FinCEN noted Liberty Reserve’s irrevocable transactions and lack of ID verification as evidence that “Liberty Reserve’s system is structured so as to facilitate money laundering and other criminal activity,” these comments worried the digital currency community and was likely what scarred off many of their banking partners.

On the 19th, the Bitcoin Foundation responded to FinCEN’s proposed special measure urging them to clarify that not all virtual currency transactions are inherently suspect.

From the letter…

“the Bitcoin Foundation does not take issue with the imposition of special measures against Liberty Reserve. Rather, the Bitcoin Foundation is filing these comments to urge FinCEN to clarify statements made in the Proposed Rule and the underlying Notice of Findings that could be misinterpreted to suggest that virtual currency transactions in general are inherently suspect.”

“the Bitcoin Foundation is concerned that the statements in question may be misinterpreted to suggest that all virtual currency operators are inherently suspect. In particular, the Bitcoin Foundation is concerned that the statements will be misread by the financial institutions implementing the final rule adopted in this proceeding (the “Final Rule”) to suggest that virtual currencies in general should be subject to a higher degree of scrutiny, and the chilling effect this could have on the still nascent bitcoin industry. “

The foundation asks for 3 specific statements from FinCEN…

• Any Final Rule Should Rely on Established Terms and Definitions
• Any Final Rule Should Emphasize Liberty Reserve’s Activity as the Sourceof Concern, Rather than any Particular Attribute of Virtual CurrencyGenerally
• Any Final Rule Should Clarify that Irrevocable Transactions May Serve Legitimate Purposes

Read the Foundation’s response in its entirety here.

Regulators were very concerned with LR’s anonymity which was a serious draw to the service for many people. But what was likely an even bigger factor in LR’s success was its irreversible payments. This is a very important feature for businesses that are at risk of payment fraud or chargebacks, and it’s a feature that is not available in the current regulated financial system.

Jon Matonis via PaymentsSource

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 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.

…

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.

…

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.

Read the PaymentsSource article in its entirety here.

Liberty Reserve S.A., Arthur Bodovsky (owner), Vladimir Kats (left the business in 2009), Ahmed Yassine Abdelghani (left the business in 2009), Allen Esteban Hidalgo Jimenez, Asseddine El Aminr, Mark Marmilev, Maxim Chukharev.

The Charges

1. Conspiracy to Commit Money Laundering

2. Conspiracy to Operate Unlicensed Money Transmitting Business

3. Operation of an Unlicensed Money Transmitting Business

Read the indictment here.

Liberty Reserve owner, Arthur Budovsky, a former U.S. citizen and naturalized Costa Rican of Ukrainian origin, was arrested in Spain last Friday. U.S. officials will likely to seek his extradition.

Also on Friday, in San José Costa Rican prosecutors raided Budovsky’s home and offices. They seized documents, computers, three Rolls Royce, Jaguar automobiles, and a motorcycle.

Seizure

US officials have seized the following domain names, Libertyreserve.com, Exchangezone.com, Swiftexchanger.com, Moneycentralmarket.com, Asianagold.com and are seeking the forfeiture of the following domain names for related exchanger sites: Wm-center.com, e-naira.com, ecardone.com, ebuygold.com, getemoney.com, epaymonster.com, instantgoldng.com, jtgold.com, goldnairaexchange.com, superchange.ru, webmoney.co.nz, m-gold.com, goldmediator.com, absolutexchange.eu, mewahgold.com, centregold.ca, electrumz.com, tukarduid.com, entelnova.com, tacoauthorized.com, intexchange.com, ukrnetmoney.com, wmirk.com, nigeriagoldexchanger.com, edealspot.com, duyduychanger.com, magnetic-exchange.com, moneyexchange.vn, abc-ex.net, mi-billetera.com, nicciexchange.com, exhere.com, alertexchanger.com, velaexchange.com, goldexpay.com.

Read it here.

28 bank accounts have been seized and the indictment is seeking the forfeiture of “all funds” in 45 different bank accounts in 9 different countries.

Patriot Act

The shutdown of Liberty Reserve was initiated and orchestrated by the Treasury. While Liberty Reserve was based in Panama and the owner had given up his US citizenship, US officials conducted the investigation using a provision of the Patriot Act that allows “the prevention, detection and prosecution of international money laundering and the financing of terrorism.”  Via the Patriot Act Liberty Reserve was declared to be “a Financial Institution of Primary Money Laundering Concern”.

Liberty Reserve did have US customers (20k according to estimates by US officials), however, the Treasury made it very clear that they intend to go after businesses regardless of location stating “We are prepared to target and disrupt illicit financial activity wherever it occurs – domestically, at the far reaches of the globe or across the internet.”

Legitimate Use

Almost certainly the service was used by thieves, but US officials failed to see any legitimate use for the service calling it “structured so as to facilitate money laundering” and stating that its structure made “any legitimate use economically unreasonable”.

I personally know a number of businesses that used the service legitimately and a number of news stories have noted legitimate business who have had their funds caught up in the shutdown.  A few examples are forex brokers based in countries where it is difficult to transfer funds and e-pay cards, a service that allowed consumers outside the US to fund cards that could be used similarly to US-issued Visa or Mastercard credit cards.

AML and Anonymity

Liberty Reserve did not comply with standard KYC and AML policies allowing customers to use the service without providing proof of identity. However, the Treasury seems to equate privacy with criminal behaviour.

“This lack of customer due diligence means that the accounts can be entirely anonymous and thus that account holders can transfer fund to or from anywhere with anyone with anonymity. Indeed, Liberty Reserve advertises this fact as a virtue of the service.“

Avoiding the US

It is interesting to note that Liberty Reserve’s owners took many steps to remove themselves from US jurisdiction and avoid direct violations of US anti-money laundering laws. Many would see this as a prudent move for owners of alternative financial services; however, US officials see this as a sign of guilt.

