Friday, June 28, 2013

Bitcoin Foundation Receives Cease And Desist Order From California

By Jon Matonis
Sunday, June 23, 2013

Directly following last month’s Bitcoin 2013 conference event in San Jose, CA that brought decent revenue into the state, California’s Department of Financial Institutions decided to issue a cease and desist warning to conference organizer Bitcoin Foundation for allegedly engaging in the business of money transmission without a license or proper authorization.

If found to be in violation of California Financial Code, penalties can be severe ranging from $1,000 to $2,500 per violation per day plus criminal prosecution which could result in fines and/or imprisonment. Additionally, it is a felony violation of federal law to engage in the business of money transmission without the appropriate state license or failure to register with the U.S. Treasury Department. Convictions under the federal statute are punishable by up to 5 years in prison and a $250,000 fine.

The Bitcoin Foundation is a nonprofit corporation registered in Washington, D.C. with mailing address in Seattle, WA. As a nonprofit, its mission is to standardize and promote the open source Bitcoin protocol and it receives generous support from individuals and corporations to advance those objectives.  The foundation also boasts significant international membership.

One activity that the foundation does not engage in is the owning, controlling, or conducting of money transmission business. Furthermore, that activity would also be against the original charter of the foundation. As general counsel for the Bitcoin Foundation, Patrick Murck has lead responsibility for corresponding with the California Department of Financial Institutions.

At this stage, it’s difficult to tell whether or not it was a general blanket action and if other bitcoin-related entities received cease and desist letters from California. If Bitcoin Foundation was not the only recipient, then expect other companies to come forward in the days and weeks ahead.

The issued letter was signed by State of California Senior Counsel Paul T. Crayton and the letter was copied to Department of Financial Institutions Deputy Commissioner Robert Venchiarutti, who also serves on the Board of Directors of the Money Transmitter Regulators Association, ironically a national nonprofit organization dedicated to the efficient and effective regulation of the money transmission industry.

Recently, the State of Illinois also issued a cease and desist letter to mobile payments processor Square for failing to have the proper licensing in accordance with the state’s Transmitters of Money Act. Prepaid card provider NetSpend and six other payments companies also received Illinois cease and desist orders. If this practice grows among states, it could have a potentially significant “chilling effect” on financial services innovation, especially upon lawful businesses that are designing infrastructure to support and grow the Bitcoin technology. Freedom of choice in currencies is probably the most important free speech issue of our time.

For similar but not wholly unrelated reasons, the Electronic Frontier Foundation and several law school clinics established the collaborative archive Chilling Effects Clearinghouse in 2001 to protect lawful online activity from harassing legal threats related to intellectual property.

Harkening back to the saga of FaceCash and Aaron Greenspan, this new far-reaching action from California’s financial regulator apparently now scoops up nonprofit scientific and educational organizations. California, the cradle of technological innovation and home to the inspiring Silicon Valley venture capital community, is now focusing its sights on the futuristic Bitcoin.

The cease and desist order is included below:

Wednesday, June 26, 2013

In-Person Bitcoin Exchanges Are Thriving

By Jon Matonis
American Banker
Friday, June 21, 2013

Call it a sign of the times, but something is definitely changing as face-to-face purchases of bitcoin are booming worldwide.

In addition to avoiding a sometimes cumbersome registration process with traditional exchangers, in-person bitcoin transactions allow you to meet interesting new people in your area – and discuss bitcoin.

Business colleagues and friends usually ask me the best way to buy and sell bitcoin. With the constantly changing regulatory landscape and the inconsistency of available payment methods, there is not always a straightforward answer. For the serious traders, I recommend both a U.S.-based exchange and an international exchange for diversification. Many choices are available with varying degrees of identification required. For the casual traders seeking more privacy, I recommend in-person trading through

Established by Finnish software developer Jeremias Kangas, LocalBitcoins is the leading person-to-person matching service for people in various locales to meet and conduct bitcoin business. LocalBitcoins has steadily added new cities and market depth. "We currently have 142 countries and 1700 cities," Kangas recently told Bitcoin Magazine, "but that most definitely isn’t enough. We want to expand to at least 170,000 cities, and have franchise exchange shops popping up here and there."

Including the capability to purchase and sell bitcoin online in addition to the in-person model, the company's statistics web page lists 244 countries with 2,004 different cities. The online option tends to support payment methods that are popular and available in that local region. Also, once you make an in-person exchange with someone, you might be more comfortable engaging online with them for subsequent trades.

