The coin prince: inside Bitcoin’s first big money-laundering scandal (from TheVerge)

charlieshrem

By Adrianne Jeffries and Russell Brandom

 A week ago, 24-year-old Charlie Shrem landed at JFK, home from giving a talk about the virtual currency Bitcoin at an e-commerce convention in Amsterdam.The trip had gone well. Shrem’s speech made the front page of the DutchFinancial Times, his Icelandair flight had internet, and he was excited to be reunited with his girlfriend, Courtney. He did not expect to be arrested when he got off the plane. But as soon as he saw the agents from the Drug Enforcement Administration and IRS waiting for him at the gate, he knew.

Whatever the trouble was, it must have something to do with Bitcoin.

Shrem had never been arrested before, but a magistrate detailed a list of felony charges against him the next morning: one count of conspiracy to commit money laundering, one count of failure to file a suspicious activity report, and one count of operating an unlicensed money transmitter, together carrying a maximum sentence of 25 years in prison. Bail was set at $1 million.

The glamorous life Shrem had been building for the past two years suddenly seemed poised to fall apart.

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Shrem is 5 feet 5 inches tall, full-bearded, and high-energy. He’s the kind of guy who likes to party and loves to organize events, but also goes to his parents’ house every Friday night for dinner. He started investing in Bitcoin as a senior at Brooklyn College, buying “many thousands” when the coins were around $3 or $4 each (they’re now over $800), but his notoriety didn’t come until BitInstant, the Bitcoin payments company he cofounded that was profitable almost from day one.

The first glimmering of BitInstant came on June 13th, 2011, when a part-time student named Gareth Nelson posted his idea for a fast pay service on the forums at Bitcointalk.org. At the time, buying and selling Bitcoin on major exchanges like Mt Gox could take as long as six days, in part because many banks take days to process transfers. Nelson thought he could speed this up by fronting the balance, then collecting a small fee for the trouble, enabling customers to receive their bitcoins on the same day even if they were using cash. Because Bitcoin transactions are irreversible, there was basically no risk. All he needed was some startup capital. “PM some more info,” Shrem wrote back. “I could work with you.”

In those heady early days of the Bitcoin gold rush, legal compliance was most often an afterthought. “Be careful and check with a good lawyer first,” one Bitcoin user advised Nelson. “You would probably be considered a money transmitter if you do this.”

Nelson, who had some experience with virtual currency in a previous venture, brushed this off. “What I’ve read up on the matter seems to suggest that I don’t need a license,” he wrote back. “I’ll look over the … rules again and seek proper legal advice on whether this may be an issue, but I truly believe it will not be.”

“HE WAS LIVING THE ‘ENTOURAGE’ LIFE. I ENVIED THE KID UP UNTIL A FEW DAYS AGO.”

Shrem rustled up $10,000 from his parents, which got the company off its feet in August of 2011. But the real cash came from angel investor Roger Ver, a staunch libertarian known as “Bitcoin Jesus” for the number of startups he’s seeded. Impressed by the new business model, Ver wiredShrem $125,000 after only a pair of detailed email exchanges and a 20 minute Skype call.

BitInstant was soon processing millions of dollars’ worth of transactions a month, struggling to keep pace with the skyrocketing demand for Bitcoin services. The sheer volume of traffic repeatedly brought the site down. Soon, transactions were backed up, causing rolling delays and even a class action lawsuit from customers who had caught the wrong side of a price shift. The site shut down, prepping a newer, faster back end, but by then it didn’t matter. Shrem had become a regular on the virtual currency speaking circuit, traveling to London and South America. He had moved out of his parents’ basement into an apartment in Midtown Manhattan and opened a showy bar on the ground floor called EVR. BusinessWeek named him one of the “Bitcoin Millionaires.” A few days before Christmas, he put a deposit on a plane.

“There is no face of Bitcoin, but he was one of the the big faces of Bitcoin,” says Marc Hochstein, executive editor of American Banker, who met Shrem through the New York Bitcoin community. “He was such a charming guy. He was really amiable, he had this beautiful girlfriend. He was this plucky, short Jewish guy from Brooklyn who had computer skills and decided to start his own company, and he was living the Entourage life. I envied the kid up until a few days ago.”