“In October 2007, Liberty Reserve’s official blog explained that registering in Costa Rica allowed the company to avoid U.S. authorities because Costa Rica does not have a mutual legal assistance treaty with the United States. Taken together, these facts suggest that Liberty Reserve has specifically sought out jurisdiction with weak anti-money laundering controls and apparent immunity from U.S. prosecution.“

Liberty Reserve used third party exchanges to move funds into the service; it did not directly accept money wires, etc.

“Liberty Reserve has structured its business to separate itself from knowledge that would allow it to detect money laundering.”

“As of 2009, Liberty Reserve had outsourced its own verification process for new exchangers to a non-affiliated company …. Relying on exchangers to conduct what little due diligence Liberty Reserve purports to require enhances the gravity of Liberty Reserve’s money laundering risk.”

FinCEN’s Special Measure

In an effort to cut Liberty Reserve off from the US financial system, it FinCEN has proposed a special measure. This new rule would require US financial institutions to perform special due diligence to ensure that correspondent accounts held by foreign banks are not used for transactions involving Liberty Reserve.

History

This isn’t the first time Liberty Reserve’s founders have had a run-in with US officials. Arthur Bodovsky and Vladimir Kats previously ran GoldAge which was an E-gold exchanger. Both were convicted in New York State of operating an unlicensed money transmitting business. Bodovsky was placed on probation, renounced his US citizenship and immigrated to Costa Rica where he became a citizen.

Search Warrants

The investigation involved more than a dozen countries and many search warrants were issued for covering phone, email, bank records, and “’cloud’-based search warrants, directed to a service provider used to process Liberty Reserve’s Internet traffic.” Authorities also “captured” online chats between two of the defendants.

Costa Rican Troubles

In 2009 Costa Rican regulators, Superintendencia General de Entidades Financieras (SUGEF), notified Liberty Reserve that it needed to apply for a license to operate as a money transmitting business. Liberty Reserve did not obtain a license and allegedly reported to Costa Rican officials that they had sold the business, emptied their Costa Rican bank accounts and setup shell companies in other countries.

Anonymity not Allowed

Secret Service Special Agent-in-Charge Steven G. Hughes said:

“These arrests are an example of the Secret Service’s commitment to investigate and apprehend criminals engaged in the misuse of virtual currencies to conduct global monetary fraud. Cyber criminals should be reminded today that they are unable to hide behind the anonymity of the Internet to avoid regulated financial systems.”

It seems clear that US regulators do not want to allow anonymous money transmitting businesses and/or money businesses outside the financial system to exist, anywhere.

I’ll just end with this tweet from the always entertaining Max Keiser…

Links:

Treasury Press Release

FinCEN Notice of Finding That Liberty Reserve S.A. Is a Financial Institution of Primary Money Laundering Concern.

FinCEN Imposition of Special Measure against Liberty Reserve S.A. as a Financial Institution of Primary Money Laundering Concern.

DOJ Press Release

DOJ U.S. v. Liberty Reserve, et al. Redacted AUSA Appln with Exhibits

DOJ U.S. v. Liberty Reserve, et al. Redacted Domain SW

DOJ U.S. v. Liberty Reserve, et al. Redacted Injunction Order

DOJ U.S. v. Liberty Reserve, et al. Redacted PIRO

DOJ Liberty Reserve, et al. Related Exchanger Website Domain Names Redacted Filed Complaint 13CV3565

DOJ U.S. v. Liberty Reserve, et al. Indictment – Redacted

The Tico Times, an English newspaper in Costa Rica, is reporting that Budovsky has been under investigation since 2011 after a request from a prosecutor’s office in New York.  Liberty Reserve is a Costa Rican business and Budovsky is a Costa Rican citizen of Ukrainian origin.

Liberty Reserve had many US customers and was an important player in the Bitcoin economy.  The business offered irrevocable and instant payments making it a popular funding option for Bitcoin exchanges.  Liberty Reserve was accepted by Mt. Gox and BitStamp and many others.

While Liberty Reserved claimed to be AML compliant and users are asked for identifying information, name, address, DOB, etc., when opening an account, no ID or other proof of identification was required.

It would appear that this shutdown was co-ordinated by US officials. KrebsonSecurity.com is reporting that the Liberty Reserve domain name is now pointing to a service previously used by the Justice Department.

“On Friday, the domain name servers for Libertyreserve.com were changed and pointed to ns1.sinkhole.shadowserver.org and ns2.sinkhole.shadowserver.org. Shadowserver is an all-volunteer nonprofit organization that works to help Internet service providers and hosting firms eradicate malware infections and botnets located on their servers.

In computer security lexicon, a sinkhole is basically a way of redirecting malicious Internet traffic so that it can be captured and analyzed by experts and/or law enforcement officials. In its 2011 takedown of the Coreflood botnet, for example, the U.S. Justice Department relied on sinkholes maintained by the nonprofit Internet Systems Consortium (ISC).“

Krebs also notes 5 online exchange services that have also gone offline last week.

“Libertyreserve.com is not the only virtual currency exchange that has been redirected to Shadowserver’s DNS servers. According to passive DNS data collected by the ISC, at least five digital currency exchanges –milenia-finance.com, asianagold.com, exchangezone.com, moneycentralmarket.com and swiftexchanger.com – also went offline this week, their DNS records changed to the same sinkhole entries at shadowserver.org.”

It would seem that other businesses are worried about US officials as Panama based Perfect Money changed its policy to ban US businesses, residents and citizens shortly after the Liberty Reserve shutdown.

Via the PerfectMoney website.

“Dear Perfect Money Customers,

We bring to your attention that 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.”