Bitcoin Bolt

General Counsel at the Bitcoin Foundation and VP of Business Development and General Counsel at CoinLab, Patrick Murck, recorded a podcast on April 26th, 2013 with the Association of Certified Financial Crime Specialists, a group connecting the global financial crime community. The talk was entitled: “Bitcoin’s promise and perils: What financial institutions should know about the new virtual currency.”

From the ACFCS website:

Until recently, the virtual currency of Bitcoin may have had almost
as many critics, skeptics and naysayers as it had actual users. Much has
changed in the past few months. With the value of Bitcoins exploding,
its exchanges doing a lively business, and more and more merchants
accepting it as payment, Bitcoin now seems close to fulfilling its
potential as a widely used, decentralized online currency.

One thing that has not changed, however, are the concerns over money
laundering and financial crime risks that have swirled around Bitcoin
since its inception. To delve into the mechanics of the online currency
and explain how it interfaces with financial institutions worldwide,
ACFCS is joined by Patrick Murck, General Counsel of the Bitcoin Foundation, on this Financial CrimeCast. He explains the inner workings
of Bitcoin, and describes what steps the currency and its exchanges are
taking to mitigate financial crime risks.

He also analyzes the impact of recent guidance by the US Financial
Crimes Enforcement Network that lays out suggested regulations for
virtual currencies for the first time, and explains what financial
institutions should know about doing business with Bitcoin users.

By Jon Matonis
American Banker
Thursday, April 25, 2013

http://www.americanbanker.com/bankthink/fincen-regulations-choking-bitcoin-entrepreneurs-1058606-1.html

More than a decade ago, regulators nearly suffocated PayPal. Now it looks like they’re trying to squelch another disruptive, innovative payments system.

At least three exchanges in the U.S. that traded the digital currency Bitcoin have shut down, apparently as a result of guidance
issued last month by the Financial Crimes Enforcement Network. That
agency has emerged as the top threat, at least in in the United States,
to the decentralized Bitcoin network – moreso than the widely reported
price volatility and hacker attacks.

“They’ve been the single biggest factor for stomping out currency competition,” says Bradley Jansen, a former assistant to Rep. Ron Paul and director of the Center for Financial Privacy and Human Rights. Speaking recently on The Daily Bitcoin
podcast with Adam Levine, Jansen expressed surprise at how little focus
bitcoin business leaders are putting on Fincen, especially considering
how regulators thwarted earlier emerging payment systems like PayPal and
e-gold. PayPal obviously survived and prospered – but only after
selling itself to eBay and agreeing to put restrictions on its service. E-gold was not so fortunate.

“Fincen
was able to stop currency competition with technical innovations in the
90s even before their expanded powers under the U.S. Patriot Act. And,
what we’ve got now is a Fincen on steroids without clear restrictions
from Congress,” Jansen says.

The guidance requires certain
intermediaries that handle virtual currency to register with Fincen as
money services businesses, which entails recordkeeping and reporting
responsibilities. And it says some of those businesses may additionally
be money transmitters, which would mean fingerprinting of directors and
officers and compliance with a patchwork of state licensing
requirements.

Jansen postulates that the recent Fincen virtual currency guidance was issued ex post facto as a way to set the stage for potential prosecutions in the future.

“It’s
a failure of Congress to do its job. We knew that these guidelines and
these prosecutions were in the works even last Congress. Ron Paul was
the chairman of the House subcommittee that had jurisdiction over Fincen
and he never had a single hearing on this.”

In a recent speech,
Fincen Director Jennifer Shasky Calvery said the new guidance aims “to
protect [digital currency] systems from abuse and to aid law
enforcement in ensuring that they are getting the leads and information
they need to prosecute the criminal actors.” She reiterated that the
guidance does not apply to everyday users who pay or accept bitcoin for
goods and services.

But by saddling startups with compliance
requirements, and making them unattractive clients for regulated banks
that despair of serving MSBs, Fincen is choking these businesses that
facilitate conversion of bitcoins into dollars. Fewer exchanges and more
red tape will make it harder for merchants or consumers (who, after
all, must still pay the bills with dollars) to take advantage of the
Bitcoin payment system’s speed, privacy and competitive costs.

On March 20 – just two days after the guidance from Fincen came out – the bitcoin exchanger bitme.com suspended
operations indefinitely. Bitme was a relatively small operation, but it
was widely suspected among bitcoin users in online forums that this
closure resulted from difficulties related to potential regulatory
compliance.

BTC Buy, another bitcoin exchange site, suspended services and closed permanently in early April, specifically citing the legal uncertainty brought up by the Fincen guidance.

Most recently, the largest bitcoin exchange to halt
trading was Bitfloor, run by Roman Shtylman, who blamed “circumstances
outside of our control.” His New York operation had average daily
trading volume of about $300,000 (depending on the exchange rate), with
U.S. dollar deposits and withdrawals running through a Capital One bank
account – which the bank unilaterally closed.  “I had very little time
to act between receiving the account closure letter and the account
being closed,” Shtylman told PaymentsSource.

In this case, the
regulatory guidance may have had an indirect effect. Bitfloor was
registered with Fincen as an MSB but was not licensed as a state money
transmitter. Shtylman surmised that Capital One had judged his business
to be “not worth the risk.”

Across the Atlantic and presumably unrelated to Fincen, Poland-based Bitcoin-24 suspended trading after the government there froze its bank account.
It reportedly did so because a bank in Germany complained of
compromised accounts transferring stolen money without identification to
Bitcoin-24. Also, U.K.-based TransferWise,
a foreign currency intermediary, ceased transfers to any bitcoin
exchanges at the request of its banking partners. TransferWise had
mostly been servicing customers in the U.K., Poland, and Spain.