LocalBitcoins offers an escrow facility and a rating system both of which can be extremely valuable for the first-time trader. The fees range from nothing to 1% for listing and a flat fee of 0.003 bitcoins (about 34 cents as of Friday morning) for wallet transfers.

According to the company, current trading volume is approximately 1,000-1,500 bitcoins per day, with 300 new users per day. Overall user count is now 45,000 and about 15,000 of those are active.

Given the robustness of trade in some large urban areas, it is entirely possible to earn a living from buying and selling bitcoin using the LocalBitcoins matching platform. The bitcoin provider sets the price markup and types of payment that will be accepted. After that is determined, the business elements include focusing on inventory and adhering to a convenient meeting timetable.

It will be interesting to watch how this business model unfolds, because it is also possible to be an in-person exchanger if bitcoin is given back as change during a regular purchase of goods or services. A gourmet food merchant in San Francisco currently offers two unique bitcoin services: "bitcoin back" from cash purchases and "cash back from bitcoin purchases," both integrated with the point of sale system. While the limits on these services are one bitcoin and $200 respectively, it serves as a great incentive to sample the merchant’s product and smartly acquire some bitcoin at the same time.

Bitcoin's price can exhibit extreme volatility and its value is not supported by any government's legal decree. It is admittedly still beta software. With a crippling "fork" of the block chain – the public transaction ledger maintained by a decentralized network of computers around the world – it could all be gone tomorrow. So, do regulatory bodies like the Financial Crimes Enforcement Network believe that virtual bitcoin sufficiently resembles real money for its exchange to be regulated under Money Services Business guidelines or money transmitter rules? Would Fincen also want to regulate the commodity-based exchange of rare gems and Tide detergent?

Bitcoin falls most appropriately into the property category of commodity, although it is an intangible commodity supported by mathematics and a distributed computing network driven by social consensus. Regulating an intangible commodity with unprovable existence places the burden of proof on the regulator since there is sufficient plausible deniability in the system for someone to deny holding bitcoin or even access to the private key required to send them from a given address on the network.

It remains to be seen whether the latest regulatory interest extends beyond the mere entry or exit point into the U.S. financial system. As exchange endpoints tighten up and authorities attempt to treat virtual objects as monetary instruments, the virtual objects might not re-enter the national fiat environment. Therefore, crypto-key disclosure laws may become the next battlefield for cryptographic financial products.

Treating bitcoin as a monetary instrument for purposes of regulation fails to understand the nature of math-based commodities that rely on reusable "proof-of-work" to verify and record transfers of ownership. In the general classification of commodity, bitcoin's trade is similar to any other collectible item, such as antique diamonds, celebrity autographs, moon rocks, Buddha figurines, and baseball cards.

People have even sold air guitars online (without the cases, presumably). Just like air guitars, person-to-person sales of bitcoin "transfer rights" will continue. Ultimately, until physical paper cash is outlawed, bitcoin will still be bought and sold in person just like any other commodity.

Saturday, June 22, 2013

The Fincen Whistleblowers

By Jon Matonis
American Banker
Monday, June 17, 2013

Why do we never hear about whistleblowers coming from the Financial Crimes Enforcement Network of the U.S. Treasury? Where are they?

Regarding surveillance, the world may never have a Fincen whistleblower in the same way that we have an NSA or CIA whistleblower. This is because the Fincen bureau conducts all of its surveillance activity out in the open and in plain sight, probably for its effect as a deterrent. Fincen even recruits banks and other agent financial institutions to participate in the direct surveillance that make serious and consequential judgment calls along the way.

Blatant and stated upfront, the unimpeded surveillance of Americans’ financial activity is Fincen's core mission. So, nothing much to blow the whistle on there.

Since the establishment of Fincen in 1990 to act as the designated administrator of the 1970 Bank Secrecy Act, two generations of educated Americans, including some smart attorneys, have been conditioned to think of money laundering as a real and legitimate category of crime. Eradication of privacy is the goal and manipulation of the semantic crime debate is the tool.

In typical crime-speak fashion, it is therefore possible to have telephone crime and email crime, because persons committing illegal acts can use telephone and email channels to execute their deeds. Perhaps this is why the U.S. administration and the NSA don't see much wrong with PRISM. In their minds, violating the privacy rights of the 99.99% is justified if it ultimately results in the identification of the evil 0.01%.

