Bitcoins Aand Liability In The Wake Of Recent Silk Road Arrests

Last week's arrests1 of Robert Faiella, an alleged seller on online marketplace Silk Road, and Charlie Shrem, the CEO of the startup BitInstant, marked a recent round in a series of law enforcement actions against what the government characterizes as a "rise in criminal activity"2 by people using the cryptographically-controlled digital currency, Bitcoin.3 The arrests of Shrem and Faiella occurred nearly contemporaneously with hearings by the New York Department of Financial Services to determine how to regulate Bitcoin in the State of New York. More than one source has suggested the timing of the arrests may have cast at least some cloud on the New York hearings on regulation of Bitcoin.

The government has not yet convinced a grand jury to return an indictment against Faiella or Shrem and a preliminary hearing is set in the Southern District of New York for February 26, 2014.4 Faiella and Shrem's cases may raise issues about how to apply federal statutes, including money laundering statutes5 and money transmitting statutes[6, to new forms of digital currency.

At issue in Faiella's case appears to be the liability of those accepting payment for illegal items with Bitcoin. If Faiella's case is to proceed, the government will likely have to show that Faiella had knowledge that bitcoins were intended to promote and support sales of narcotics over Silk Road. The government may have to address similar issues in various other actions alleging illegal sales of narcotics7, firearms and weapons8, stolen credit cards and personal information9, and other illegal items. Prosecutions of people shown to have known they have anything of value representing the proceeds of illegal conduct may not appear too troubling. More specifically, most would agree conventional theories of money laundering allow the government to bring criminal charges for processing Bitcoin transactions that a seller knows involve the proceeds of illegal activity. As a result, the charges against Faiella may not appear too surprising or troubling to most.

Shrem's case, however, presents the more difficult issues of liability of Bitcoin exchangers who are charged with knowledge about suspicious activities of sellers. A criminal prosecution simply for providing a digital currency exchange that could potentially be misused is more problematic than a criminal prosecution against a seller, because any form of exchange is potentially subject to abuse. Such prosecutions may potentially...