Why the Liberty Reserve money-laundering scandal poses a major threat to bitcoin

May 29, 2013
Obsession
Digital Money
May 29, 2013

Yesterday, the US Treasury charged virtual currency exchange Liberty Reserve in a $6 billion money-laundering scheme. The company, which used its own transferable tokens (Liberty dollars) to move money from anonymous account to anonymous account and in and out of other currencies, highlights bigger problems plaguing the cryptocurrency bitcoin and its exchanges.

Liberty Reserve’s setup isn’t that different from many of the companies being developed to handle bitcoin transactions. And the scandal isn’t the first; just a few weeks ago Mt.Gox, which handles about 80% of the world’s bitcoin exchanges, saw its accounts at Wells Fargo and Dwolla frozen.

Because bitcoin is anonymous and transferrable across borders, it’s bound to be used by criminals, whether they are the desired clientele or not. The Mt.Gox account seizures and Liberty Reserve money laundering indictments suggest that the US government is stepping up its monitoring of virtual currencies:

1. The US government will aim to marginalize virtual currencies

“The Bank Secrecy Act (BSA), as amended and implemented by regulations passed by FinCEN [Financial Crime Enforcement Network], requires a wide-swath of otherwise unregulated financial institutions to register with the government, implement anti-money laundering procedures, keep data, and report certain transactions and other data,” wrote Reuben Grinberg, a lawyer for Davis Polk & Wardwell, in an academic paper on bitcoin in 2011. However, at this point monitoring of money transfers in bitcoin may be more trouble than it’s worth for the US government.

Sidelining the currency altogether might be simpler and more effective. “Under the statute, FinCEN has power to prevent US financial institutions from dealing with institutions that deal with Bitcoin, which would essentially outlaw it in the US,” Grinberg told Quartz in an email. “Previously in interviews I have said that I think it’s unlikely that the US Government would just outright ban Bitcoin. But this action shows that its not impossible. “

2. Old anti-money laundering standards don’t apply

Liberty Reserve was based in Costa Rica, which is not a member of the Financial Action Task Force on Money Laundering (FATF), the international organization that collaborates on anti-money money laundering (AML) rules. And yet, Costa Rican authorities cooperated with the US government (which is a member).

Therefore, “not being located or not operating out of the US is not going to save you unless you are ultra careful not to have any kind of connection to the US market, a tall order,” says Grinberg. For its part, Liberty Reserve allegedly encouraged criminal activity, and made no attempt to keep out US users. Even if it had warned criminal clients not to use its service, the company still could have been subject to US law, particularly if it suspected that its clients were laundering money.

3. Exchanges will have to be decentralized

Liberty Reserve was a centralized operation, making it an easy target for US law enforcement and an easy operation to dismantle. But bitcoin users tend to be anti-establishment and anti-government. If anything, the future of bitcoin probably involves decentralized structures that are difficult for US authorities to target.  For example, services like Open Transactions (reincarnated as Monetas), a decentralized, blind money transfer service, believe that no server or user can ever be trusted.

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