The Politics of Bitcoin Mixing Services

By Jon Matonis
Forbes
Wednesday, June 5, 2013

http://www.forbes.com/sites/jonmatonis/2013/06/05/the-politics-of-bitcoin-mixing-services/

As the cryptocurrency arms race escalates beyond identity verification at exchange endpoints, mixing services for bitcoin may emerge as the next frontier in the battle for financial privacy.

If bitcoin exchange regulation becomes so effective that exchange operators are required to link specific bitcoin addresses to individual customers, then users may have few remaining choices should they want to maintain transactional privacy. Call it the law of unintended consequences for overarching bitcoin exchange regulation.

Two facets of the growing political debate on anonymizing services are the traditional centralized bitcoin mixers and the newer decentralized bitcoin mixers that require a modification to the Bitcoin protocol.

With traditional bitcoin mixers, the process could become highly-charged politically and the regulatory status of mixing services called into question. Reliable legal jurisdictions for operating bitcoin mixing services would therefore gain prominence since it reasonably could be viewed as a protected free speech issue. Potentially, Iceland could serve as a bitcoin mixing haven.

The emergence of services that mingle bitcoin for the purpose of returning bitcoin not associated with the original input address has had a somewhat spotty history. Also called bitcoin laundries, these web-based services charge bitcoin holders a nominal fee to receive different bitcoins than the ones initially transferred. The sites never handle national currencies like the dollar or euro so technically they are not exchanges. Also, the administrator of the service has to be trusted to delete any archival logs and not to run off with the coins.

The largest such service operating today is the Blockchain.info mixing service which has a maximum transaction size of 250 bitcoins and a 0.5% transaction fee. Transaction logs are removed after eight hours and customers can use the taint analysis tool to verify that coins were properly mixed. Other services include BitLaundry and The Bitcoin Laundry operated by Mike Gogulski.

Advances on the decentralized mixer front were highlighted in Olivier Coutu’s largely theoretical presentation at the Bitcoin Conference in San Jose. Although it resolves the trusted intermediary vulnerability, the political debate with decentralized mixers revolves around convincing bitcoin core developers that it is essential functionality or creating a different bitcoin client altogether. Either development approach would subsequently require majority support from the bitcoin mining community.

Zerocoin from Johns Hopkins University is a method whereby the trusted intermediary for mixing can be eliminated. The software is already written and soon to be released as open source code. However, it requires modifications to the core Bitcoin protocol and adoption by the majority of bitcoin miners. With the current political climate tilting towards full disclosure for bitcoin transactions, at least at the exchange level, it is unlikely that Bitcoin core developers would elevate bitcoin privacy to an “all-hands-on-deck” emergency priority. Yes, open source projects are comprised of political animals as well.

According to Johns Hopkins University cryptography professor Matthew Green, Zerocoin researchers are examining voluntary compliance options that reduce but don’t eliminate your transaction privacy, such as accountability limits on dollar amounts of anonymous transactions. This type of alternate approach to Zerocoin adoption would be possible without support of the Bitcoin client software. However, not integrating Zerocoin into the Bitcoin protocol would require third-party services to act as issuers of its anonymizing tokens with trust problems similar to the centralized laundry services.

Also, in-person exchange LocalBitcoins.com could act as a pure person-to-person mixing service for bitcoin users that meet in designated places like cafés. Personal mixing has the additional benefit of introducing plausible deniability into the entire bitcoin ecosystem because the coins cease becoming provably yours at that point. After seeing the LocalBitcoins selling-for-cash section in the U.S., Carol Van Cleef, a partner in Patton Boggs’ banking practice and adviser on anti-money laundering policies, ominously warned, “You better get yourself registered, or you better get your name off the list real fast.”

Vitalik Buterin of Bitcoin Magazine argues that Bitcoin is not losing its soul through regulation and that the core principles of the bitcoin protocol, such as user-defined anonymity and user-defined transactional privacy, remain intact due to optional mixing services. This is a critical point because, when it comes to bitcoin oversight, regulators and law enforcement must comprehend that which can be constrained versus that which cannot be constrained.

