Bitcoin, the world’s first decentralized digital currency, doesn’t exist on paper. It has no public face or founder and it isn’t regulated or backed by a government. You probably haven’t even heard of it. Once a hobbyhorse for techno-libertarians, black-market drug dealers, or just those skeptical of centralized banking, the online crypto-currency gained a broader interest earlier this year when the value of Bitcoins shot up tenfold. Since then, not only have consumers been paying more attention — so have the cops and the feds.
In Washington, a crackdown on Bitcoin might be coming. Last week, multiple federal agencies met with advocates for virtual currency in a closed-door meeting where representatives from the Bitcoin Foundation warned against overregulation. A U.S. Senate subcommittee is investigating whether to regulate virtual currencies like Bitcoin. It’s a hot commodity right now, and part of all the recent excitement surrounding Bitcoin sparked right here in Charleston.
Back in April, federal agents allege that they seized 11.02 Bitcoins from a 31-year-old hospitality worker named Eric Hughes, who was living in downtown Charleston. The case immediately made a splash in the murky realm of online economies. The federal Drug Enforcement Agency said Hughes went by Casey Jones, a name linked to an identity on the internet black market called Silk Road in connection with the sale of prescription pills. The underground marketplace exists on the anonymous Tor Network in the caverns of the Undernet, also known as the Deep Web. The Charleston seizure here marked the first time the feds had ever confiscated Bitcoins, and the DEA posted a public forfeiture notice online. The 11.02 Bitcoins were worth about $814. But the DEA has still not charged Hughes with a crime.
David Aylor in the Deep Web
Shortly after the DEA seized those Bitcoins, high-profile Broad Street lawyer David Aylor took the case. He says the feds named the wrong guy, and his client, Hughes, never posted as Casey Jones on Silk Road.
“My client has always maintained that he did not have any Bitcoins and that the Bitcoins that were seized and attributed to him are not his,” Aylor said in a recent interview in his downtown office. He declined to talk about any specifics of the case. Aylor is also defending Hughes on state drug charges stemming from a raid on his apartment in June where local authorities allegedly found pot and pills. The lawyer says the drug case is unrelated to the actions of the DEA and the Bitcoins. But the federal Bitcoin seizure has put Aylor at the center of the fast-emerging new world of unregulated virtual currency. If the seizure is the first of its kind by the feds, then Aylor is the first attorney trying to prove the feds wrong in a Bitcoin seizure case. It could set a precedent, and many around the world who follow Bitcoin are watching what happens here closely.
“I think it’s new for everybody,” Aylor says.
So, What is Bitcoin?
A finite number of Bitcoins exist — 21 million to be exact — and to obtain them they must be “mined” online.
The first thing you should know about Bitcoin is that it’s not real money you can hold in your hand. Instead, it’s kept in virtual wallets. But it can act as an alternative to the dollar, the euro, yen, or any other currency accepted throughout the world. It’s free to set up an account with a Bitcoin company and get an online wallet — anyone with an internet connection can do it — and there are no fees or chargebacks when making a transaction. Like other commodities, the price of Bitcoins fluctuates with the market.
Aylor, the Charleston attorney, says he’s been getting a fast education about Bitcoins and the broader issue of virtual currency. In fact, as a small business owner, he’s debating whether his law firm should start accepting Bitcoins as payment from clients.
“Essentially, I think you’re going to see more and more use of Bitcoins,” he says. “It’s just another form of currency that’s unregulated at this point.”
He’s not alone. Bitcoins have attracted the attention of some big names. The Winklevoss twins, famous for their court fight against Mark Zuckerburg over the founding of Facebook, are Bitcoin champions. Actor Ashton Kutcher, who also runs a venture firm, has sung its praises. Venture capitalist Peter Thiel, who co-founded PayPal and was an early investor in Facebook, has been funding Bitcoin startups. So has Sean Parker, who co-founded Napster. The blogging company WordPress accepts Bitcoins, as does WikiLeaks, the dating website OKCupid, and the popular social news and entertainment site Reddit. So does nearly an entire neighborhood in Berlin, Germany. A year ago, one of City Paper‘s advertising reps invested in Bitcoins with his wife at the suggestion of a friend who works in IT. They put in $500 and cashed out at $4,000.