In true Machiavellian spirit that glorifies instrumentality in statebuilding, "the ends justify the means," especially when it comes to using our money as an identity tracking device. In order to rule successfully, deceit and violence may be necessary for the stabilization of power, to eliminate political rivals, to coerce resistant populations, and to purge the community of other individuals with strong character.

The larger debate around privacy is not just a matter of perception. Nor is it about striking the proper balance, as many have implied. The debate is about zero privacy or zero surveillance as the default and who defines the variations from the default.

Since the available cryptography and technical tools of today permit near absolutes on each side of the privacy-surveillance spectrum, each advancement from one side elicits an equally strong reaction from the other side. More pervasive and aggressive surveillance techniques at the governmental level encourage greater general use of advanced cryptography tools among average citizens. Last week’s headlines only served to spread public awareness of these privacy tools.

It shouldn't have to be this way. We shouldn't always have to deploy the strongest available encryption techniques against the surveilling class. The surveilling class should simply stop watching us.

As shameful as the existence of PRISM is, and it is monumentally shameful for a free society, it doesn't even compare to the unprecedented level of financial surveillance the world is on the verge of witnessing. With FATCA nearing its debut, the IRS goes global, and with FATF, the OECD develops policies to assist in standardizing worldwide enforcement of financial surveillance, ensuring there is nowhere left to hide. These are the agents of our "financial" PRISM.

As banks and credit card companies become more complicit in the surveillance, digital currencies with proper mixing services such as bitcoin become a viable option for preserving some transactional privacy, even if identification is required for its initial acquisition from licensed money transmitters.

At a conference last week, the U.S. Institute of Peace and the International Centre for Missing & Exploited Children trotted out Bitcoin and the anonymized web browser Tor as whipping boys in a gross and misguided attempt to paint certain technologies as indirectly enabling immoral behavior. The theme of the conference was brainstorming possible ways to reconcile the opportunities of innovative financial technologies with the needs and concerns of law enforcement.

Some type of back door, or exception, for law enforcement must certainly be possible – to protect the children, you know. Although virtual currency exchange endpoints can be regulated, two representatives of the Bitcoin Foundation clearly stated the obvious limitations in altering the Bitcoin transaction protocol itself. Also, for the life of me, I cannot imagine how the Tor Project could compromise itself in an acceptable way. It would be like asking a toaster not to toast.

In her opening remarks at the conference, Fincen Director Jennifer Shasky Calvery cited the two wildly different lenses through which observers see the virtual currency issue. Generally, it's thwarting financial innovation versus establishing a clear and safe regulatory environment. She happens to be correct about this framework.

However, upon leaving the director's U.S.-centric bias, two other lenses emerge – U.S. interests versus rest-of-the-world interests. And, this is where we find our elusive whistleblower.

The Fincen whistleblower is other sovereign nations and they are starting to speak.

In April, the Dutch Minister of Finance and president of the Board of Governors of the European Stability Mechanism, Jeroen Dijsselbloem, answered questions from his country’s parliament regarding bitcoin. (His remarks were later translated by a Dutch member of the Bitcoin community.)

When asked if "the activities as performed by Bitcoin fall under the Financial Supervision Act or is this a private activity," Minister Dijsselbloem responded, "Anyone is free to develop and/or use alternative (digital) products, as long as it does not conflict with the Dutch law, such as the law on gambling."

He continued: "The current understanding is that Bitcoin is not electronic money as meant in the Financial Supervision Act, partly because Bitcoins are not issued in exchange for received money and they do not represent a claim on the issuer. Because of this, Bitcoin does not meet at least two of the four requirements set out in the law. Also, Bitcoin is not in any other way a financial product as meant by the law. (Mediation in) the purchase or sale of Bitcoins is not a financial service either, so the Financial Supervision Act does not apply."

Many educated and developed countries don't immediately see every product as something to track and don't necessarily view financial privacy as a negative. Indeed, prior to immense and unparalleled pressure from the U.S., bank secrecy and client confidentiality had been a proud heritage in countries such as Switzerland, Austria, and Liechtenstein.

But will the world listen to the up and coming Fincen whistleblowers? They should. Either willingly or begrudgingly, the world has embarked on a path of greater and greater transparency in a bargained exchange for the warm embrace of security. But, the ends do not justify the means in that grand tradeoff. A world where privacy isn't sacrificed and all human transactions aren't tracked is not only possible, but imperative. The alternative will be far worse than you can imagine.

