Money-Laundering Network’s Demise Is Bad News for Bitcoin

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Agent Joe Bogus, on the case. Photo: iStockphoto

Liberty Reserve, an online currency exchange headquartered in Costa Rica, was broken up by authorities today after its operators were accused of hosting more than $6 billion-worth of illegal transactions over the last seven years. The indictment, which involved law enforcement officials in an astounding seventeen countries, accuses the site of functioning as the "bank of choice for the criminal underworld."

You've probably never heard of Liberty Reserve, which allowed people to transfer money around the world without verifying their identities. Not all of the activity on Liberty Reserve was criminal, but you can imagine how its lack of required verification made it the favored payment network for drug dealers, child pornographers, and other ne'er-do-wells. One law enforcement official told the Times that Liberty Reserve had essentially become "PayPal for criminals" and that it was brought down by an undercover agent who created a Liberty Reserve account under the fake name "Joe Bogus" and described his account's purpose as "for cocaine."

The legal issues surrounding Liberty Network are interesting in their own right. But even more interesting, I think, is what the fed's breakup of Liberty Network means for the Bitcoin community. Bitcoin, of course, is a lot like Liberty Network — it's a payments system that derives much of its value from the anonymity of users. And like Liberty Network, Bitcoin has also attracted the attention of regulators and law enforcement officials, who see that same anonymity as a dangerous enabler of illegal activity.

The main difference between Bitcoin and Liberty Network is that in Bitcoin's case, there's nobody to arrest, no entity to prosecute for the sins of the system as a whole. As Timothy B. Lee points out, the fact that Bitcoin is so decentralized and leaderless makes it harder to shut down. And Bitcoin fans on Reddit are already talking about how the Liberty Network bust is good for Bitcoin, since it means less competition in the anonymous-payments world. Amazingly, the price of Bitcoin is basically flat on the day, meaning that even having the other major anonymous-payments system busted in an unprecedented, globe-spanning sting operation hasn't dented the enthusiasm of Bitcoin fans.

But anonymity alone won't protect Bitcoin from doom. It's true that Bitcoin is decentralized by design and has no leader who can be hauled away in handcuffs, but its use as a payment network depends on all kinds of third-party exchanges, processors, and wallet sites. And those pieces of the Bitcoin ecosystem do have leaders and can be prosecuted — and almost certainly will be if their networks become a conduit for tons of illegal activity.

Already we're seeing law enforcement chip away at the biggest pieces of the Bitcoin ecosystem — starting with payments processors and exchanges like Mt. Gox. And if the Liberty Network sting is any indication, it won't be long until the feds figure out how to crack down on other major Bitcoin-affiliated businesses. The lesson of this bust is that law enforcement officials are willing to go to extreme lengths in order to bring the world of online money-moving out of the shadows and into their purview. If I were in the business of Bitcoins, I'd be calling a lawyer right about now.