This article was first delivered as a seminar to the Young Fraud Lawyers in the North Association. The article has since been updated and a PDF of the updated version is here.
“Rather as with contract bridge, the effort required to get your head around Bitcoin seems wildly disproportionate to any potential benefit that might conceivably head your way.
Rhodri Marsden, The Independent, 2nd January 2014
1. The History of Digital Currencies
2. The Development of Bitcoin
3. How Bitcoin Operates in Practice
4. The Positives/Negatives of Bitcoin as a currency
5. How Bitcoin Can be Used for Crime
6. Opportunities for Lawyers
1. The History of Digital Currencies
1. Although Bitcoin is very much in the news at present, it is not the first digital currency. Others have lived relatively long lives but have usually closed amidst allegations of fraud.
2. Perhaps the best known is E-Gold. It was a digital gold currency allowed users to open an account on their web site denominated in grams of gold (or other precious metals) and gave them the ability to make instant transfers of value to other E-gold accounts. The company was founded in 1996 and had grown to five million users by 2009, when it was shut down by the US Department of Justice. At its peak in 2009 E-gold was processing more than US $2 billion worth of precious metals transactions per year.
3. The driving force behind e-gold was Douglas Jackson, who in July 2008 pleaded guilty to running an illegal money transmitting business and to aiding money laundering, after federal investigators suggested that “criminals of every stripe gravitated to e-gold as a place to move their money with impunity”; but he was only fined.
4. You can’t keep a good man down. In late November 2013 Mr Jackson emerged as consultant to a membership organisation called Coeptis that hopes to launch a new version of his gold-backed currency, as a rival to Bitcoin and to help businesses avoid the costs involved in transferring money using major clearing banks. The chief executive of the parent company announced that “We believe we will have better anti-money laundering procedures than any other virtual currency business and that we will compare well with the banking industry,”
5. Other digital currencies that bit the dust amidst allegations of fraud were the Digital Money Trust, Flooz and Liberty Reserve.
6. Bitcoin is not unique. There are others, which work in similar ways, vying for popularity at the moment. Most of them are easily recognised because the word “coin” always appears. There are Litecoin, Namecoin, Peercoin, Primecoin, Feathercoin, Novacoin, Infineticoin, Megacoin and Quark Coin, to name just a few. You can even create your own digital currency using a service at coingen.bluematt.me.
7. So let’s look at how Bitcoin developed and why it has obtained such prominence.
2. The Development of Bitcoin
The Beginning
8. Bitcoin was created by Satoshi Nakamoto. He probably doesn’t exist, there are no photos of him and no-one has met him, but the development of Bitcoin goes back to a paper written in his name in 2009, “Bitcoin: A Peer-to-Peer Electronic Cash System”. It was introduced as open-source software, that is to say that anyone can download the code of the programme, see how it works and suggest or make improvements. (http://bitcoin.org/bitcoin.pdf).
A “Cryptocurrency”
9. Bitcoin is a cryptocurrency, so-called because it uses public key cryptography for security. Users send payments by broadcasting digitally signed messages to the network. Transactions are verified, time-stamped, and recorded by specialised computers into a shared public transaction history database called the “block chain” (more of which later).
10. The purpose of Bitcoin, thinly veiled or perhaps not veiled at all, it to allow currency transactions online to take place without there being a central organisation (eg a bank) to control what happens. As the Nakamoto paper said:
“The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions … what is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”
11. The paper went on to say that the usual solution is:
“… to introduce a trusted central authority, or mint, that checks every transaction for double spending. After each transaction, the coin must be returned to the mint to issue a new coin, and only coins issued directly from the mint are trusted not to be double-spent. The problem with this solution is that the fate of the entire money system depends on the company running the mint, with every transaction having to go through them, just like a bank.”
12. So the essential raisons d'être were:
(i) to avoid transaction costs;
(ii) and to avoid reliance on a vulnerable central authority such as a bank,
and these remain the most often used justifications for the system.
