Amid Arrests And Prosecutions, Rules Around Selling Bitcoin Remain Fuzzy

According to credit card records, patients visited Louisiana chiropractor Randall B. Lord’s offices for services like “mood counseling” and “chakra realignment.” But in reality, Lord hasn’t been licensed to practice in nearly a decade, and was actually using his credit card merchant accounts to sell hundreds of thousands of dollars in bitcoin, some of which went toward illicit purposes, federal prosecutors say.

Lord, along with his son Michael Aaron Lord, pleaded guilty in federal court last month to conspiring to operate an unlicensed money servicing business. According to an indictment filed in the case, Michael advertised “bitcoin services” on the website LocalBitcoins.com, a peer-to-peer marketplace that connects bitcoin users looking to buy and sell the digital currency both online and in person. And, prosecutors say, the two men accepted more than $3.5 million in cash, money orders, and MoneyPak prepaid cards in exchange for bitcoin they would purchase from online exchanges.

The case, one of a handful in recent years to bring charges for operating unlicensed bitcoin operations, highlights the vagaries involved in regulating the buying and selling of virtual currencies. In the U.S. and elsewhere, these transactions are subject to federal and local anti-money laundering laws, which require sellers of bitcoin to verify the identities of their customers, just as banks do.

While U.S. federal law requires money service businesses—traditionally, enterprises like check-cashing stores and money transmitters like Western Union and PayPal—to register with the Treasury Department’s Financial Crimes Enforcement Network, known as FinCEN, and obtain any required state licenses, experts say exactly when those requirements apply to bitcoin trades can still be unclear.

“It’s very fuzzy,” says lawyer Marco Santori, a partner at Pillsbury Winthrop Shaw Pittman and the leader of the firm’s digital currency and blockchain technology team, referring to when a trading operation falls under federal rules. “It’s heavily dependent on what we like to call the facts and circumstances test, which is not a test at all—it’s just how good of a narrative you can construct. Unfortunately, it often comes down to how good of a lawyer you have.”

State rules can also vary significantly, with some states allowing money transmitters to operate with no licenses at all, and others implementing policies specifically aimed at regulating cryptocurrency businesses. New York’s so-called BitLicense, probably the most famous of these, has been the subject of some complaints from bitcoin-related startups after delays in issuing licenses, though businesses already in operation are allowed to continue under a “safe harbor” provision while their licenses are processed.

Meanwhile, Craigslist-style sites like LocalBitcoins, where the Lords apparently sold bitcoin to unknown buyers, along with other classified sites like Gliph and Craigslist itself, don’t not fall under FinCEN regulations themselves because they’re not technically centralized bitcoin exchanges.

In 2013, FinCEN issued a document saying mere users of virtual currencies aren’t money servicing businesses, but exchangers of the currencies are.

“A user is a person that obtains virtual currency to purchase goods or services,” the agency said. “An exchanger is a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency.”

Simply buying, selling, or even mining bitcoin for your own use or investment doesn’t put make you the operator of a money services business, any more than buying and selling stock through a broker puts you legally in the securities business, says corporate finance lawyer Martin Mushkin.

“Generally speaking, if you are buying and selling for yourself on the web, our view is that you are not in the money service business because you are simply a day trader,” he says.

But the question becomes more complicated when users trade bitcoin outside of the confines of licensed web exchanges. Advertisers on LocalBitcoins and other classified-style sites are often able to sell bitcoin at a higher price, or buy it at a lower price, than through formal exchanges for the same reason that government officials are concerned: Certain bitcoin users are willing to pay a premium for a one-on-one transaction, and the anonymity it can bring, rather than buy and sell through an online exchange.

In some ways, the legal situation is similar to the laws around firearm sales, where gun dealers are required to hold federal licenses and conduct background checks, but individual sales go unregulated, leaving room in the middle for gun hobbyists who sell with some regularity but without setting up a full-time business.

