The advent of the Internet is not all positive – criminals like to use the Internet and they are very good at doing so.  The same might be said for Bitcoin, the new raging virtual currency.

Bitcoin is on the government’s radar screen from both a regulatory and an enforcement perspective.  Eventually, Bitcoin will be regulated.  In the meantime, however, the trade press is definitely enjoying the headlines when criminals using the Internet merge their operations with Bitcoin (or any other virtual currency).

Silk Road was a black-market website where consumers could buy illegal products.  Most of its trade involved drugs.  Customers’ identities were anonymous.  The FBI seized the website servers and arrested its owner and operator.

Silok Road used Bitcoin for users to buy and sell its illegal goods.  In the aftermath of the seizure, Bitcoin’s value dropped 20 percent.  But that has been just a temporary blip.  Just like the war on drugs, the war on online sellers of drugs results in a shifting of resources – you take one drug dealer down, another will pop up or demand from other dealers will grow.  Other illegal drug sites exist and will expand their market share.

Websites which sell illegal products depend on anonymity of their buyers and use software to provide important identity protection.  Bitcoin and other virtual currencies plug into the system very easily.

Bitcoin’s advocates contend that the use of Bitcoin for illegal purposes is only a small percentage of users.  Bitcoin wants to grow into legitimate online commerce as a virtual worldwide currency for users.  People are investing in Bitcoin in the hopes that it develops into the premier virtual worldwide currency.

The Silk Road case had very little to do with Bitcoin.  Instead the investigation focused on identifying the owner of the site through cyber-world techniques and technologies.  The owner and operator slipped up on a few occasions and left public trails of his path which eventually led to the FBI identifying him.

Bitcoin did not contribute significantly to the operator’s ability to hide his identity from law enforcement.  However, Bitcoin and other virtual currencies will need to develop appropriate compliance programs to ensure that they do not violate AML laws and regulations.

The virtual currency industry and related exchanges are going to have to adopt stringent “know your customer” policies and procedures.  As time moves on, Bitcoin and other virtual currencies will face a number of regulatory and operating challenges.  The key will be whether those regulatory requirements strangle Bitcoin and other virtual currencies from competing with more traditional currency or result in the suppression of innovation.