13. The problem which Mr Nakamoto purported to solve was this:
“How can you ensure that Bitcoins are not spent twice without introducing a central financial institution to monitor the transactions ?”
14. The solution was a purely “peer-to-peer” version of electronic cash which would allow online payments to be sent directly from one party to another without going through a financial institution. A digital signature provided part of the solution, but did not solve the problem altogether. What was proposed was the introduction of a peer-to-peer network which would timestamp transactions by “hashing“ them (i.e. using an algorithm to turn the data into a fixed length series of letter and numbers) into an ongoing chain of proof-of-work, forming a record that cannot be changed .
15. Bitcoin wanted, though, to retain some form of “privacy”. We will come on to wonder why in due course, although there is an understandable desire for people not to want the world to know their business. Banks retain privacy by limiting the amount of information that is made public while keeping a careful record of what happened; but to ensure the integrity of a Bitcoin (i.e. that it had not been spent twice), all transactions needed to be announced publicly.
16. The solution was that “public” keys to the transactions could be kept anonymous, i.e. the public could see that someone was sending an amount to someone else, but without publishing the identities of the individuals.
17. The necessity to announce all transactions publicly precludes this method, but privacy can still be maintained by breaking the flow of information in another place: by keeping public keys anonymous. The public can see that someone is sending an amount to someone else, but without information linking the transaction to anyone.
18. There was perceived to be a risk of attack from outside the network, but this was to be overcome by the fact that it would not normally be possible to create a transaction chain that was as long as the genuine one in the same time. It would be more profitable to use the computing power required to create Bitcoins.
19. Of less threat to Bitcoin there are anecdotal reports of clusters of computer users, using Trojan software to hack into clusters of computers (often in Universities) to use their processing power. Although this doesn’t undermine the currency at face value, it provides a disincentive for “honest miners” (more of this in a moment) and threatens its legitimacy.
How do Bitcoins come into Existence ?
20. This takes us to the altogether mystical way in which Bitcoins come into existence in the first place.
21. When you send some Bitcoins to someone, you create a message, attaching the new owner's “public key” to the amount of coins, and sign it with your “private key”. When this transaction is broadcast to the Bitcoin network, this lets everyone know that the new owner of these coins is the owner of the new key. Your signature on the message verifies for everyone that the message is authentic. The complete history of transactions is kept by everyone, so anyone can verify who is the current owner of any particular group of coins.
22. This complete record of transactions is kept in the block chain, which is a sequence of records called blocks. All computers in the network have a copy of the block chain, which they keep updated by passing along new blocks to each other. Each block contains a group of transactions that have been sent since the previous block. In order to preserve the integrity of the block chain, each block in the chain confirms the integrity of the previous one, all the way back to the first one, the “genesis block”.
23. Each block contains, among other things, in its block header a record of some or all recent transactions, and a reference to the block that came immediately before it. It also contains an answer to a difficult-to-solve mathematical puzzle - the answer to which is unique to each block. New blocks can't be submitted to the network without the correct answer - the process of "Mining" is essentially the process of competing to be the next to find the answer that "solves" the current block.
24. Mining is a very complicated process which requires huge computational power. The operators of these computers, almost always now working in pools, are rewarded with transaction fees and newly minted Bitcoins. This is how Bitcoins are created. The reality is that mining is now almost exclusively a commercial process, albeit that some single user groups exist. The difficulty for them is that the more people who try to mine at any one time raises the difficulty of the problem to be solved, meaning ever greater processing power is required.
25. There is a fixed number of Bitcoins; at present it is estimated that there are about 11 million and the maximum possible is 21 million. It has been predicted that we will get to 21 million Bitcoins in 2040 but that depends on a number of factors including how hard the puzzles are to solve.
3. How Bitcoin Operates in Practice
26. A quick guide comes from the video from the official Bitcoin website at http://bitcoin.org/en/. The video is also on YouTube at http://www.youtube.com/watch?v=Um63OQz3bjo.
27. There are two very important statements in the video which might attract criminal activity:
(i) “Your account cannot be frozen”; and
(ii) “After a few minutes the transaction is verified by a miner and permanently and anonymously stored in the network” .