“Law enforcement officials are particularly concerned about face-to-face cryptocurrency exchanges because they have been used as money laundering platforms,” according to a 2014 Department of Homeland Security report. “Not only do these transactions require no [personally identifiable information] to be exchanged, which makes the transactions completely anonymous, one can convert anything of value into Bitcoin simply by bartering or buying them.”

DHS has been active in investigating a number of bitcoin exchange-related cases, according to court records, apparently maintaining a task force targeting the use of digital-currency money laundering. Often alleged operators of unlicensed exchanges are also charged with laundering the proceeds of drugs, or other illegal activity.

In one pending case, Anthony R. Murgio, the alleged operator of a purported unlicensed online exchange called Coin.mx, is charged partially in connection with claims the exchange sold bitcoin to victims of ransomware attacks, who were hoping to use the currency to pay blackmailers to unlock their personal data. Murgio has pleaded not guilty.

“Anthony is vigorously contesting the charges,” says attorney Brian Klein, a partner at Baker Marquart who represents Murgio. “And he is looking forward to getting his day in court.”

In 2013, the U.S. closed Liberty Reserve, an unlicensed exchange where it alleged that the site’s widely used digital currency was being used to launder proceeds from credit card trafficking, identity theft, Ponzi schemes, and hacking. This month, one of the site’s founders received a 20-year prison sentence, while the other, who agreed to help prosecute his ex-partner, was sentenced to 10 years.

As part of a plea deal with the Lords, prosecutors agreed to drop additional charges against the two Shreveport men, including a money laundering charge tied to an alleged $14,000 cash-for-bitcoin trade with a drug informant, as well as wire fraud charges relating to the credit card transactions. Neither the Lords’ attorney, nor federal prosecutors, replied to multiple requests for comment.

While some bitcoin trading advertisers on sites like LocalBitcoins may be effectively running exchanges—the Lords allegedly took money from buyers that they’d immediately use to buy bitcoin online—others may simply be investors taking advantage of better exchange rates available through person-to-person transactions.

That’s the position Colorado engineer Burt Wagner says he was in in 2014, when he was arrested by federal agents and charged in connection with operating an unlicensed “digital currency exchange business.” Wagner says he mostly bought and sold bitcoin through Mt. Gox, the leading online exchange at the time, but he also advertised on LocalBitcoins, meeting up with local trading partners at coffee shops and the like.

“It was a small part of my entire trading,” he says. “The main reason I did it was just to meet bitcoiners and chat with them.”

An indictment filed in the case alleged that Wagner handled funds “known to the defendant to have been derived from a criminal offense and were intended to be used to promote and support unlawful activity,” but Wagner says he never knowingly did any shady deals. The charges against him were dropped in 2015—though not before, he says, he paid thousands of dollars in legal fees. Federal prosecutors declined, through a spokesman, to comment on the case, and many of the documents in his case remain under seal.

But from documents that are available, it appears he was tied by authorities, correctly or not, to alleged dark web drug transactions.

“The indictment in this case follows a 15-month investigation involving online and conventional undercover activities,” prosecutors wrote in a court filing. “Specifically, the investigation involves individuals engaging in digital currency transactions and/or the purchase and sale of controlled substances over the internet using ‘Deep Web’ black marketplaces.”

Generally, most people who have been charged in connection with unlicensed exchanges have also been linked by prosecutors to other illegal activity, such as online drug sales, says Santori. “Realistically, as a matter of enforcement, we have not seen any significant enforcement activity against people who were just trading bitcoin in an unregistered manner,” he says.

One thing that’s meant in practice is that many cases so far have ended in guilty pleas, with defendants cutting deals with prosecutors to avoid facing more serious drug or other charges, he says. And that means there’s yet to be a serious challenge to prosecutors’ interpretation of what constitutes a bitcoin-related money services business, or the FinCEN guidelines’ distinctions between exchanges and individual traders, he says.

“One day, somebody with the means to do so and the risk tolerance will dispute the interpretation in the FinCEN guidance and then we’ll see the extent to which [it] can actually stand up in court,” he says.

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