Iranian Rial Currency Targeted For Destruction

By Jon Matonis
Monday, June 17, 2013

Effective July 1st, the United States has authorized new sanctions directly targeting the already-devalued Iranian rial with penalties for transacting or holding the currency outside of Iran. This represents the first time that the U.S. has focused specifically on the Iranian monetary unit itself and the ninth set of sanctions President Barack Obama has imposed against Iran.

White House Press Secretary Jay Carney said, “This new action targets Iran’s currency, the rial, by authorizing the imposition of sanctions on foreign financial institutions that knowingly conduct or facilitate significant transactions for the purchase or sale of the Iranian rial, or that maintain significant accounts outside Iran denominated in the Iranian rial.”

The tough sanctions are intended to increase the financial pressure on the Islamic republic to abandon its nuclear program. However, Iran maintains that its nuclear energy program is for peaceful purposes only and has refused to back down arguing that it has this right.

Carney explained how the sanctions also target the foreign assets of Iran’s leaders, “Further increasing the pressure on the Iranian government, the Executive Order authorizes the imposition of additional sanctions on persons who provide material support to Iranian persons and certain other persons designated pursuant to Iran sanctions authorities that are included on the list of Specially Designated Nationals and Blocked Persons (SDN List) maintained by the Department of the Treasury.”

The Government of Iran’s leadership controls a vast overseas network of 37 private businesses for the purpose of managing off-the-books investments that are shielded from the view of international regulators.

This month in exchange for pledges to reduce oil purchases from Iran, the U.S. State Department renewed six-month waivers on Iran sanctions for nine countries in total, including China, India, South Korea, Malaysia, Singapore, South Africa, Sri Lanka, Turkey and Taiwan.

In early 2012, the U.S. and the European Union imposed payment sanctions on Iran’s oil and financial sectors with the goal of weakening Iranian oil exports and blockading transactions with the Central Bank of Iran via Swift. However, a European Union court in February ruled against the EU banking sanctions imposed on one of Iran’s largest banks, which extends to the payment sanctions imposed by Swift in March of last year.

The Iranian currency has already been suffering from record inflation losing more than two-thirds of its value in the past two years, trading at 36,000 per U.S. dollar as of April 30th, compared with 16,000 at the beginning of 2012.

“The idea is to cause depreciation of the rial and make it unusable in international commerce,” according to David Cohen, the Treasury Department’s undersecretary for terrorism and financial intelligence.

President Obama issued this latest Executive Order on June 3rd and during an interview Cohen said, “the purpose of the one-month phase-in period is to give financial institutions currently holding rials the opportunity to dump them.”

Monday, June 10, 2013

The Politics of Bitcoin Mixing Services

By Jon Matonis
Wednesday, June 5, 2013

As the cryptocurrency arms race escalates beyond identity verification at exchange endpoints, mixing services for bitcoin may emerge as the next frontier in the battle for financial privacy.

If bitcoin exchange regulation becomes so effective that exchange operators are required to link specific bitcoin addresses to individual customers, then users may have few remaining choices should they want to maintain transactional privacy. Call it the law of unintended consequences for overarching bitcoin exchange regulation.

Two facets of the growing political debate on anonymizing services are the traditional centralized bitcoin mixers and the newer decentralized bitcoin mixers that require a modification to the Bitcoin protocol.

With traditional bitcoin mixers, the process could become highly-charged politically and the regulatory status of mixing services called into question. Reliable legal jurisdictions for operating bitcoin mixing services would therefore gain prominence since it reasonably could be viewed as a protected free speech issue. Potentially, Iceland could serve as a bitcoin mixing haven.

The emergence of services that mingle bitcoin for the purpose of returning bitcoin not associated with the original input address has had a somewhat spotty history. Also called bitcoin laundries, these web-based services charge bitcoin holders a nominal fee to receive different bitcoins than the ones initially transferred. The sites never handle national currencies like the dollar or euro so technically they are not exchanges. Also, the administrator of the service has to be trusted to delete any archival logs and not to run off with the coins.

The largest such service operating today is the mixing service which has a maximum transaction size of 250 bitcoins and a 0.5% transaction fee. Transaction logs are removed after eight hours and customers can use the taint analysis tool to verify that coins were properly mixed. Other services include BitLaundry and The Bitcoin Laundry operated by Mike Gogulski.

