What seizure of illicit Silk Road means for virtual currency Bitcoin

The once-obscure Bitcoin has been making news all year.

There have been stories about the wild swings in the virtual currency’s exchange rate, moves by financial regulators to shut down some Bitcoin-related businesses, and the attempts by its boosters to gain more mainstream credibility.

But this week, the Bitcoin community was hit with a story potentially bigger than all the others: the seizure of the illicit Silk Road website and the arrest of its founder, Ross William Ulbricht, a 29-year-old former physics student from San Francisco.

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For the last two years, Silk Road has been the bogeyman for Bitcoin critics. They pointed to the ability to buy drugs and guns on the site using the virtual currency as evidence Bitcoin could enable terrorist and criminal activity.

The service gained widespread notoriety in 2011 when Sen. Charles E. Schumer (D-N.Y.) singled it out as the poster child for how Bitcoin could potentially be used by terrorists and criminals.

“Literally, it allows buyers and users to sell illegal drugs online, including heroin, cocaine and meth, and users do sell by hiding their identities through a program that makes them virtually untraceable,” Schumer said at a June 2011 news conference calling for a crackdown on the service. “It’s a certifiable one-stop shop for illegal drugs that represents the most brazen attempt to peddle drugs online that we have ever seen. It’s more brazen than anything else by light years.”

So, with the crackdown this week, it would seem like a dark day for the growing Bitcoin community. But not so fast. In talking to several Bitcoin observers this week, it appears they are taking a very nuanced view of the Silk Road story.

Yes, the Silk Road story is ugly. But there is also reason for optimism.

For Adam Levine, editor-in-chief of the Let’s Talk Bitcoin blog and podcast, he saw the arrest as part of Bitcoin’s natural evolution from renegade currency to mainstream adoption.

“When you tame the west, you’ve got to hang all the outlaws,” Levine said. “It’s an inevitable transitional phase. If Bitcoin is going to turn into a mainstream thing, this has to happen. The legitimate uses cannot be overshadowed by the illicit uses.”

Jerry Brito, a senior research fellow at the Mercatus Center at George Mason University, noted the shutdown of Silk Road was very much different than other government actions against Bitcoin-related endeavors.

In recent months, state and federal regulators have moved to shut down various Bitcoin-related businesses. However, those businesses were attempting to operate legitimately but were accused of violating various currency rules and regulations, Brito said.

By comparison, Silk Road was focused on using Bitcoins to foster transactions.

The actual Silk Road marketplace, however, was not simple to find or trace. It was cloaked by an Internet encryption standard known as TOR. Once on the service, all transactions had to be paid in Bitcoins.

The virtual currency was created in 2009 by a programmer using the pseudonym Satoshi Nakamoto.

Bitcoin is really an open-sourced protocol that anyone can add to or alter. These protocols run across a wide number of servers around the world for regulating the creation and trading of Bitcoins. People can get Bitcoins either by buying them with traditional currency or by “mining” them. The mining process involves solving complex computing puzzles that reward a person with Bitcoins.

Bitcoin boosters like it because it is a currency that’s decentralized, not controlled by any government or company.

Indeed, it turns out that according to the indictment, a large portion of existing Bitcoin seemed to have flowed through Silk Road at one point or another.

But Brito says some elements of the arrest and the reaction should provide some reassurance about Bitcoin’s future.

For instance, while the value of Bitcoin dropped sharply after the news of the arrest, from about $140 to $118, the currency recovered later in the day to $128, where it remained Thursday. A year ago, one Bitcoin traded for $14.

Brito said some folks have wondered whether services such as Silk Road represented the bulk of Bitcoin-related purchases.

“A lot of folks have made the case that Bitcoin’s only value was that it could be used to buy drugs or guns on Silk Road,” he said. “If they’re right, and that’s Bitcoin’s only value, well, it should be trading at zero.”

Also, the fact that law enforcement officials were able to track down and seize Silk Road means they’re developing the necessary tools to fight more sophisticated digital crimes, Brito said.

“The fact that law enforcement could take it down shows there’s nothing different about Bitcoin,” Brito said. “Yes, it has a potential illicit use like any other tool. Law enforcement is going to have to develop new techniques to deal with it.”

Gary Kremen, a Silicon Valley entrepreneur, said he hopes the ongoing scrutiny of Bitcoin enterprises by government agencies will get Bitcoin entrepreneurs to take seriously issues such as auditing and compliance with federal financial regulations.

“If Bitcoin is going to go mainstream and be respected, these issues must me addressed,” Kremen said.

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