28. The website also provides some handy advice on starting up with Bitcoin. There are three types of wallet that you can use to store your Bitcoins, a Software Wallet which is installed on your computer, a Mobile Wallet for your phone which can be used to pay in shops by scanning a QR code or using NFC "tap to pay", or a Web Wallet, which is exactly what it says. So to the website.
Some things you need to know
http://bitcoin.org/en/you-need-to-know
29. Securing your wallet: “Always remember that it is your responsibility to adopt good practices in order to protect your money.” This is important. In November 2013 the British press widely reported the plight of James Howell, who realised that in a summer clear-out he had thrown away a hard drive with the details of his digital wallet containing 7,500 Bitcoins, then worth about £4m. He began but later gave up his search on the Docksway landfill site, near Newport, South Wales. His money is lost forever. Perhaps this is why Elliptic Vault, with the backing of Lloyds of London, recently launched an insured “deep cold storage” service to hold Bitcoins using secure physical locations and strong encryption.
30. Bitcoin price is volatile: “The price of a Bitcoin can unpredictably increase or decrease over a short period of time due to its young economy, novel nature, and sometimes illiquid markets. Consequently, keeping your savings with Bitcoin is not recommended at this point.” We will see just how volatile it is in a moment.
31. Bitcoin payments are irreversible: “Any transaction issued with Bitcoin cannot be reversed, they can only be refunded by the person receiving the funds. That means you should take care to do business with people and organizations you know and trust, or who have an established reputation.”
32. Bitcoin is not anonymous: “Some effort is required to protect your privacy with Bitcoin. All Bitcoin transactions are stored publicly and permanently on the network, which means anyone can see the balance and transactions of any Bitcoin address. However, the identity of the user behind an address remains unknown until information is revealed during a purchase or in other circumstances. This is one reason why Bitcoin addresses should only be used once. Always remember that it is your responsibility to adopt good practices in order to protect your privacy.”
33. “A Bitcoin transaction is usually deployed within a few seconds and begins to be confirmed in the following 10 minutes. During that time, a transaction can be considered authentic but still reversible. Dishonest users could try to cheat.”
34. Bitcoin is still experimental: “Bitcoin is an experimental new currency that is in active development. Although it becomes less experimental as usage grows, you should keep in mind that Bitcoin is a new invention that is exploring ideas that have never been attempted before. As such, its future cannot be predicted by anyone.”
35. Don't forget government taxes: “Bitcoin is not an official currency. That said, most jurisdictions still require you to pay income, sales, payroll, and capital gains taxes on anything that has value, including Bitcoin.
Protect your privacy
http://bitcoin.org/en/protect-your-privacy
36. Before the money launderers out there give up Bitcoin as a bad job, they should consider some extra official advice about privacy. The detail suggests that it really is possible to move money anonymously. We are told that “Bitcoin is often perceived as an anonymous payment network. But in reality, Bitcoin is probably the most transparent payment network in the world. At the same time, Bitcoin can provide acceptable levels of privacy when used correctly.”
37. Understanding Bitcoin traceability: “Anyone can see the balance and all transactions of any address. Since users usually have to reveal their identity in order to receive services or goods, Bitcoin addresses cannot remain fully anonymous. For these reasons, Bitcoin addresses should only be used once and users must be careful not to disclose their addresses.”
38. Use new addresses to receive payments: “To protect your privacy, you should use a new Bitcoin address each time your receive a new payment. Additionally, you can use multiple wallets for different purposes. Doing so allows to isolate each of your transactions in such a way that it is not possible to associate them all together. People who send you money cannot see what other Bitcoin addresses you own and what you do with them. This is probably the most important advice you should keep in mind.”
39. Use change addresses when you send payments: “You can use a Bitcoin client like Bitcoin-Qt that makes it difficult to track your transactions by creating a new change address each time you send a payment.”
40. Be careful with public spaces: “Unless your intention is to receive public donations or payments with full transparency, publishing a Bitcoin address on any public space such as a website or social network is not a good idea when it comes to privacy.”
