How a New York startup disregarded the law to help get bitcoin off the ground

charlie shrem

In recent weeks, the digital currency bitcoin has experienced a massive rise in price, briefly reaching a new all-time high of more than $ 2,900. Today the total market value of all cryptocurrencies is more than $ 100 billion, and there are dozens of 24-hour online exchanges that allow users to swap fiat currencies, such as dollars or euros, for these new digital assets.

But in the spring of 2012, financial services for the bitcoin economy were sorely lacking. One startup trying to solve this problem was BitInstant, which helped move digital currency between exchanges and provided customers with bitcoins in exchange for cash deposits at banks and retail stores such as CVS and 7-Eleven. At one point, the New York-based startup was processing fully 30% of all bitcoin transactions. 

In this exclusive excerpt from his new book,  How Money Got Free: Bitcoin and the Fight for the Future of Finance, author Brian Patrick Eha provides a glimpse into the devil-may-care attitude of BitInstant’s young CEO, Charlie Shrem, and highlights some of the laws that were transgressed in order to get bitcoin off the ground. 

In May 2012, having moved into The Yard—its first real office space—BitInstant announced its biggest initiative yet, an expansion of its cash deposit service beyond banks to more than 700,000 retail locations, convenience stores, drugstores, and other outlets across the United States, Russia, and Brazil.

One of the chief obstacles to bitcoin adoption by the masses, Charlie Shrem admitted in a press release, was the difficulty of acquiring the digital currency—for most people “a lengthy and confusing process.”

By partnering with a cash-payments company called ZipZap, BitInstant sought to make bitcoin acquisition easier than ever, so that customers in three of the world’s largest economies—Russia, Brazil, and the U.S.—could anonymously exchange their local currency for digital money.

In Russia, Qiwi and Cyberplat—networks of cash kiosks—provided the local interface for accessing the BitInstant system. In Brazil, it was Boleto Bancário, enabling cash deposits at bank branches, ATMs, post offices, and even some supermarkets and drugstores.

It was Americans, however, who were truly spoiled for choice.

Where previously cash deposits to BitInstant had been possible only at the branch offices of four banks—JPMorgan Chase, CitiBank, Wells Fargo, and Bank of America—people could now trade cash for bitcoins, often without providing any personal identifying information, at Walmart, CVS, 7-Eleven, and thousands of local independent stores and money service providers.

7-elevenThe new deposit network “was just like a different version of the same thing, a better version,” says Alex Waters, a developer who later became BitInstant’s chief information officer.

The whole system, though cumbersome and prone to malfunctioning, was effective; it gave a growing number of bitcoin users a way to acquire digital currency that was more or less anonymous and difficult to trace.

It was an initiative worthy of the ambitious role that Shrem, under the influence of his right-hand man, Erik Voorhees, now envisioned for BitInstant; the company described itself as leading “the financial integration of the international, open-source Bitcoin payment network”—of linking up a stateless rogue currency to the vast global banking and payments sector.

They drew inspiration from prior revolutions; announcing the new cash deposit network, Shrem declared, “Bitcoin is to money what email is to the Postal Service.”

And yet, even as BitInstant raced ahead with new services, its compliance with state and federal law lagged behind.

In the United States, money services businesses are required to register with the Financial Crimes Enforcement Network, or FinCEN—the branch of the Treasury Department tasked with fighting money laundering—and to comply with various regulations designed to thwart criminal abuse of their systems.

These anti-money laundering and Know Your Customer regulations, as they are collectively known, obligated BitInstant to report any large transactions or suspicious activity to FinCEN and, at the very least, to record the identity of any customer sending or receiving a sum of $ 3,000 or more.

BitInstant had launched in 2011 without any legal protections whatsoever, but on March 26, 2012, the startup belatedly registered with FinCEN as a money services business. On its website, BitInstant announced plainly that it opposed “money laundering, financing terrorism, and all other illegal uses of the Bitcoin network.” On the surface, Charlie Shrem seemed to be doing his best to play it straight. 

But internal operations didn’t always match the veneer of legality. Rachel Yankelevitz, who was hired in the late summer of that year, recalls the slipshod way in which AML and KYC policies were implemented.

“At first it was kind of a free-for-all,” she says. “There really was no cross-checking [of identities]. People would put in hilarious names”—John Doe and even more obvious fakes.

Customers were supposed to be at least 18 years old to use the site, but BitInstant had no way of confirming their ages. Some locations, when customers were making cash deposits, would ask to see identification, but others wouldn’t.

“I’m sure plenty of people found that one 7-Eleven where they just didn’t give a sh– and would take your money and not care,” is how Yankelevitz puts it.