The case basically comes down to fewer than a dozen emails between Shrem and a customer calling himself “BTCKing,” who was buying bitcoins on BitInstant using large amounts of cash.BTCKing was a reseller, someone who bought bitcoins and resold them at a markup. His customers, however, were users of the infamous Silk Road, the underground Bitcoin-only marketplace where people bought and sold illegal drugs.

According to the complaint, on January 17th, 2012, BTCKing tried to deposit $4,000 in cash on BitInstant in a single day. By then, awareness of money transmitter laws was growing within the Bitcoin community and a new attitude of caution was taking hold. BitInstant was registered as a money transmitter with the federal government, which meant anything over $3,000 had to be reported. In addition, BitInstant officially refused deposits over $1,000, although it occasionally broke this rule.

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BTCKing had pushed the limit before, and BitInstant’s cash-processing company TrustCash had doubts. Shrem went nuclear, cc’ing the TrustCash CEO on a fire-breathing email banning BTCKing from the service permanently. “We have all your deposits on record, your picture from bank security cameras,” Shrem wrote. “Any attempt at a new transfer will result in criminal prosecution.” By the end, BTCKing was begging just to get his money back.

But BTCKing was a whale, doing thousands of dollars in transactions a week. For a small exchange like BitInstant, it was hard to let that business go. After the kerfuffle died down, Shrem messaged him privately with a much softer tone. “No problem, in the future please have your customers respect our $1,000 limit,” he wrote, according to court documents. “Your email address is banned, but you can use a different one.”

According to an IRS investigation, the man behind BTCKing was Robert Faiella, a 52-year-old Florida man. Faiella never registered with any financial authorities, of course.

THE CASE BASICALLY COMES DOWN TO FEWER THAN A DOZEN EMAILS

Faiella knew he would face jail time if the authorities ever found out what he was up to, according to conversations he allegedly had with the former Silk Road operator, the pseudonymous Dread Pirate Roberts. But by all indications, Shrem didn’t take the law seriously. While his co-founder Nelson had reversed his earlier bluster and become very careful about money-laundering laws, Shrem was cavalier.

“He has not broken a law and Silk Road itself is not illegal,” Shrem said in one email to his co-founder cited in the complaint. “We also don’t have any rules against resellers. We make good profit from him.”

Right, Nelson replied, but “so many of his transactions smell like fraud or money laundering.”

“Cool,” came the one-word reply.

The criminal complaint alleges that Shrem himself had bought drugs on Silk Road, which squares with the pothead lifestyle he boasted about to reporters. “I won’t hire you unless I’ve either had a drink with you or smoked weed with you. That’s just my rule,” he told both The New York Observerand Vocativ. In February of 2012, he messaged a Verge reporter, excited about receiving a package. “Wow, Silk Road actually works,” he wrote. “Just got my batch of brownies.” (While Silk Road did sell non-drugged food items, it was implied that the brownies were laced with pot.)

The companies kept growing, Shrem’s and Faiella’s in parallel, according to the investigation. Soon Faiella was doing $20,000, $30,000, $40,000 in a single week. Shrem reassured him, “I always take care of you, we even know which orders are yours.” As Faiella brought in more and more money, Shrem started offering him discounts. By October of 2012, Faiella had bought more than $1 million worth of Bitcoin through BitInstant.

That same month, TrustCash decided it had had enough and broke off its business with Shrem, leaving BitInstant unable to process cash deposits. When TrustCash left, so did Faiella. He started taking cash on his own, telling clients to deposit money directly into his bank account.

That was the last Shrem heard of BTCKing until the day of his arrest. While Shrem was being arraigned in New York, Faiella was being indicted in Florida.

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Charlie Shrem, right, exits Manhattan federal court with an unidentified person on Monday, January 27th, 2014, in New York. (AP Photo / Louis Lanzano)

For the first wave of users, buying Bitcoin felt like a game you played with an elite group of people who knew something everyone else didn’t. It was an incredibly complex world that grew more sophisticated by the week, but it felt protected and separate from reality, to say nothing of the world of regular finance.

