Arrest shocks the Bitcoin world

The arrest of Charlie Shrem is stunning because he is one of Bitcoin's most active and public admirers, and became famous in New York technology circles because of his involvement in the currency. Shrem is part-owner of a Manhattan bar that accepts Bitcoin as payment. According to a long profile in the New York Observer, Shrem printed the passwords to his large Bitcoin account on a ring around his finger, earning the nickname "four-finger Charlie" on the assumption that people will one day cut off his finger to get that ring.

Shrem, 24, is CEO of BitInstant, a company that offered a way for people to easily transfer Bitcoin funds. The Observer called him the "newest boy wonder" of the New York tech scene. But that boy wonder was arrested Monday at John F. Kennedy Airport.

  The tech community has expressed surprise at Shrem's arrest. Yet almost since its creation in 2009 Bitcoin has been linked with illegal activity, including money-laundering and buying drugs online. It also has been repeatedly hacked and stolen.

Authorities say Shrem was tied up in a money laundering scheme related to Silk Road, a notorious online black market that has been called the Amazon.com of illegal drugs. Users can reportedly buy cocaine, heroin, ecstasy and marijuana on the site, and the products are shipped through regular mail to the buyer's home.

According to a federal criminal complaint, Shrem worked with a 52-year-old Silk Road user named Robert Faiella to launder funds. Here's how it worked, according to the complaint.

Silk Road only accepts Bitcoins, so Faiella sold the currency to people who wanted to buy drugs on the site. Faiella filled those Bitcoin orders through Shrem's company. Faiella then sold the Bitcoins back to Silk Road users at a markup.

Shrem had personally bought drugs on Silk Road and knew what the website was all about, according to prosecutors. He knew what Faiella was doing but kept doing business with him and didn't file a report alerting the U.S. Treasury Department to the suspicious activity.

  Shrem and Faiella allegedly exchanged a total of more than $1 million in cash into Bitcoins before Shrem's company stopped accepting cash payments in late 2012.

Both men were charged with conspiracy to commit money laundering and operating an unlicensed money transmitting business, and face a maximum 25 years in prison. Shrem is also charged for failing to file a suspicious activity report, and could see another five years added to his sentence.

"When Bitcoins, like any traditional currency, are laundered and used to fuel criminal activity, law enforcement has no choice but to act," said Manhattan U.S. Attorney Preet Bharara in announcing the arrests.

Does the bust mean that all the people buying and selling drugs on Silk Road are going down? Probably not. Silk Road offers users complete anonymity, and uses Bitcoin exclusively because it's so hard to track. 

Federal officials could try to crack down on Silk Road users, but that would require significant time and resources. Instead, authorities seem so far to be going after the bigger fish, the ones who allegedly facilitated those transactions -- and profited from them. Last year, the FBI arrested the man alleged to be the owner and manager of Silk Road, shut the site down and seized millions of dollars worth of Bitcoins.