41. Your IP address can be logged: “Because the Bitcoin network is a peer-to-peer network, it is possible to listen for transactions' relays and log their IP addresses … you might want to consider hiding your computer's IP address with a tool like Tor so that it cannot be logged.” This, we will see, is very important.
4. The Positives/Negatives of Bitcoin as a currency
42. Before looking at the criminal use of Bitcoin, it is worth seeing how its general use is being reported. I have not always given references for the news reports; some items have been very widely reported, but for others it will be obvious that some circumspection is required.
43. There have been some very high profile announcements in relation to Bitcoin suggesting that it has a legitimate commercial future:
(a) In August 2013, Bitcoin was recognized by the German Finance Ministry as a "unit of account", meaning it is can be used for tax and trading purposes in the country. This was good news and bad news. Its legal recognition was obviously a positive, but it also means that any profit from them is subject to Germany’s capital gains tax, at 25% unless they are held for more than a year.
(b) On the 15th September Wordpress 2013, the blogging site, announced that it would accept Bitcoins to purchase upgrades to its services.
(c) On the 2nd May 2013 San Diego launched the first Bitcoin ATM, where you can deposit cash to have Bitcoins transferred to your Bitcoin wallet on your phone, or withdraw cash after scanning your phone at the ATM. At that time the transfer rate was US $100 to 1 Bitcoin. The first ATM was unveiled for use in Vancouver in a café on the 29th October 2013. By then the exchange rate was US $211 to 1 Bitcoin.
(d) On the 5th November 2013 the Canada Revenue Agency website recognised digital currencies including Bitcoin, saying that although Bitcoins are not controlled by central banks or any country, and can be traded anonymously, tax rules still apply and when digital currency is used to pay for goods or services, the rules for barter transactions apply. The value of the goods purchased using digital currency must be included in the seller’s income for tax purposes. Digital currency can also be bought or sold like a commodity. Any resulting gains or losses could be taxable income or capital for the taxpayer.
(e) On the 18th November 2013 a Justice Department official said at the Senate Committee on Homeland Security and Governmental Affairs meeting that Bitcoins can be “legal means of exchange”, boosting prospects for wider acceptance. The Chairman of the Federal Reserve, Ben Bernanke, told the Senate committee that it has no plans to regulate the currency. Jennifer Calvery, director of the Financial Crimes Enforcement Network, said that "Innovation is a very important part of our economy. It's something for us to be proud of.” Mythili Raman of the Justice Department said "There is good reason for us to remain watchful … but we also intend to balance that against the need for legitimate users to use the technology.” Edward Lowery of the Secret Service testified that cyber criminals "have not by and large gravitated toward peer-to-peer cryptocurrencies." Rather, they "have by and large gravitated toward centralized digital currencies that are based in a locale that may have less regulatory guidelines and less aggressive law enforcement." The timing of this meeting is important, as it was after the arrest of Ross Ulbricht, which we will come to soon.
(f) On the 22nd November 2013, Richard Branson announced that Virgin Galactic would accept Bitcoin for its space flights, saying “All of our astronauts are pioneers … and this is one more way to be forward-thinking'.
(g) On the 5th December 2013 the Guardian reported that Bitcoin had been endorsed by a Wall Street currency analyst who claimed it shows "clear potential for growth". David Woo of Bank of America Merrill Lynch argued that "Bitcoin can become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money transfer providers".
(h) On the same day the Daily Telegraph reported that the Mayor of Vicco, Kentucky had approved a measure to pay Tony Vaughn, the Chief of Police, in Bitcoins.
(i) On the 10th December 2013 Mel B, the former Spice Girl, announced that she would accept Bitcoins for the digital download of her new single.
(j) On the 21st January 2014 Cumbria University announced that it will accept Bitcoins for two new courseson the roles of complimentary currencies in economic systems, which will be taught from summer this year.
