NEW YORK — The federal government has arrested one of the biggest names in the bitcoin community in the latest crackdown on digital currencies and their illicit use.
Charlie Shrem, chief executive of digital currency exchange BitInstant, stands accused with a Florida man of laundering money through a notorious drug-trafficking website. Shrem is also vice chairman of the Bitcoin Foundation, a nonprofit group aimed at promoting the digital currency.
He and codefendant Robert M. Faiella of Cape Coral, Fla., are accused of selling more than $1 million worth of bitcoins to people attempting to buy and sell illegal drugs on the Silk Road website, which the FBI shut down in October.
Not only is Shrem prominent in the digital currency world, but so are two backers of his company: Cameron and Tyler Winklevoss, the twins famous for alleging that Facebook was their idea. The Winklevosses have also been trying to win regulatory approval for a financial vehicle that would enable ordinary investors to cash in on bitcoins, whose value has skyrocketed over the last year.
Federal prosecutors also accused Shrem and Faiella of sidestepping regulations aimed at keeping criminal proceeds out of the financial system.
The charges come as state and federal authorities wrestle with how to regulate burgeoning digital currencies. They also come just before Benjamin Lawsky, New York's top financial regulator, kicks off two days of hearings on potential new rules for digital currency exchangers.
"This is going to send shivers through a lot of people," said Carol Van Cleef, a partner at the law firm Patton Boggs in Washington, D.C., and an expert on regulations aimed at curbing money laundering who will testify at the hearings in New York. "It's intended clearly to send a lot of messages to the bitcoin community."
The criminal case arrives at an uncomfortable time for the Winklevosses — they too are set to testify Tuesday at Lawsky's hearings.
In a statement, the brothers said they were "obviously deeply concerned" about Shrem's arrest. They noted that BitInstant's management assured them that the company would follow all laws. The pair invested $1.5 million in the company.
"We fully support any and all governmental efforts to ensure that money-laundering requirements are enforced, and look forward to clearer regulation being implemented on the purchase and sale of bitcoins," the Winklevosses said.
Shrem, who lives in New York City, was arrested Sunday at John F. Kennedy International Airport. Federal agents arrested Faiella at his home in Florida on Monday.
Shrem, 24, and Faiella, 52, were each charged with one count of conspiracy to commit money laundering and one count of operating an unlicensed money-transmitting business.
Faiella allegedly ran an underground bitcoin exchange on Silk Road. When he received orders for bitcoins, he would fill them through his exchange and then sell them to Silk Road users for a profit, according to the government.
Shrem, also the chief compliance officer of BitInstant, allegedly knew the purpose of Faiella's exchanges. In addition, the government says, Shrem himself bought drugs on Silk Road.
Shrem was also charged with alleged willful failure to file a suspicious activity report with regulators related to Faiella's numerous bitcoin purchases conducted through his exchange.
"Truly innovative business models don't need to resort to old-fashioned law-breaking, and when bitcoins, like any traditional currency, are laundered and used to fuel criminal activity, law enforcement has no choice but to act," said Preet Bharara, the U.S. attorney in Manhattan, whose office brought the case. "We will aggressively pursue those who would co-opt new forms of currency for illicit purposes."
Attempts to reach attorneys for the defendants were unsuccessful Monday.
The arrests are likely to mean continued scrutiny of digital currencies and businesses that use them.
Sen. Thomas R. Carper, a Delaware Democrat who chairs the Senate's Homeland Security and Governmental Affairs Committee, said the arrests underscore the threat posed by of digital currencies. But he said the federal government needs to learn more "about the potential promises and risks of this emerging technology and develop thoughtful and sensible policies that protect the public without stifling innovation and economic growth."