Otherwise, legislators and government officials risk inadvertently steering Bitcoin advancements in the direction of even more liberating decentralized architectures. Remember, it was the forceful and horrific crackdown on casual file sharers that provided the impetus for the remarkable BitTorrent technology.

One can only defer the bitcoin privacy issue for so long. At some point, Bitcoin core developers, mining operators, lobbyists, and industry thought leaders have to take a principled position and decide on what side of history they wish to stand.

Why There Is A Demand For Liberty Reserve's Services

By Jon Matonis
PaymentsSource
Tuesday, June 4, 2013

http://www.paymentssource.com/news/why-there-is-a-demand-for-liberty-reserves-services-3014312-1.html

In a free society with a market-driven economy, payment privacy and payment finality are legitimate and useful features of a currency – physical or digital. To believe otherwise is to submit to the erroneous notion that full, involuntary financial transparency should be the norm and that a cashless society is a noble goal.

By default, Federal Reserve-issued physical cash comes with payment privacy and payment finality. Therefore, cash is a problem to regulators because the flip side to payments privacy is the ability to determine which transactions are seen by the watchful eyes of governments and to store wealth privately.

In a recent BankThink post, American Banker Executive Editor Marc Hochstein points out that "the anonymity-bashing has begun" and that the Feds wrongly demonize privacy in the Liberty Reserve case. Where was the Liberty Reserve government affairs lobbying team and would it have mattered? Also, why did U.S. prosecutors wait 12 years to move on a service provider that had been around since 2001?

These types of enforcement actions can also be viewed as seminal events along the ultimate trail to full cash eradication. Brandished as unnecessary and dangerous, the $100 bill is continually under attack by regulators and in Europe the fabled 500-euro note is more like the monetary unicorn: Many have heard about it but few have seen it.

Once troublesome physical cash is finally eradicated, any digital currency with privacy and irreversibility attributes will be next for scheduled termination. 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 some jurisdictions, the act of not respecting your client's privacy is a punishable event, subject to serious jail time.

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.

Referred to as digital gold, decentralized Bitcoin is also an irreversible payment method. But, bitcoin (small "b") is also the measured unit of account within the overall Bitcoin payment network similar to the LR-USD and LR-EUR units of account within the Liberty Reserve system. The notable difference being that bitcoin is a nonpolitical unit of account whereas LR-USD and LR-EUR were anchored to the respective political units of account.

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.

Liberty Reserve also extended into the foreign exchange trading world, as a means of paying independent brokers who signed up clients for forex trading firms, and in some cases as a deposit option for client accounts. In these cases, the Liberty Reserve payment system acted as an international wire service for regions of the world that were totally ignored or blockaded by SWIFT and the international banking system.

Masroor Ghoori, a foreign exchange broker and analyst in Pakistan, told the website Forex Magnates, "Forex brokers have been benefiting from Liberty Reserve's vast access as a payment provider, especially in countries where traders face difficulties in transferring funds. Liberty Reserve was a 'gift' for several traders, especially after the State Banks' (State Bank of Pakistan) changes to international money transfers."

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.

New Bitcoin VC Fund Seeks Edge with Regulatory, Security Skills

By Jon Matonis
American Banker
Wednesday, May 29, 2013

http://www.americanbanker.com/bankthink/new-bitcoin-vc-fund-seeks-edge-with-regulatory-security-skills-1059453-1.html

A new investment fund dedicated to Bitcoin startups aims to bring digital money entrepreneurs up to speed in two areas where they have proven most vulnerable: network security and compliance.

This month Liberty City Ventures, based in New York, launched the $15 million Digital Currency Fund, which seeks to invest in all types of firms in the Bitcoin ecosystem, including exchanges, banks, brokerages, investment services, insurance, infrastructure, and supporting products and services. It is the largest Bitcoin-related investment fund to date.