(k) Just last week the New York Department of Financial Services held two days of hearings to try to devise a framework for regulating digital currencies, according to the Wall Street Journal. Although this is not necessarily good news for everyone using Bitcoins, it does give rise to a future stability that has not always seemed possible.
(l) On the 6th February 2014 Bitcoin took a further significant step towards inserting itself into the global financial system when Perseus Telecom, a provider of heavy-bandwidth telecommunications connections for securities exchanges and their customers in the United States, said it would accept payments in the digital currency.
(m) And finally, on the 13th February 2014 Sheridans, the media solicitors, became the fist UK law practice to accept payment in Bitcoins.
44. But there have been many significant setbacks too:
(a) On the 29th July 2013 Bitcoin itself announced that it had suspended activities in Thailand. After receiving a presentation from Bitcoin, the Foreign Exchange Administration and Policy Department advised that “due to lack of existing applicable laws, capital controls and the fact that Bitcoin straddles multiple financial facets, Bitcoin activities are illegal in Thailand”. This extended to buying Bitcoins, selling Bitcoins, buying any goods or services in exchange for Bitcoins, selling any goods or services for Bitcoins, sending Bitcoins to anyone located outside of Thailand and receiving Bitcoins from anyone located outside of Thailand.
(b) On the 28th November 2013 JP Morgan, America’s biggest bank, filed a patent for its own digital currency. The press described it as a “Bitcoin Killer”; but because wallets were to be stored on a “host web server”, presumably under the control of JPMorgan, it is not a real rival.
(c) On the 1st December 2013 the illicit “dark net” market Sheep Marketplace was shut down after US $5.3m (£3.3m) in Bitcoins was stolen from the site.
(d) On the 5th December 2013 China’s central bank barred financial institutions from handling Bitcoin transactions, in a move designed to regulate after an 89-fold jump in Bitcoin’s value sparked a surge of investor interest in the country. We will look at the fluctuations in value shortly.
(e) On the following day, the 6th December, the music service on Baidu, China’s biggest search engine was suspended. Its Internet announcement said that due to the recent fluctuations in the price of Bitcoin, it felt unable to protect the interests of its users.
(f) On the 10th December 2013 the Guardian reported that Apple had forced the secure messaging app Gliph to remove the ability to send Bitcoin payments or be removed from the iOS App Store. The move reinforced belief that the company has an unstated policy against allowing Bitcoin apps on the store, despite allowing alternative forms of ecommerce such as apps from PayPal and Square.
(g) On the 18th December 2013 the BBC reported that BTC China, its biggest Bitcoin exchange, was saying that local exchanges had been blocked from providing it with clearing services, meaning that it could no longer accept deposits based on the main Chinese currency, the Yuan. This caused the price of a Bitcoin to tumble once more, reportedly as low as US $421.
(h) There is a lack of clarity about the VAT position with Bitcoins in the UK, meaning that Bitcoin exchanges here face uncertainty. Anecdotal evidence suggests that HMRC are classifying Bitcoins as vouchers, which means VAT would be due on any sales. A 20% mark-up on Bitcoin prices would make UK exchanges untenable. In December 2013 representatives from the UK Bitcoin industry met HMRC and on the next day, Tom Robinson of BitPrice reported that HMRC guaranteed it would withdraw its previous guidance about Bitcoin, changing the classification. However the HMRC press release on the 20th January 2014 was rather more circumspect, saying:
“There is a VAT exemption for currency transactions but the currency in question must be legal tender. We have held constructive meetings with stakeholders, but this is a complex issue, and we will continue to listen to arguments for alternative VAT treatments under existing VAT law. Most assets are liable to Capital Gains Tax when sold or disposed of. This includes gains on non-sterling currency, other than foreign currency bought for personal use outside the UK. We are reviewing this very complex area and considering how VAT should be applied."
(i) There have been problems in India; on the 27th December 2013 Sky News reported that the Indian Central Bank had issued advice saying "There is no underlying or backing of any asset for virtual currencies and as such their value seems to be a matter of speculation … the huge volatility in the value of virtual currencies has been noticed." BuySellBitCo.in, India's biggest Bitcoin trading platform, suspended operations after the warning, although it appears to be up and running again.
