Black eye for Bitcoin: US arrests Bitcoin Foundation exec for money laundering day before hearings

The virtual currency Bitcoin has come a long way in shedding its early reputation as a tool for crime, and now enjoys the support of many respected investors and mainstream businesses. On Monday, however, that reputation suffered a setback as the federal government announced criminal charges against two men who ran the online exchange BitInstant, one of whom is a senior figure in a trade group that lobbies for Bitcoin’s legitimacy.

In a press release, the Manhattan U.S. Attorney’s Office said it is charging Robert Faiella and Charlie Shrem with conspiracy to commit money laundering in relation to their activities on Silk Road, a notorious online bazaar for drugs and other criminal services.

The release said that Shrem was arrested at JFK Airport in New York yesterday and Faiella at his residence in Florida. Both men are expected to attend court hearings today. Shrem’s name is notable because not only was he CEO of BitInstant, but also Vice Chairman and one of five board members of the Bitcoin Foundation, an umbrella group that has testified before Congress about the virtual currency. Shrem’s profile is still up on the Foundation’s website, but here is a screenshot in case it disappears:

Charlie Shrem bitcoin foundation

Update: A spokesperson for the Bitcoin Foundation said by email: “We are surprised and shocked by the news today. As a foundation, we take these allegations seriously and do not condone illegal activity.”

As Forbes notes, Shrem’s company is backed by the Winklevoss twins, who invested $1.5 million last year and who are major players in the Bitcoin world.

The criminal compliant itself claims that Shrem and Faiella took in over $1 million in cash Silk Road users in exchange for supplying them with bitcoins that the government alleges were used to engage in illegal transactions.

While Silk Road, which the FBI shut in dramatic fashion last summer, was a well-known criminal forum, that doesn’t mean that there is anything inherently criminal about Bitcoin. As supporters of the currency point out, drug dealers favor U.S. dollars to conduct their business — and there is nothing illegal about using cash.

Shrem’s arrest, however, comes at a bad time: Bitcoin supporters are gathering in New York City this week for hearings at which they will testify before state regulators about the currency’s benefits.

The Shrem incident is unlikely to do permanent damage to Bitcoin as an idea, but it does undermine the credibility of the Bitcoin Foundation at a time when the mainstream media and financial industries are starting to pay serious attention to the currency. (Others like my colleague David Meyer remain skeptical about the point of Bitcoin in the first place).

If convicted, both Shrem and Faiella face a maximum of twenty years for the conspiracy charges plus an additional five for operating an unlicensed money-changing business. Shrem faces an additional five years for “willful failure to file a suspicious activity report.”

This story was updated at 11pm ET to include a statement from the Bitcoin Foundation.