As host and sponsor of the monthly NY Bitcoin Startups Meetup, Liberty City Ventures has been involved in the broader Bitcoin ecosystem through mining and currency investing for a number of years. The team is also very familiar with financial services and payment system startups, having recently retained former U.S. Treasury officials and regulators and computer engineers as advisors.

Very few computer security professionals have crossed over into the bitcoin financial realm and the startups have simply not had the capital to replicate the security infrastructure and procedures of a large commercial bank. Even though real-time access to bitcoin is similar to the handling of physical cash, sophisticated management of multiple "hot wallets" (Bitcoin accounts connected to the Internet) and "cold wallets" (coins stored offline, such as in a USB drive in a bank vault) is a relatively new technical skill set.

Hence, Bitcoin-related firms such as InstaWallet have suffered devastating security hacks. And recent government actions against Mt. Gox, the world’s largest exchange for trading bitcoins for government currencies, and Liberty Reserve, which issued its own private currency, underscore the importance of regulatory expertise to companies in this space. (For the record, Liberty City Ventures has no affiliation with Liberty Reserve.)

As TechCrunch said, paraphrasing Liberty City founding partner Charles Cascarilla, "none of the current [investment] options would live up to the type of scrutiny that most real-world banking institutions face." Cascarilla told PandoDaily he sees an opportunity to bring advanced trading technology along with capital to the sector.

Liberty City was founded about nine months ago as the early-stage venture division of Cedar Hill Capital Partners by technology investors Cascarilla, Emil Woods, Andrew Chang, and Dorothy Jean. The fund has already raised capital from high net worth individuals and secured commitments from institutional investors. Additionally, the firm plans to establish a Bitcoin incubator in Manhattan catering to the needs of young digital currency startups.

Since the complex nature of payment systems and surrounding regulation is inherently capital-intensive, the fund's founders recognized that the initial capital required for success will much larger than a social-media or mobile tech startup would need. "Our typical investment size will vary based on the type of startup backed,” says Jean, 29 years old. “For example, a currency exchange might require significantly more capital than a wallet or eCommerce company."

In addition to companies that are proactive with respect to network security and regulatory compliance, it appears that Liberty City will concentrate initially on New York City-area companies since those are the entrepreneurs the founders know best. However, they are not prepared to announce any angel investments at this time.

The fund’s current largest competitor is Union Square Ventures, which recently led the $5 million round for the exchange and wallet service Coinbase. Other significant operators investing in the fast-moving space include Barry Silbert's Bitcoin Opportunity Fund, Adam Draper's Boost Bitcoin Fund, Chris Dixon at Andreessen Horowitz, Peter Thiel's Founders Fund, and Tyler and Cameron's Winklevoss Capital Management.

A large fund size and a dedicated focus certainly meet the requirements for the emerging digital currency sector. However, the ability to think globally as a service provider will prove critical for those Bitcoin companies wanting to maintain a leadership role. Liberty City Ventures would be wise to partner with similar investment efforts in other international jurisdictions.

U.S. Shuts Liberty Reserve Currency Exchange

By Jon Matonis
Forbes
Tuesday, May 28, 2013

http://www.forbes.com/sites/jonmatonis/2013/05/28/u-s-authorities-close-another-digital-currency-exchange

In conjunction with Costa Rican authorities and Spanish police, U.S. law enforcement participated in a joint operation on Friday to arrest the founder of Liberty Reserve S. A., a private digital currency exchange service based in Costa Rica.

U.S. authorities accused the currency exchange of facilitating $6 billion worth of money laundering, calling it a “bank of choice for the criminal underworld.”

Today, the website domain is resolving again but a notice on the homepage states: “THIS DOMAIN NAME HAS BEEN SEIZED by the United States Global Illicit Financial Team.” Domain names were also seized for asianagold.com, exchangezone.com, moneycentralmarket.com and swiftexchanger.com most likely for their affiliation with Liberty Reserve.