(j) One of the big concerns about Bitcoin is the volatility of the price. Bitcoins can be exchanged for US Dollars relatively easily but there have been huge fluctuations. The chart below shows the price as against the US Dollar for the year from the 7th January 2012 to the 7th January 2013. There has obviously been a huge increase but sudden drops occurred. The large drops in December coincided with the problems in China.
After further international exchange problems, on the 13th February 2014 one Bitcoin was worth US $645.
5. How Bitcoin Can be Used for Crime
The Silk Road and Ross Ulbricht
45. The most notorious criminal use of Bitcoins is alleged to have been controlled by 29-year-old American Ross Ulbricht. He is awaiting trial in New York on counts of conspiring to commit narcotics trafficking, conspiring to commit computer hacking and conspiring to commit money laundering. Here the information has a clear source, as remarkably both the Criminal Complaint and the letter opposing bail from the US Attorney Preet Bharara are freely available on the internet.
46. The prosecution allege that Ulbricht owned and operated an underground website known as “Silk Road,” a bustling black-market bazaar where illegal drugs of every variety were sold, along with other illegal goods and services, such as malicious computer software and fake identification documents. Silk Road was the most prominent of a number of websites that operate as what is sometimes called the “dark web” or the “darknet marketplace”.
47. At the same time, the site sought to operate outside the reach of law enforcement, by running on a special part of the Internet known as the “Tor” network, designed to hide users’ true IP addresses (and thereby their identities and locations), and by requiring all purchases to be made with Bitcoins. You will remember that the use of the Tor Network (sometimes know as the Onion Router) is openly advocated on the official Bitcoin website.
48. The prosecution allege that during its two-and-a-half years in operation, Silk Road was used by several thousand vendors to distribute hundreds of kilograms of illegal drugs and other illicit goods and services to well over a hundred thousand users, as well as to launder hundreds of millions of dollars from these illegal transactions.
49. Those basic facts do not seem to be in issue; what really matters is who owned and operated the Silk Road. The online identity of that person is “Dread Pirate Roberts” or “DPR”; the question is whether Ross Ulbricht is that man. This was not small-time villainy. It is said that Ulbricht managed a small staff of employees who assisted in the day-to-day operation of the site but that he alone controlled the profits generated as commissions (ranging from 8 to 15% depending on the value of the transaction) from the illicit sales conducted through the site. The Complaint also describes how Ulbricht was willing to use violence to protect his online drug empire, commissioning six “murders for hire” in seeking to guard his interests in Silk Road. He has been separately charged with one of these attempted murders in an indictment issued by the United States Attorney’s Office for the District of Maryland.
50. So how was Ulbricht caught ? Interestingly, it does not appear to have been through the use of Bitcoins. The slip-up came from the computer code embedded in the Silk Road server which restricted administrative access to a single IP address (Internet Protocol addresses are assigned to a single device in any network), the last log-in for which was at an Internet Café very close to Ulbricht’s San Francisco address. His gmail account was being used from a friend’s house in San Fransisco close to the café, and they posted a Youtube video saying that they were living together. He moved to another address in San Francisco in July 2013 and a package of counterfeit documents with his photograph were sent there (though they were first intercepted by the authorities) from Silk Road at a time when “DPR” was seeking them on the website.
51. The prosecution allege that Ulbricht posted to a discussion forum for computer programmers using the username “frosty,” seeking advice concerning an error generated by certain computer code he was developing. A modified version of that computer code was found on the Silk Road web server, which was covertly imaged during the Government investigation. A login authentication key was also found on the server, containing the string “frosty@frosty,” indicating that “frosty” was the name of the only user, as well as the name of the only computer, authorized to log in to the Silk Road server directly.