It
will be interesting to watch how Fincen intends to treat one-way,
fixed-rate brokers that either buy or sell bitcoin at a fixed price.
Since a two-way exchange market is not involved it could be seen as
merely a typical commodity purchase or sale.

Tangible Cryptography LLC, which registered as an MSB this month, operates FastCash4Bitcoins for selling bitcoins and Bitcoins Direct
for private off-exchange purchases. The two businesses function
independently of each other and neither is technically an exchange.
Bitcoins Direct is frequently closed to new clients and its cash deposit
feature was recently cancelled.

The fact that bitcoin survives at all with so many powerful forces lined up against it is a testament to its resiliency and tenacity. Now, in addition to the vicious press coverage
and persistent denial of service attacks on exchanges, the emerging
cryptographic money has to contend with onerous and targeted regulation.

With respect to bitcoin and financial regulation, Jansen warns: “I
think the lesson from the 90s was that you either become what Fincen
wants you to be or you’re not going to be.”

Not in the
U.S., that is. But jurisdictional competition will kick in and overseas
exchanges will gain market share and liquidity. They just may not have
U.S. customers.

Update: Silk Road is now back online.

The Silk Road, the world’s largest online anonymous market famous for its wide collection of illicit drugs and its use of Tor and Bitcoin to protect its users’ privacy, reports that it is currently being subjected to what may be the most powerful distributed denial-of-service attack against the site to date. The site has now been inaccessible for roughly two days, although the official forums continue to be online and some users have even reported brief intermittent periods of availability for the main site as well. One possible motivation behind the attack is a ransom attempt; Australian news media is reporting that the Silk Road had received a message demanding a payment of $5,000 on April 27. However, evidence of this is scant; the claim does not appear anywhere in Silk Road administrator Dread Pirate Roberts’ public forum posts, his primary (if not only) medium of public communication.

Regarding the current status of the attack, Roberts has posted a public update on the situation on the official forum, writing the following:

We have come a long way in the battle, but still do not have the upper hand. It’s looking more and more like a restructuring of the tor software or even the tor network will be required to mitigate the kind of attack we are under. If this can be solved by modifying the tor client software running the silk road .onion, then it will be a matter of patching and redeploying the hidden service. If it is a network issue, it will require the cooperation of the Tor developers, or running a new network of nodes. I haven’t given up hope for a faster solution, but if one can not be found, then we will move to a semi private scheme where users will be given access through many private URLs. I’ll keep everyone updated on how we will move forward, but please be prepared for a few more days at the least of no access.

This is not the first major outage for Silk Road; in November 2012, following a combination of technical difficulties and a sudden growth in usage the website was down for an entire week. However, the words of Dread Pirate Roberts strongly suggest that this attack is not like the others. First of all, this is not the first DDoS attack to take place within the past week – an earlier attack had taken the site down for 36 hours between April 24 and April 26. After successfully bringing the Silk Road back online, Dread Pirate Roberts released a public message announcing his victory and even praising the attacker’s intellect, writing “I have zero respect for the attacker’s tactics, but I have huge respect for his intellect, giving me confidence that we can and will overcome any future technology-based attacks on Silk Road.” The short time difference between this last attack and the current one, and the fact that both attacks have managed to bring the site down for over 36 hours, provides some evidence suggesting that the perpetrators of the two attacks are one and the same. This paints a grim picture of the assailant: a person, or organization, that is highly intelligent, has a lot of resources at their disposal, and is not willing to give up.

Second, the fact that Dread Pirate Roberts is even talking about moving to a “semi-private scheme” – that is, requiring users to jump through hoops to obtain a Tor address at which to access the site, is another sign that this attack is very serious. One of the main attractions of the Silk Road is that anyone, even those who have no “connections” or knowledge of where to find illicit products on the street, can purchase a wide assortment of goods from an interface that is, once Tor and Bitcoin are set up, no harder to use than Amazon or eBay. Requiring new users to, say, go on reddit.com/r/silkroad and ask for a semi-private address to access the site would seriously hamper adoption and, equally importantly, create a central point of failure. Law enforcement could easily pressure Reddit to take down r/silkroad and play a constant cat-and-mouse game with the Silk Road community as they attempt to find other portals on which to set up a public entrance point – a game that law enforcement would never be able to win, but which would nevertheless make it even more difficult for new users to join.

In the meantime, there are two other online black markets available that Silk Road users can use as a fallback: Black Market Reloaded and Atlantis. Black Market Reloaded recently released statistics that showed that the site was doing quite well: its monthly trade volume is now up to $750,000 per month, over a third of the $2 million per month figure estimated for Silk Road by Carnegie Mellon researchers last summer. Its selection of goods is now as large as that of Silk Road, as since Silk Road’s last major outage in November a large number of Silk Road sellers have started maintaining profiles on both. However, the infrastructure is not yet as well-developed; some Silk Road users complain that Black Market Reloaded has a much weaker consumer protection framework and it is harder to find vendors with an established reputation that can be trusted. Atlantis is currently very small; the site was only released this year in March, and less than a thousand different goods are offered for sale. Its main attraction: supporting Litecoin as well as Bitcoin.

Of course, these two markets themselves are safe from attack; if the attacker currently targeting the Silk Road is doing so with the intent of disrupting all Tor-based crypto-commerce, they can easily add Black Market Reloaded and Atlantis’s Tor addresses to their list of targets and expand the attack. It is likely that the two fledgling competitors would fare even more poorly than the Silk Road, as they have not had the prior experience handling DDoS attacks than the Silk Road had. As for the Silk Road itself, the latest word from Dread Pirate Roberts is that he is “still working on a solution.” Whether the Silk Road will emerge from this attack unscathed or not is a question the answer to which is unfolding with each passing second, and tens of thousands of people are watching to find out.

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