According to the indictment unsealed today, U.S. prosecutors said that the case involved law enforcement agencies in 17 countries and “is believed to be the largest international money laundering prosecution in history.” This latest action follows the 2007 closure of Doug Jackson’s famous e-gold service and this month’s seizure of Mt. Gox’s assets and account facility at U.S.-based Dwolla.

Arthur Budovsky, 39, a former U.S. citizen and naturalized Costa Rican of Ukrainian origin, was arrested in Spain and U.S. officials are likely to seek his extradition. He has been under investigation in Costa Rica since 2011 for suspicion of money laundering and for using various shell companies to operate Liberty Reserve.

On Friday, San José prosecutors raided Budovsky’s home and offices in Escazú and Santa Ana, southwest of San José, and in the northern province of Heredia. Agents from the organized crime unit of the Costa Rican Prosecutor’s Office seized documents, computers, three Rolls Royce and Jaguar automobiles, and a motorcycle. A Russian national with the last name Chukharev was also arrested and the U.S. is seeking his extradition as well.

Costa Rica state prosecutor José Pablo Gonzalez said that Costa Rica’s financial regulator, Financial Institution Superintendency (SUGEF), had refused to issue a license to Liberty Reserve in 2011 due to concerns about its transparency and funding procedures.

Investigators allege that Budovsky’s businesses in Costa Rica were used to launder funds from drug trafficking, identity theft, and pornography websites. The seized digital and physical evidence from the companies will be turned over to U.S. law enforcement in accordance with “international penal assistance.” The involved companies are Silverhand Solutions & Technology S.A. (Santa Ana), Worldwide E-Commerce Business S.A., or WEBSA (Escazú), Grupo Lulu Limitada (Escazú), Triton Group A & A, S.A. (Escazú), and Cyberfuel.com (Santa Ana).

Some Liberty Reserve users are estimating that the company may have held customer funds in excess of $150 million at the time of the seizure. There has been no statement from authorities on the reclamation process.

Since 2002, Liberty Reserve had been operating one of the oldest and most popular payment processors in the world with millions of clients. Vitalik Buterin of Bitcoin Magazine credits the company with being “one of the chief enablers of the Bitcoin economy’s early growth.” Payment methods such as credit cards and ACH transfers are not a great match for the irreversible bitcoin, because those payment methods can be reversed, or charged back. In 2010 and 2011 with the bitcoin exchanges struggling for irreversible inbound payment methods, Liberty Reserve Dollars and Liberty Reserve Euros were proprietary digital units that satisfied the need for payment finality.

Although security researcher Brian Krebs emphasizes the more salacious cyber crime aspects of the case, Liberty Reserve was also utilized by many legal businesses.

According to Forex Magnates, Liberty Reserve was “the leading payment channel for traders in emerging and frontier markets” and it was used by several international forex brokers, such as Marketiva, FXOpen, Markets.com, and Instaforex. Citing Masroor Ghoori, a foreign exchange broker in Pakistan, Forex Magnates said, “Forex brokers have been benefiting from Liberty Reserve’s vast access as a payment provider, especially in countries where traders face difficulties in transferring funds. Liberty Reserve was a ‘gift’ for several traders, especially after the State Banks’ (State Bank of Pakistan) changes to international money transfers.”

In a separate report, Forex Magnates predicts that bitcoin may be a viable alternative for payments to introducing brokers and even direct forex account funding now that centralized systems are under attack.

Mitchell Rossetti, co-founder of virtual prepaid ePay Cards, told the BBC that his company now faces an “uphill battle” to make up potentially lost funds because his business had about $28,000 sitting in a Liberty Reserve account at the time the site went offline. The cards allow consumers outside the U.S. to purchase goods from stores in the country as if they owned a locally-issued Visa or Mastercard credit card. Based in Texas and London, the firm allowed its customers to load their virtual prepaid cards with Liberty Reserve because it was quick, efficient and secure.