52. On the 2nd October 2013 Ulbricht was arrested while working on his laptop computer at a San Francisco public library. The evidence recovered from the computer is said conclusively to confirm that Ulbricht was in fact the individual who created and controlled the Silk Road website:
(a) Ulbricht was logged in to the Silk Road website at the time he was arrested. The webpage open on his Tor-enabled Internet browser was part of the administrative infrastructure of Silk Road, consisting of a customer-support interface listing messages from Silk Road users that had been flagged for administrative attention.
(b) The previous two pages he had viewed in the browser were similarly part of the Silk Road administrative interface: one page contained a customer-support control panel from which various administrative actions could be taken, e.g deleting listings, demoting sellers; the other page, titled “mastermind,” provided an overview of the transactions and money moving through the site.
(c) Further, in a separate window, Ulbricht had a Tor-enabled chat program open, in which he was logged in under the username “dread,” paired with an avatar matching the avatar of “DPR” on Silk Road. Finally, the name of Ulbricht’s computer appeared in the top right-hand corner of the screen as “frosty”, and a check of the name of the computer revealed that it too was named “frosty” matching, again, the login authentication key recovered from the Silk Road web server.
(d) Forensic analysis of Ulbricht’s computer since his arrest has yielded abundant additional evidence of his operation of Silk Road. Most significantly, Ulbricht kept a journal on his computer in which he wrote about his creation and operation of Silk Road.
(e) For example, one spreadsheet, titled “sr_accounting,” lists hundreds of expenditures relating to Silk Road, from “server rent” to “pay off hacker,” spread throughout 2010 to 2013.
(f) In another spreadsheet, titled “NetWorthCalculator,” Ulbricht listed all of his assets and liabilities, the most notable of which was an entry for “sr inc,” listed as an asset worth US $104 million. Moreover, actual proceeds (from commission fees) derived from Silk Road were found on the computer, in the form of a Bitcoin wallet containing approximately 144,000 Bitcoins, equivalent to over US $20 million based on prevailing exchange rates at the time of Ulbricht’s arrest.
53. The site had well over a hundred thousand users. Not only did the site make it easy for drug dealers to conduct sales online, but it also vastly expanded their geographic reach. Silk Road made illegal drugs available to anyone with an internet connection and a shipping address.
54. The intended killer for the first “murder for hire” was a user claiming to be a large-scale narcotics trafficker, but he was in fact was an undercover law enforcement agent. On the 26th January 2013, Ulbricht through his “DPR” account on Silk Road’s private message system, told the undercover officer that a Silk Road employee (the “Employee”) had stolen approximately US $350,000 in Bitcoins from Ulbricht, by taking advantage of “some of the tools I gave him to do vendor support to rip a bunch of vendors off, who I will have to compensate.” At first he wanted the employee “beat up” and “forced to send the bitcoins he stole back”, but later he said that he wanted to “change the order to execute rather than torture”.
Other Arrests and Other Sites
55. In December 2013 the Southern District of New York issued an unsealed indictment against Andrew Michael Jones, Peter Phillip Nash and Gary Davis, accusing them of participating in the Silk Road’s conspiracy to traffic in narcotics, as well as computer hacking and money laundering, working for Ulbricht. Jones was arrested in the USA but Nash was arrested by Australian Federal Police in Brisbane, Australia and Davis is believed to be at large in Ireland.
56. Earlier in December a federal grand jury in Oregon charged four Portland-area residents with selling methamphetamine (well known to Breaking Bad viewers) through the Silk Road. It is alleged that they made more than 3,000 sales between August 2012 and August 2013 to buyers in the United States, Australia, Canada, Czech Republic, Italy and the UK.
57. Just like all great criminal enterprises, the removal of the Silk Road website led to a number of imitators emerging, including Silk Road 2.0, Sheep Marketplace (now shut down) and Blackmarket Reloaded. The dark net and digital currencies are here to stay.
58. On the 27th January 2014 Charlie Shrem, chief executive of New York-based BitInstant, and Robert Faiella, a virtual currency trader known as BTCKing, were arrested in the United Stated for conspiring to sell over $1 million Bitcoins (£603,000) to users of black market website Silk Road and for operating an unlicensed money transmitting business, who allegedly used the site to buy drugs anonymously.