Advances on the decentralized mixer front were highlighted in Olivier Coutu’s largely theoretical presentation at the Bitcoin Conference in San Jose. Although it resolves the trusted intermediary vulnerability, the political debate with decentralized mixers revolves around convincing bitcoin core developers that it is essential functionality or creating a different bitcoin client altogether. Either development approach would subsequently require majority support from the bitcoin mining community.

Zerocoin from Johns Hopkins University is a method whereby the trusted intermediary for mixing can be eliminated. The software is already written and soon to be released as open source code. However, it requires modifications to the core Bitcoin protocol and adoption by the majority of bitcoin miners. With the current political climate tilting towards full disclosure for bitcoin transactions, at least at the exchange level, it is unlikely that Bitcoin core developers would elevate bitcoin privacy to an “all-hands-on-deck” emergency priority. Yes, open source projects are comprised of political animals as well.

According to Johns Hopkins University cryptography professor Matthew Green, Zerocoin researchers are examining voluntary compliance options that reduce but don’t eliminate your transaction privacy, such as accountability limits on dollar amounts of anonymous transactions. This type of alternate approach to Zerocoin adoption would be possible without support of the Bitcoin client software. However, not integrating Zerocoin into the Bitcoin protocol would require third-party services to act as issuers of its anonymizing tokens with trust problems similar to the centralized laundry services.

Also, in-person exchange could act as a pure person-to-person mixing service for bitcoin users that meet in designated places like cafés. Personal mixing has the additional benefit of introducing plausible deniability into the entire bitcoin ecosystem because the coins cease becoming provably yours at that point. After seeing the LocalBitcoins selling-for-cash section in the U.S., Carol Van Cleef, a partner in Patton Boggs’ banking practice and adviser on anti-money laundering policies, ominously warned, “You better get yourself registered, or you better get your name off the list real fast.”

Vitalik Buterin of Bitcoin Magazine argues that Bitcoin is not losing its soul through regulation and that the core principles of the bitcoin protocol, such as user-defined anonymity and user-defined transactional privacy, remain intact due to optional mixing services. This is a critical point because, when it comes to bitcoin oversight, regulators and law enforcement must comprehend that which can be constrained versus that which cannot be constrained.

Otherwise, legislators and government officials risk inadvertently steering Bitcoin advancements in the direction of even more liberating decentralized architectures. Remember, it was the forceful and horrific crackdown on casual file sharers that provided the impetus for the remarkable BitTorrent technology.

One can only defer the bitcoin privacy issue for so long. At some point, Bitcoin core developers, mining operators, lobbyists, and industry thought leaders have to take a principled position and decide on what side of history they wish to stand.

Sunday, June 9, 2013

Why There Is A Demand For Liberty Reserve's Services

By Jon Matonis
Tuesday, June 4, 2013

In a free society with a market-driven economy, payment privacy and payment finality are legitimate and useful features of a currency – physical or digital. To believe otherwise is to submit to the erroneous notion that full, involuntary financial transparency should be the norm and that a cashless society is a noble goal.

By default, Federal Reserve-issued physical cash comes with payment privacy and payment finality. Therefore, cash is a problem to regulators because the flip side to payments privacy is the ability to determine which transactions are seen by the watchful eyes of governments and to store wealth privately.

In a recent BankThink post, American Banker Executive Editor Marc Hochstein points out that "the anonymity-bashing has begun" and that the Feds wrongly demonize privacy in the Liberty Reserve case. Where was the Liberty Reserve government affairs lobbying team and would it have mattered? Also, why did U.S. prosecutors wait 12 years to move on a service provider that had been around since 2001?

These types of enforcement actions can also be viewed as seminal events along the ultimate trail to full cash eradication. Brandished as unnecessary and dangerous, the $100 bill is continually under attack by regulators and in Europe the fabled 500-euro note is more like the monetary unicorn: Many have heard about it but few have seen it.

Once troublesome physical cash is finally eradicated, any digital currency with privacy and irreversibility attributes will be next for scheduled termination. In the case of Liberty Reserve, It's not the individual infractions committed by clients of Liberty Reserve that are worrisome to the regulators, it's the fact that a semi-reliable platform for private payments existed in the first place.