Bitcoin was founded in 2008 by a programmer who goes by the name Satoshi Nakamoto, a presumed pseudonym. Bitcoin’s revolutionary peer-to-peer system enables online transactions without requiring third-party services such as PayPal or MasterCard.
According to Adam Levine, who edits the San Francisco-based website Lets Talk BitCoin! and broke the Charleston seizure story with Brian Cohen, the recent Bitcoin buzz has been good news.
“We’re basically watching the continued legitimization of Bitcoins, and of crypto-currency,” he says. “It’s not only about Bitcoins — it’s more about this idea that there are monies that work on the internet that are different from monies that we have now.”
Levine does a twice-weekly audio show in California about Bitcoins, and he acknowledges the topic can be difficult for a mainstream audience to grasp.
The easiest way to get people to understand how Bitcoins work, Levine says, is to compare it to cash and to gold. When it comes to money, there are two types of systems: debt-based systems such as credit cards, wire transfers, or any other form that processes payments with a third party like PayPal. When you make a wire transfer, for instance, the bank owes another bank, which then owes you. In that system there are protections that look out for both parties involved in a transaction. The downside is that all transactions can be reversible. “That’s totally the opposite of what you have when you’re dealing with just cash dollars,” he says. When you give someone a dollar you can’t call your bank and have them put a hold on the transaction. Whoever holds it owns it.
“If I send you .05 Bitcoins, that doesn’t go through some Bitcoin processor. It just goes from me straight to you,” Levine says. “One involves a middle party — at least one middle party, with banks a lot of times it’s a bunch of middle parties — but in the case of these other methods it’s just person to person.”
Andrea Castillo, who works for the Mercatus Center at George Mason University and co-authored a policy paper on Bitcoins, says using them also neutralizes the possibility of a government or company censoring a business transaction from an entity it deems unfriendly. Some major credit-card companies, for instance, blocked payments to the whistleblower website WikiLeaks. In Bitcoin transactions, that can’t happen. When the open-source blogging platform WordPress decided to accept Bitcoins, it released a statement saying some payment services like PayPal block access from certain countries, and many credit card companies have similar restrictions.
“Some are blocked for political reasons, some because of higher fraud rates, and some for other financial reasons,” the WordPress statement read. “Whatever the reason, we don’t think an individual blogger from Haiti, Ethiopia, or Kenya should have diminished access to the blogosphere because of payment issues they can’t control. Our goal is to enable people, not block them.”
According to Castillo, Bitcoin replaces those trusted third-parties with cryptography. Bitcoin users allow their computers to “mine” more coins by using a program that verifies Bitcoin transactions and records them in a public ledger, called the block chain. “Instead of being issued by a central bank, Bitcoins are gradually mined and capped at a total of 21 million,” says Castillo. “As more miners contribute their processing power, the difficulty in mining increases — mimicking the natural mining rate of gold. As it becomes more valuable, people will spend more money on mining equipment to release remaining Bitcoins.”
This way, no coin can be spent more than once, she says. “Miners are rewarded for maintaining the network with newly minted bitcoins — hence the name. This means that Bitcoin is the world’s first decentralized digital currency … I can send money to anyone in the world almost instantaneously and virtually for free … In this way, Bitcoin is both a payment system — like PayPal — and a currency, like the U.S. dollar.”
And, if someone wants to keep his or her identity private in a transaction, they can do so to a much easier degree with Bitcoins.
This pseudo-anonymity has raised concern with law enforcement. Bitcoin operates as a person-to-person transaction, meaning it’s more difficult to track. No third party is watching those transactions take place. Bitcoin does have a continuous ledger, so every transaction is accounted for and viewable to the public. “If you can decode it then you could ostensibly have any transaction that’s ever happened,” Levine says.
So while it’s not technically anonymous, it’s certainly easier to hide your identity by using Bitcoins.
