Monday, March 3, 2014

No. 34: Bitcoins Suddenly Become Big News

For some years there has been discussion of "Bitcoins," a form of "virtual currency" or "cryptocurrency," but in recent weeks they have suddenly become big news. The subject is of interest to me because of the significant risks assumed by people who invest in virtual currency.

What Are Bitcoins?
Later in this blog I discuss the federal indictment of a prominent promoter of Bitcoins. In that case, a special agent of the Federal Bureau of Investigation (FBI) provided this definition of Bitcoins:
Bitcoins are an anonymous, decentralized form of electronic currency, existing entirely on the Internet and not in any physical form. The currency is not issued by any government, bank, or company, but rather is generated and controlled automatically through computer software operating on a "peer-to-peer" network. Bitcoin transactions are processed collectively by the computers composing the network....
Bitcoins are not illegal in and of themselves and have known legitimate uses. However, Bitcoins are also known to be used by cybercriminals for money-laundering purposes, given the ease with which they can be used to move money anonymously.
A Civil Lawsuit by the SEC
On July 23, 2013, the Securities and Exchange Commission (SEC) filed a civil lawsuit in federal court against 30-year-old Trendon T. Shavers (McKinney, TX), the founder and operator of a Bitcoin company. The SEC alleged that Shavers "falsely promised investors up to 7% interest weekly" and claimed that "risk is almost 0." The SEC also alleged that Shavers operated a Ponzi scheme in which he used funds from new investors to make interest payments and cover withdrawals by earlier investors, and that he exchanged Bitcoins for U.S. dollars to pay his personal expenses. Shavers does not yet have an attorney.

On August 6, 2013, a federal magistrate issued an order in which he found that Bitcoin investments are securities. He thus found that the court has jurisdiction in the case.

On December 30, 2013, the magistrate issued an order laying out the timetable for the case. If the timetable is followed, the case would come to trial on March 12, 2015. (SEC v. Shavers, U.S. District Court, Eastern District of Texas, Case No. 4:13-cv-416.)

A Federal Criminal Lawsuit
On September 27, 2013, a special agent of the FBI filed a complaint in federal court in New York against 29-year-old Ross William Ulbricht, also known as "Dread Pirate Roberts," "DPR," and "Silk Road." Ulbricht was identified in part through a Texas driver's license. The FBI agent said Bitcoins were the "only form of payment accepted on Silk Road," sought an arrest warrant, and alleged that Ulbricht was part of a conspiracy to violate U.S. narcotics laws.

On October 1, 2013, federal agents arrested Ulbricht in California. He is now in a federal jail in New York, where he is being held without bond. 

On February 4, 2014, a federal grand jury indicted Ulbricht. U.S. Attorney Preet Bharara of the Southern District of New York filed the indictment. The four counts are "narcotics trafficking conspiracy," "continuing criminal enterprise," "computer hacking conspiracy," and "money laundering conspiracy."

The indictment alleges that Ulbricht "created an underground website known as 'Silk Road,' designed to enable users across the world to buy and sell illegal drugs and other illicit goods and services anonymously and outside the reach of law enforcement." The indictment also alleges that "Silk Road emerged as the most sophisticated and extensive criminal marketplace on the Internet." Further, the indictment alleges that "seeking to protect his criminal enterprise and the illegal proceeds it generated," Ulbricht "pursued violent means, including soliciting the murder-for-hire of several individuals he believed posed a threat to that enterprise."

On February 7, 2014, Ulbricht was arraigned before U.S. District Judge Katherine B. Forrest. Ulbricht entered a plea of not guilty. Judge Forrest set the jury trial for November 3, 2014. (U.S.A. v. Ulbricht, U.S. District Court, Southern District of New York, Case No. 1:14-cr-68.)

Investor Alerts
On July 23, 2013, the day the SEC filed the Shavers lawsuit, the SEC's Office of Investor Education and Advocacy issued an investor alert entitled "Ponzi Schemes Using Virtual Currencies." The purpose was "to warn individual investors about fraudulent investment schemes that may involve Bitcoin and other virtual currencies." Alerts also have been issued by other agencies such as the Texas State Securities Board, the Securities Division of the Louisiana Office of Financial Institutions, and the Missouri Secretary of State.

Media Coverage
On November 23, 2013, The Wall Street Journal ran an article entitled "Bitcoin or Bust." The article asked: "Is it just the latest in a long line of speculative manias, or could it have staying power?" The article quoted people from across the spectrumsome saying Bitcoins have potential, some saying it might be a good idea to speculate with a small amount of Bitcoins in the hope of making a killing, and some saying they should be avoided altogether.

On February 25, 2014, The New York Times ran an article entitled "Apparent Theft Rattles the Bitcoin World." The article reported that Mt. Gox, the most prominent Bitcoin exchange, was on the verge of collapse after the discovery of what appeared to be a major theft.

On February 26, The Wall Street Journal ran an article entitled "Shutdown Rattles Bitcoin Market." The article reported that Tokyo-based Mt. Gox stopped all transactions and that its website had disappeared.

On February 27, The New York Times ran an article entitled "Now, Nations Mull the Ways to Regulate Bitcoin." The article reported that a spokesman for the Japanese government told a news conference: "At the moment, we are still in the information-gathering stage." It also reported that, in the U.S., federal prosecutors, the FBI, and the Internal Revenue Service have been examining Bitcoin, and that the Commodity Futures Trading Commission and the New York State Department of Financial Services are considering the matter.

On March 1, Bitcoin stories flooded the major media. For example, in a page one story entitled "Almost Half a Billion Worth of Bitcoins Vanish," The Wall Street Journal reported Mt. Gox's bankruptcy filing and its admission that it had lost about 750,000 of its customers' Bitcoins and about 100,000 of its own.

Little or nothing has been said in the major media about Bitcoin investigations conducted in 2013 relating to its potential for use in drug trafficking, money laundering, and other illegal activity. However, the subject has been discussed extensively in specialized media. For example, on October 3, 2013, Ars Technica posted on its website a detailed article about the Ulbricht case. On February 5, 2014, Ars Technica posted another article containing an interview with a person who supposedly is the new operator of Silk Road. These articles suggest that at least some Bitcoin promoters are libertarians with extreme anti-government views.

General Observations
I do not pretend to understand fully how Bitcoins work. Even if I did, I would not invest in them. I am too conservative in money matters to even consider the possibility of investing in such a scheme. I would not touch Bitcoins or any other virtual currency with a ten foot pole.

I am offering as a complimentary PDF the 12-page indictment filed by U.S. Attorney Bharara. Send an e-mail to and ask for the indictment in the Ulbricht case.