Liberty Reserve provided a service that had a true market demand from legitimate business sectors and from non-criminals, notwithstanding the government’s claim that “virtually all” its business was illicit. If banks and traditional financial institutions still respected basic client privacy and facilitated some form of digital payments that did not always involve harmful reversibility to the merchants, then companies like Liberty Reserve wouldn't even be necessary. In some jurisdictions, the act of not respecting your client's privacy is a punishable event, subject to serious jail time.

In addition to transactional privacy (or anonymity), payment finality is important here. Many users of digital currency systems probably wouldn't object to revealing their identity if they could obtain payment finality.

Otherwise known as irreversible payments, or payments without chargebacks, payment finality is required for a large number of merchant categories that aren't serviced by traditional payment methods. Liberty Reserve satisfied that demand as well.

Naturally, merchants would prefer that all sales were final. But for some merchants, finality is a protection against cardholder fraud. As an industry that suffered a high degree of customer disputes, online gambling is instructive because when certain customers lost in the casino and "changed their mind," it became necessary for these merchants to accept only payment methods with finality.

Gold bullion and coinage is another merchant category that experiences an abnormally high percentage of customer credit and debit card fraud so these merchants are either ignored by the card networks and PayPal or they are charged significantly higher processing fees. To protect themselves, merchants require payment finality or irreversible payment methods. That means using only international wires or services like Liberty Reserve.

Referred to as digital gold, decentralized Bitcoin is also an irreversible payment method. But, bitcoin (small "b") is also the measured unit of account within the overall Bitcoin payment network similar to the LR-USD and LR-EUR units of account within the Liberty Reserve system. The notable difference being that bitcoin is a nonpolitical unit of account whereas LR-USD and LR-EUR were anchored to the respective political units of account.

In the early days of bitcoin, exchangers and sellers of the currency suffered because Visa MasterCard and PayPal blocked any transactions involving the acquisition of bitcoin, and for good reason. The purchasing of an irreversible instrument is simply not a good match for a payments industry that offers transaction repudiation, merchant chargebacks, and also has to absorb losses from counterfeit cards. To get their money to the Bitcoin exchanges, customers were forced to rely on expensive international wires and the services of Liberty Reserve. This was done more for the payment finality reasons than any desired anonymity.

Other business sectors that benefit from payment finality include online casino gaming, sports betting, lotteries, adult services, pawn shops, credit repair services, debt settlement services, and virtual currency exchanges that involve the trade of other negotiable instruments or the loading of prepaid cards. Although operating as legal businesses in many jurisdictions, these merchant categories have typically been labeled as high-risk and subsequently restricted by the payment networks. Liberty Reserve filled the market need left by the larger payment networks.

Liberty Reserve also extended into the foreign exchange trading world, as a means of paying independent brokers who signed up clients for forex trading firms, and in some cases as a deposit option for client accounts. In these cases, the Liberty Reserve payment system acted as an international wire service for regions of the world that were totally ignored or blockaded by SWIFT and the international banking system.

Masroor Ghoori, a foreign exchange broker and analyst in Pakistan, told the website Forex Magnates, "Forex brokers have been benefiting from Liberty Reserve's vast access as a payment provider, especially in countries where traders face difficulties in transferring funds. Liberty Reserve was a 'gift' for several traders, especially after the State Banks' (State Bank of Pakistan) changes to international money transfers."

Widely used by foreign exchange traders where domestic central banks restricted bank transfers to foreign entities, such as in Malaysia, Pakistan, Nigeria, Argentina, and Brazil, Liberty Reserve thrived as the preferred payment method. It offered traders a fast and cost effective funding method.

Clearly, identity is not the entire agenda. Any payment service offering payment finality must be "in the system," because according to the government, payment finality cannot be left to the free market. In the U.S., the government is the final arbiter of what transactions may or may not be reversed and it wants mandatory account identification because it facilitates the targeted enforcement. In the physical world with cash and gold, the power is exercised via seizure and confiscation. In the digital world with electronic accounts, the power is exercised through transaction reversals and account suspensions. At its essence, Liberty Reserve was an electronic value transfer service where payment finality was provided by the operator without judgment.

Choice in currency is a freedom of speech issue. Failing to recognize that fact only serves to strengthen the entrenched payment oligarchies and to undermine personal liberties in the transactions environment.

Today, voluntarily exiting the digital banking system has become a popular method of attaining a relative degree of financial independence and safety. Expect to see a lot more of these voluntary exits especially since the free market has been mostly stripped of digital payment finality and "Cyprus-ed" has become a verb.