The Silk Road Connection
Bitcoin is the coin of the realm on Silk Road, which exists deep in the internet’s underbelly. There, goods and services both legal and illegal are bought and sold under the cloak of anonymity and outside the regulatory watch of taxing authorities.
In a recent online podcast, Nicolas Christin, an associate director of the Information Networking Institute at Carnegie Mellon University who has studied Silk Road, called it a marketplace similar to eBay or Craigslist. “The only difference, which is a major difference, is that it is an anonymous marketplace,” he said. “What that means is that the location of the server that hosts the marketplace is very difficult to find and people who want to participate in transactions on that website are also anonymous.”
Silk Road is hosted on the anonymous Tor Network through hidden protocols that create a byzantine connection to scramble the identities of those trying to access it. Once there, people who buy and sell on Silk Road don’t know who they’re buying from or selling to, which is the point. Hence, while legit products are bought and sold on Silk Road, so are drugs and other illegal contraband. And they’re all paid for in Bitcoins.
Back in April, when the DEA posted a public forfeiture notice about seizing 11.02 Bitcoins from the Charleston man whom the DEA accused of being Casey Jones, Bitcoin users were immediately suspicious that the feds might have infiltrated Silk Road. According to Post and Courier reporter Glenn Smith, “Discussion of ‘Casey Jones’ started popping up on a Silk Road chat forum after news of the seizure broke. Commenters described Casey Jones as an active vendor on the site who bought and sold drugs such as Suboxone and Adderall.”
Asked if he thought the DEA might have infiltrated Silk Road, Hughes’s attorney Aylor only spoke only in generalities.
“In my opinion, not even DEA specific, but just in general, I think that the federal government is taking a vested interest in the Bitcoin world as a whole, and I’m sure are in some way or another engaging themselves in the process to have a better understanding of it and also to determine what all the capabilities are,” he said.
Regulators, Mount Up
Last week, Bitcoin advocates met with regulators in Washington, D.C. amid growing concern about the new currency. The U.S. Treasury Department’s Financial Crimes and Enforcement Division, known as FinCEN, hosted the event. Agencies such as the FBI, IRS, Homeland Security, and the DEA were also involved in the talks. The Securities and Exchange Commission, Department of Justice, and the Conference of State Bank Supervisors were also there.
The discussion was part of an “ongoing dialogue with virtual currency operators within the U.S.,” a Treasury Department official told The Washington Post. The treasury wants money services businesses to stay in the United States, he said, but also wants to make sure all forms of them, both traditional or virtual, are practicing the same kinds of controls to guard against money laundering.
Earlier this month, the top banking regulator in New York subpoenaed nearly two dozen Bitcoin companies to see if they were abiding by the nation’s financial regulatory rules because the anonymous nature of virtual currency “helped support dangerous criminal activity, such as drug smuggling, money laundering, gun running, and child pornography.”
In at least one case, accusations of fraud by a Bitcoin company have given the crypto-currency even more legitimacy.
Consider this incident in July. The Securities and Exchange Commission sued a man in Texas who owned a company called Bitcoin Savings and Trust, claiming that he was operating a Ponzi scheme. Regulators accused him of raising more than 700,000 Bitcoins from investors and promising a good return, but using incoming money from new investors to pay older ones. The company owner, Trendon Shavers, argued that Bitcoins couldn’t be securities since they aren’t actually money and shouldn’t be regulated by American entities. But a federal judge’s decision in that case ruled that Bitcoins “meet the definition of investment contract, and as such, are securities.” While that might not be good news for Shavers, it was good news for those who seek legitimacy of Bitcoin.
Back in Charleston, attorney David Aylor says a few years from now people will look back and think how crazy it was when they could buy and sell things online under the cloak of anonymity and with unregulated Bitcoins.
“You’re really starting to see it come to the forefront. I definitely don’t think it’s something the general public is familiar with right now, but I think they will be,” he says. “If we were sitting here this time next year I think we’ll really be in a completely different situation in regards to how the U.S. government particularly looks at Bitcoins because there are so many sides to it.”
In the meantime, Aylor has a federal Bitcoin case to defend.