59. The Ulbricht criminal complaint describes the overall statistics thus:
(i)From the 6th February 2011 to the 23rd July 2013 there were 1,229,465 transactions completed on the Silk Road site.
(ii) More than 100 undercover purchases from the site by law enforcement agencies revealed high quality drugs being sent from 10 different countries.
(iii) The value of the transactions over this period are equivalent to US $1.2 billion in revenue and US $79.8 million in commissions.
(iv) The site had 146,946 registered buyers and 3,877 registered vendors.
(v) During the 60-day period from 24th May to the 23rd July 2013, there were 1,217,218 messages sent over Silk Road's private messaging system.
(vi) Silk Road had collected 9.5 million Bitcoins in revenue out of the 11.75 million Bitcoins in circulation.
(vii) According to information users provided upon registering, 30% of users were from the United States, 27% chose to be "undeclared," and beyond that, in descending order of prevalence: the United Kingdom, Australia, Germany, Canada, Sweden, France, Russia, Italy, and the Netherlands.
60. So who does make money from Bitcoin ? Obviously the miners make money when Bitcoins are created. Those who bought them a year ago have seen their value rocket, even if there have been some fluctuations along the way. Websites taking commission from Bitcoin transactions are making money. Perhaps most importantly, there are the Bitcoin exchanges. These are the only method by which the average individual can buy or sell Bitcoins. Just as eBay’s profits are fuelled by commissions made by its wholly owned payment system Paypal, so the real profits from Bitcoin come to those who buy and sell them.
6. Opportunities for Lawyers
61. What are the possibilities for lawyers ? Hopefully you may have spotted a few clues already.
62. Well in the first instance, it is hard to see how criminal work will not see the infiltration of Bitcoin operations as alleged ways of money laundering and buying and selling guns, firearms and other illicit goods.
63. The global nature of digital currencies means that crime involving them is likely to involve extradition proceedings.
64. Secondly, in conjunction with accountants, advice on the tax implications of trading in Bitcoins, accepting them as payment for goods and services, and using them to pay for goods and services, is bound to be required. Although the HMRC are bound to formulate and publish a policy on Bitcoins some time this year, having a working knowledge of the currency, or even an expertise in it, is likely to be advantageous when the tax authorities look to place their stamp on the operation of Bitcoin.
65. It is possible, of course, that Bitcoin will go the way of MTIC frauds and the like: in the first instance criminal prosecutions will come, but as the cost heightens and the enthusiasm weakens, the regulatory approach will gain a head of steam and the Financial Conduct Authority and/or HMRC will use tribunals to enforce whatever rules they put in place.
66. Regulation of some kind is almost certainly on the way. How easy it will be to enforce is a vexed question. On the 12th December 2013 the European Banking Authority dipped its toe into the water, issuing a press release warning consumers:
(a) “You may lose your money on the exchange platform” as some have gone out of business or failed without any protection being offered in this event.
(b) “Your money may be stolen from your digital wallet” because digital wallets are not impervious to hackers. Cases have been reported of consumers losing virtual currency in excess of US $1 million, with little prospect of having it returned.
(c) “You are not protected when using virtual currencies as a means of payment” because when using virtual currencies as a means to pay for goods and services you are not protected by any refund rights under EU law offered.
(d) “The value of your virtual currency can change quickly, and could even drop to zero”; this is self-explanatory.
(e) “Transactions in virtual currency may be misused for criminal activities, including money laundering”; this is also self-explanatory.
(f) “You may be subject to tax liabilities”; for lawyers, this is likely to be the most important area of work, depending always on there being regulation of the tax position in the first case. As we have seen, that seems almost inevitable, yet the whole attraction to many of Bitcoins is the anonymity and lack of regulation that it can provide.
67. If it is right that regulation is inevitable, other than when Bitcoins have been used in Silk Road type transactions for the open purchase of illegal goods, taxation and regulation are where lawyers and accountants are most likely to be engaged.
Nigel Power QC 13th February 2014
Ian Whitehurst