Wednesday, June 5, 2013

New Bitcoin VC Fund Seeks Edge with Regulatory, Security Skills

By Jon Matonis
American Banker
Wednesday, May 29, 2013

A new investment fund dedicated to Bitcoin startups aims to bring digital money entrepreneurs up to speed in two areas where they have proven most vulnerable: network security and compliance.

This month Liberty City Ventures, based in New York, launched the $15 million Digital Currency Fund, which seeks to invest in all types of firms in the Bitcoin ecosystem, including exchanges, banks, brokerages, investment services, insurance, infrastructure, and supporting products and services. It is the largest Bitcoin-related investment fund to date.

As host and sponsor of the monthly NY Bitcoin Startups Meetup, Liberty City Ventures has been involved in the broader Bitcoin ecosystem through mining and currency investing for a number of years. The team is also very familiar with financial services and payment system startups, having recently retained former U.S. Treasury officials and regulators and computer engineers as advisors.

Very few computer security professionals have crossed over into the bitcoin financial realm and the startups have simply not had the capital to replicate the security infrastructure and procedures of a large commercial bank. Even though real-time access to bitcoin is similar to the handling of physical cash, sophisticated management of multiple "hot wallets" (Bitcoin accounts connected to the Internet) and "cold wallets" (coins stored offline, such as in a USB drive in a bank vault) is a relatively new technical skill set.

Hence, Bitcoin-related firms such as InstaWallet have suffered devastating security hacks. And recent government actions against Mt. Gox, the world’s largest exchange for trading bitcoins for government currencies, and Liberty Reserve, which issued its own private currency, underscore the importance of regulatory expertise to companies in this space. (For the record, Liberty City Ventures has no affiliation with Liberty Reserve.)

As TechCrunch said, paraphrasing Liberty City founding partner Charles Cascarilla, "none of the current [investment] options would live up to the type of scrutiny that most real-world banking institutions face." Cascarilla told PandoDaily he sees an opportunity to bring advanced trading technology along with capital to the sector.

Liberty City was founded about nine months ago as the early-stage venture division of Cedar Hill Capital Partners by technology investors Cascarilla, Emil Woods, Andrew Chang, and Dorothy Jean. The fund has already raised capital from high net worth individuals and secured commitments from institutional investors. Additionally, the firm plans to establish a Bitcoin incubator in Manhattan catering to the needs of young digital currency startups.

Since the complex nature of payment systems and surrounding regulation is inherently capital-intensive, the fund's founders recognized that the initial capital required for success will much larger than a social-media or mobile tech startup would need. "Our typical investment size will vary based on the type of startup backed,” says Jean, 29 years old. “For example, a currency exchange might require significantly more capital than a wallet or eCommerce company."

In addition to companies that are proactive with respect to network security and regulatory compliance, it appears that Liberty City will concentrate initially on New York City-area companies since those are the entrepreneurs the founders know best. However, they are not prepared to announce any angel investments at this time.

The fund’s current largest competitor is Union Square Ventures, which recently led the $5 million round for the exchange and wallet service Coinbase. Other significant operators investing in the fast-moving space include Barry Silbert's Bitcoin Opportunity Fund, Adam Draper's Boost Bitcoin Fund, Chris Dixon at Andreessen Horowitz, Peter Thiel's Founders Fund, and Tyler and Cameron's Winklevoss Capital Management.

A large fund size and a dedicated focus certainly meet the requirements for the emerging digital currency sector. However, the ability to think globally as a service provider will prove critical for those Bitcoin companies wanting to maintain a leadership role. Liberty City Ventures would be wise to partner with similar investment efforts in other international jurisdictions.

Sunday, June 2, 2013

U.S. Shuts Liberty Reserve Currency Exchange

By Jon Matonis
Tuesday, May 28, 2013

In conjunction with Costa Rican authorities and Spanish police, U.S. law enforcement participated in a joint operation on Friday to arrest the founder of Liberty Reserve S. A., a private digital currency exchange service based in Costa Rica.

U.S. authorities accused the currency exchange of facilitating $6 billion worth of money laundering, calling it a “bank of choice for the criminal underworld.”