But that’s no longer true: Bitcoin’s part of the system now. Any money transmitter, from Western Union on down, is required to register with the US Treasury’s Financial Crimes Enforcement Network (FinCEN) and install compliance officers whose sole purpose is to sniff out money launderers. BitInstant is no exception. Shrem registered as a chief compliance officer in March of 2012, obligating him to report potentially illegal activity back to the government. The US attorney says he was negligent in those duties, but the larger issue of BitInstant’s independence was already settled: in the libertarian battle between the state and free enterprise, money exchanges are already occupied territory.

The actual penalties are less clear. Michael Bachner, a New York attorney who specializes in white-collar crime, says it’s very unlikely that Shrem will serve 25 years. If he cooperates with the police and assists with the case against Faiella, he could even walk without doing time — it all depends on the judge.

Some members of the Bitcoin community believe that the prosecutor’s aggressiveness stems from the government’s animosity toward the virtual currency, but Bachner says it’s just the fact that the case involves drugs. “If he was laundering the proceeds of a tax scheme or a securities scheme or some other white-collar offense, it would be not nearly as serious as a narcotics offense,” he says.

Already, the trial could have repercussions far beyond just BitInstant and Charlie Shrem. The same week as Shrem’s arrest, the New York Department of Financial Services (NYDFS) held a two-day hearing as the first step in creating a new regulatory category for Bitcoin transmitters. The stakes are high: the government is still asserting its jurisdiction over the decentralized, peer-to-peer network it could quite possibly destroy. Naturally, the rest of the Bitcoin community is taking pains to appear as law-abiding as possible.

THE GOVERNMENT IS STILL ASSERTING ITSELF OVER THE TECHNOLOGY IT COULD QUITE POSSIBLY DESTROYAp854264803240

Image credit: AP Photo / Louis Lanzano

Other Bitcoin companies have been quick to distance themselves from anything to do with money laundering. “I think Charlie Shrem was respected by a lot of people,” says Jeremey Allaire, CEO of the gestating payments facilitator Circle. “It just underscores that if you’re building a company in this space, you need to take the Bank Secrecy Act and money-transmitter laws very seriously.” BitInstant’s former competitor Coinbase issued a similar statement: “While we cannot comment directly on this case given the investigation surrounding it is still underway, it is to the benefit of the Bitcoin community to root out any bad actors, and we applaud law enforcement’s action in this regard.” The Winklevoss twins of Facebook fame, who gave Shrem $1.5 million in investment, quickly sided with the government, saying they were “obviously deeply concerned.”

The Bitcoin Foundation, the trade group that serves as the closest thing to an official voice of the Bitcoin movement, quickly announced that Shrem had resigned as vice chairman. Noting that while he was innocent until proven guilty, the foundation felt compelled to clarify that it “does not condone illegal activities.”

That doesn’t sit well with many hard-line Bitcoin partisans, many of whom identify as voluntarist or, in simpler terms, libertarian. Roger Ver says he doesn’t believe any crime has taken place, even if it’s wise to abide by money-laundering regulations for practical reasons. “Money laundering is not a crime,” Ver says. “It’s just because certain men with guns don’t like what other people are doing with their own money, so they decide it’s okay to lock those people in a cage. Even if absolutely everything the government is alleging is true, Charlie has done nothing that’s morally wrong.”

In the meantime, Charlie Shrem has no shortage of friends. He was released on house arrest after his parents put up their house as collateral. He’s started asking for donations for his legal defense in Bitcoin, and many of his past associates—- even one who felt burned after a business deal gone bad — have jumped to his defense.

Hochstein recalls how Shrem was the one who told him the meaning of “FUD,” the acronym for “fear, uncertainty, and doubt.” He recalled the scrappiness of BitInstant, which had an office in the Flatiron district of Manhattan where Bitcoin users would gather. “It was very much a startup in the classic sense, which I just thought was very cute, and I don’t mean that in a condescending way,” he says. “But it was starting to collide with the reality of the regulations that we live under. It’s just sort of cruel the way they will make an example and throw the book at a guy who, as far as I can tell, was maybe just a little mischievous and a little cocky.”

read more: http://www.theverge.com/2014/2/4/5374172/the-coin-prince-charlie-shrem-bitinstant-bitcoin-money-laundering-scandal

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