Demonstrating that those most harmed in targeted digital currency shutdowns are law-abiding U.S. citizens, Panamanian payment system Perfect Money announced the following on Saturday:

"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."

Top 10 Bitcoin Merchant Sites

By Jon Matonis
Forbes
Friday, May 24, 2013

http://www.forbes.com/sites/jonmatonis/2013/05/24/top-10-bitcoin-merchant-sites/

If you’re involved in Bitcoin, you have no doubt been asked the question “So, who accepts bitcoin?” True, it is the quintessential chicken and egg paradox, but that is not unexpected for the world’s first decentralized cryptocurrency lacking a political authority.

Commodity money and quasi-commodity money must gain legitimacy and acceptance through the rigors of the free market unlike political currencies that simply gain prominence by virtue of State sanctioning. In the true absence of State sanctioning or legal tender status, the monetary unit with the superior features will prevail in a competitive marketplace.

Let’s take a look at the top ten merchant sites on the Internet that are currently accepting bitcoin as payment. Uncensored rankings are based on the amount of three-month traffic received by the website according to Alexa Top Sites (as of May 24th, 2013). The updated list is provided courtesy of The Bitcoin Trader, but a separate version of the Bitcoin Ladder is also tracked on the Bitcoin wiki.
 1. WordPress.com (Alexa Global Ranking 22) – Site offers free blogs managed by the developers of the WordPress software and includes custom design templates, integrated statistics, and automatic spam protection. WordPress announced their decision to start accepting bitcoin in November 2012.

2. The Pirate Bay (Alexa Global Ranking 108) – As a large BitTorrent directory for music, movies and software, The Pirate Bay started accepting bitcoin for donations in April 2013.

3. Reddit (Alexa Global Ranking 117) – The social news and entertainment site focuses on user-generated news links with votes promoting top stories to the front page. Reddit started accepting bitcoin for the purchase of reddit gold in February 2013.

4. The Internet Archive (Alexa Global Ranking 245) – The Internet Archive is a nonprofit organization established to provide a permanent digital library by preserving Web sites. The Wayback Machine provides links to older versions of various webpages. They started accepting bitcoin donations and paying some employees in bitcoin in February 2013.

5. OkCupid (Alexa Global Ranking 687) – The free friendship, dating and social networking site started accepting bitcoin to pay for bonus features in April 2013.

6. 4chan.org (Alexa Global Ranking 882) - 4chan is a simple image-based bulletin board where anyone can post comments and share images without a requirement to register. The boards are dedicated to a variety of topics, from Japanese animation and culture to video games, music, and photography. They started accepting bitcoin for premium subscriptions in December 2012.

7. Namecheap (Alexa Global Ranking 974) -Namecheap offers affordable domain name registration, parking, e-mail, URL forwarding, and SSL certificates. They began accepting bitcoin in March 2013.

8. EZTV (Alexa Global Ranking 1,052) – EZTV.it is your one-stop source for all your favorite TV shows and they started accepting bitcoin donations in April 2013.

9. Mega.co.nz (Alexa Global Ranking 1,783) – MEGA offers 50 GB of free storage space and uploaded files are encrypted with only the user holding the decryption keys. Processed by Bitvoucher, the Kim Dotcom site started accepting bitcoin for private package upgrades in February 2013.

10. Lumfile (Alexa Global Ranking 3,761) – Lumfile is a free cloud-based file server that has been accepting bitcoin for premium accounts since at least December 2012.

Other notable sites in the ranking include LewRockell.com (9,202), OKPay (11,704), and the Tor Project (14,028). Of course, top merchant sites by bitcoin volume would produce an entirely different list, but that data is not always publicly available. Additional bitcoin merchants from a wide variety of categories can be found on the Bitcoin Trade wiki.