Today, the website domain is resolving again but a notice on the homepage states: “THIS DOMAIN NAME HAS BEEN SEIZED by the United States Global Illicit Financial Team.” Domain names were also seized for,, and most likely for their affiliation with Liberty Reserve.

According to the indictment unsealed today, U.S. prosecutors said that the case involved law enforcement agencies in 17 countries and “is believed to be the largest international money laundering prosecution in history.” This latest action follows the 2007 closure of Doug Jackson’s famous e-gold service and this month’s seizure of Mt. Gox’s assets and account facility at U.S.-based Dwolla.

Arthur Budovsky, 39, a former U.S. citizen and naturalized Costa Rican of Ukrainian origin, was arrested in Spain and U.S. officials are likely to seek his extradition. He has been under investigation in Costa Rica since 2011 for suspicion of money laundering and for using various shell companies to operate Liberty Reserve.

On Friday, San José prosecutors raided Budovsky’s home and offices in Escazú and Santa Ana, southwest of San José, and in the northern province of Heredia. Agents from the organized crime unit of the Costa Rican Prosecutor’s Office seized documents, computers, three Rolls Royce and Jaguar automobiles, and a motorcycle. A Russian national with the last name Chukharev was also arrested and the U.S. is seeking his extradition as well.

Costa Rica state prosecutor José Pablo Gonzalez said that Costa Rica’s financial regulator, Financial Institution Superintendency (SUGEF), had refused to issue a license to Liberty Reserve in 2011 due to concerns about its transparency and funding procedures.

Investigators allege that Budovsky’s businesses in Costa Rica were used to launder funds from drug trafficking, identity theft, and pornography websites. The seized digital and physical evidence from the companies will be turned over to U.S. law enforcement in accordance with “international penal assistance.” The involved companies are Silverhand Solutions & Technology S.A. (Santa Ana), Worldwide E-Commerce Business S.A., or WEBSA (Escazú), Grupo Lulu Limitada (Escazú), Triton Group A & A, S.A. (Escazú), and (Santa Ana).

Some Liberty Reserve users are estimating that the company may have held customer funds in excess of $150 million at the time of the seizure. There has been no statement from authorities on the reclamation process.

Since 2002, Liberty Reserve had been operating one of the oldest and most popular payment processors in the world with millions of clients. Vitalik Buterin of Bitcoin Magazine credits the company with being “one of the chief enablers of the Bitcoin economy’s early growth.” Payment methods such as credit cards and ACH transfers are not a great match for the irreversible bitcoin, because those payment methods can be reversed, or charged back. In 2010 and 2011 with the bitcoin exchanges struggling for irreversible inbound payment methods, Liberty Reserve Dollars and Liberty Reserve Euros were proprietary digital units that satisfied the need for payment finality.

Although security researcher Brian Krebs emphasizes the more salacious cyber crime aspects of the case, Liberty Reserve was also utilized by many legal businesses.

According to Forex Magnates, Liberty Reserve was “the leading payment channel for traders in emerging and frontier markets” and it was used by several international forex brokers, such as Marketiva, FXOpen,, and Instaforex. Citing Masroor Ghoori, a foreign exchange broker in Pakistan, Forex Magnates said, “Forex brokers have been benefiting from Liberty Reserve’s vast access as a payment provider, especially in countries where traders face difficulties in transferring funds. Liberty Reserve was a ‘gift’ for several traders, especially after the State Banks’ (State Bank of Pakistan) changes to international money transfers.”

In a separate report, Forex Magnates predicts that bitcoin may be a viable alternative for payments to introducing brokers and even direct forex account funding now that centralized systems are under attack.

Mitchell Rossetti, co-founder of virtual prepaid ePay Cards, told the BBC that his company now faces an “uphill battle” to make up potentially lost funds because his business had about $28,000 sitting in a Liberty Reserve account at the time the site went offline. The cards allow consumers outside the U.S. to purchase goods from stores in the country as if they owned a locally-issued Visa or Mastercard credit card. Based in Texas and London, the firm allowed its customers to load their virtual prepaid cards with Liberty Reserve because it was quick, efficient and secure.

Demonstrating that those most harmed in targeted digital currency shutdowns are law-abiding U.S. citizens, Panamanian payment system Perfect Money announced the following on Saturday:

"Due to changes in our policy we forbid new registrations from individuals or companies based in the United States of America. This includes US citizens residing overseas. If you fall under the above mentioned category or a US resident, please do not register an account with us. We apologize for inconvenience caused."