FILE PHOTO: A Bitcoin (virtual currency) paper wallet with QR codes and a coin are seen in an illustration picture taken in Paris, France May 27, 2015.  REUTERS/Benoit Tessier/File Photo Indeed, anecdotal evidence suggests that ZipZap cash deposit was the preferred method of acquiring bitcoins among users of the underground drug marketplace Silk Road. It was even more convenient and anonymous than depositing cash at banks.

BitInstant did place limits on cash deposits; customers were permitted no more than $ 1,000 per person per day. But if a friend made the deposit on the user’s behalf, or the user accessed BitInstant’s website using a new email address and alias, he or she could easily circumvent those restrictions. Charlie Shrem and his team must have known that anyone tech-savvy enough to be using Bitcoin would be able to exploit these loopholes. 

Other services, such as transfers between Bitcoin exchanges, were even more permissive, with no monetary limits at all—except for when BitInstant didn’t have the funds to accommodate the transfer, so it got stuck, Yankelevitz says.

In February 2012, Shrem had paid lip service to AML and KYC policies, saying that even though TradeHill, then the world’s second-largest Bitcoin exchange, had lifted its daily withdrawal limits—allowing customers to move their entire balance in one go—anyone transferring $ 10,000 or more through BitInstant in a single 30-day period would be required to verify their identities.

The problem was that U.S. money transmitters—a designation that goes beyond merely being a money services business—are required to obtain a license for just about every state in which they have customers. Forty-seven states, plus the District of Columbia, have these licensing requirements.

For BitInstant that would mean complying with 48 sets of requirements, enduring 48 lengthy bureaucratic processes, paying 48 filing fees, and obtaining 48 surety bonds. The costs might vary by state, but they normally total about $ 200,000—more if the company in question is a bigger risk.

And that is far from all.

national mallA company seeking a money transmitter license in, for example, New York must also provide audited financial statements; an extensive breakdown of the company’s operations; fingerprints of all owners, officers, stockholders, and directors; a two-year projection of business in the state; and much more, while also submitting to a background investigation of its executives. The process was expensive and time-consuming enough to have shut down TradeHill altogether.

BitInstant was now in the same position, and Shrem appeared to have learned from TradeHill’s fate. But in many respects he and his team played fast and loose with the regulations.

Shrem was listed as BitInstant’s compliance officer, responsible for ensuring that the company, in addition to registering with FinCEN, abided by all the money transmitter requirements of every state in which it served customers.

But there he fell short.

New York State, for instance, mandates that a compliance officer must have at least three years of experience performing compliance for a money transmitter or bank, a requirement that Shrem, then twenty-two, didn’t meet. But the young CEO chose to keep his startup running rather than close up shop, as TradeHill had, to raise money from investors. 

Shrem and his two closest compatriots, Erik Voorhees and Ira Miller—to say nothing of Roger Ver, the startup’s libertarian director of business development and primary investor—were young guns of the “move fast and break things” school popularized by Mark Zuckerberg, and they made no more than a passing gesture toward compliance.

Neither FinCEN nor the Internal Revenue Service nor any other agency of the U.S. government, whether state or federal, had yet ruled that bitcoin was money, and although the BitInstant leadership believed that it was—in the truest sense—they nevertheless relied on official silence and inattention as air cover for their actions.

The status of this new asset class, about which most of the world remained in the dark, was uncertain.

“It could be information, could be speech, could be a commodity,” Ira said of the lack of consensus in those days.

But even those AML and KYC policies to which the company paid lip service were being subverted by its CEO.

Shrem, as he fielded customer complaints in the last days of 2011, encountered a 52-year-old BitInstant customer named Robert Faiella, who, on Silk Road, went by the moniker BTCKing. There he was turning a handsome profit reselling bitcoins to other Silk Road users, who wanted to buy drugs but didn’t want to go through the hassle—or the exposure—of acquiring bitcoins through normal means.

Faiella’s operation would later be described by the feds as an unlicensed money transmitting business. When a Silk Road user came to him for, say, $ 500 in bitcoins, Faiella would place an equivalent order on BitInstant, using the bank cash deposit method, and once the customer had paid up, he would zap the bitcoins to the relevant Silk Road account, minus his own commission.

The whole process was fairly convoluted. But it was easy money. 

And Charlie Shrem, who soon worked out the nature of Faiella’s operation, began helping him make it.

 

Adapted from the book How Money Got Free: Bitcoin and the Fight for the Future of Finance. © 2017 by Brian Patrick Eha. Reprinted with permission from Oneworld Publications.

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