Liberty Reserve: Serving The Unbanked Or The “Underworld”?

Merchant acquiring can be a competitive and complicated business. New players especially need an angle, an innovation, something to differentiate what and how they serve their merchants.

Arthur Budovsky was no different. His focus was on eliminating friction from trading partners who wanted to do business with each other but didn’t have bank accounts or couldn’t get them. His idea was to create a digital platform, the “PayPal for the unbanked” that would use digital currencies to enable payment between trading partners. No bank account needed, just an ability to buy virtual currency which was pegged to the dollar, which sellers would accept.

At its peak, Budovsky’s platform had 1 million registered accounts and more than 200,000 users in the U.S. conducted approximately 55 million transactions through its “virtual currency” system — pumping $6 billion in volume.

So far, Budovsky sounds just like every other innovator enamored with the possibilities at the intersection of technology and virtual currency. Except that those billions, according to the Fed, were driven by the proceeds of credit card fraud, identity theft, investment fraud, computer hacking, narcotics trafficking and other crimes.

In other words, a ginormous global-money laundering operation disguised as an innovative merchant acquiring business.

Budovsky’s platform was called Liberty Reserve (LR) and his story is detailed in the May 2015 edition of The Atlantic where Author Jake Halpern takes the reader through many conversations with the man who created a virtual currency system that once had more than a million users.

According to Halpern’s report, Budovsky claims that “The current banking system has not invented anything new for quite some time, while the world and technology have moved on.” And that he simply wanted to provide an alternative where users could buy virtual currency through LR – but have it be untraceable.

A “PayPal for people around the world,” Halpern writes, “who don’t have bank accounts or credit cards.”

Or who have them but didn’t want to use them for the type of business that LR enabled.

“Liberty Reserve emerged as one of the principal money transfer agents used by cybercriminals around the world to distribute, store, and launder the proceeds of their illegal activity. Liberty Reserve was used extensively for illegal purposes, functioning as the bank of choice for the criminal underworld because it provided an infrastructure that enabled cybercriminals to conduct anonymous and untraceable financial transactions,” according to the U.S. Department of Justice’s claims.

LR is described by the Feds as an online epicenter for people involved in credit-card/ID fraud, computer hacking, child porn and narcotic trafficking.

Not to mention drugs, guns and stolen identities…

LR became a place to help criminals conduct illegal transactions that were said to be untraceable.

That’s where the legal troubles surfaced — and why the U.S. Department of Justice stepped in.

“Budovsky allegedly built Liberty Reserve overseas to provide the international underworld with a crime-friendly digital currency and elude the scrutiny of American authorities. He even renounced his U.S. citizenship to try to escape facing justice in an American courtroom,” Assistant Attorney General Leslie Caldwell wrote in a news release from October 2014 when Budovsky was extradited from Spain to face federal U.S. charges.

The plot thickens as Budovsky was accused at that time of enabling illegal payment processing to launder billions of dollars in crime using Liberty Reserve. U.S. authorities even stated that he operated LR in Costa Rica to evade U.S. law enforcement.

This wasn’t Budovsky’s first run-in with U.S. authorities. In 2006, he was convicted of operating a company called Gold Age Inc., an unlicensed money transmitting business. The year following, the E-Gold operators were charged with money laundering, amid other things. Once his third-party exchange services were shut down, that didn’t stop him from generating his next wave of digital currency. That’s when he moved to Costa Rica and started Liberty Reserve — coined by its creators as the “largest payment processor and money transfer system,” which ran until it was shut down in May 2013 by the U.S. government.

As The Atlantic‘s article points out, Liberty Reserve was created in a similar manner to bitcoin. Both were digital currencies, and both were decentralized and could be traded somewhat anonymously. Bitcoin’s value, however, is volatile, and that’s what separated LRs. They were tied to the U.S. dollar, and would be transacted out of Liberty Reserve’s hub in the U.S. territory of Costa Rica. Budovsky told The Atlantic that the purpose for headquartering the operations there was simply for the weather. The U.S. authorities, of course, know better, as do most who’ve experienced the governmental oversight (or lack thereof) in the region.

“It probably seemed like the perfect environment to set up this type of business,” David Boddiger, editor of the The Tico Times told The Atlantic. “There’s no military; it’s a small, democratic country with underfunded and understaffed law-enforcement agencies and an inefficient justice system.”

Bingo.

Turns out, Costa Rica is also a “place where dirty money could be cleaned,” Halpern reported. And with Costa Rica’s already thriving illegal drug market, money laundering seemed to fit like a glove. The Atlantic cited figures from the nonprofit organization Global Financial Integrity that suggests that more than $21 billion in laundered money is transferred out of the country each year. While Halpern noted the Costa Rica conspiracy was simply a theory, the Feds believe Budovsky ran Federal Reserve from Costa Rica for that very reason.

“The indictment alleges that Budovsky devoted himself to building and expanding Liberty Reserve so that the company could profit from attracting more and more criminal customers, all while seeking to evade the scrutiny and reach of U.S. law enforcement authorities,” according to the statement from the Department of Justice.

While sites like Liberty Reserve and The Silk Road have since shut down because of relation to illegal activity, as least for LR, there’s reason to believe that there were users of the site who turned to it for legitimate transfer purposes. Halpern spoke with Mitchell Rossetti, the entrepreneur who started the Houston-based ePayCards.com, who was a mainstream merchant who accepted the online currency.

Rossetti said he used Liberty Reserve because his customers didn’t have bank accounts or credit cards, so they wouldn’t be able to make online purchases. He also said PayPal allowed customers to dispute charges, causing him to lose out on the sale. With LR funds, however, payments were final. For a merchant, the factor became very attractive. At least until LR went under. In another interview, Rossetti said he had about $28,000 in Liberty Reserve at the time it was shut down.

So just how widespread was the Liberty Reserve’s reach? Outside of the legitimate merchants who turned to its alternative way to process payments, the number of criminals is suspected to be in the thousands.

“Thousands of criminal websites relied on Liberty Reserve as their payment processor of choice,” prosecutors argued in a memo submitted to the U.S. District Court for the Southern District of New York. “These websites predominated the sources of Liberty Reserve’s online traffic and generated billions of dollars in transactions run through the company’s system.”

Still, the cases of Arthur Budovsky and the “Bank of the Underworld,” or Ross Ulbricht and the Silk Road, raise questions about how authorities are going to keep up with how cyber transactions are monitored and tracked. How can the Feds keep up with cybercriminals and technologies that attempt to stay one step ahead of the curve? These questions will be left up to the Feds as they work to craft their cybersecurity legislations.

About a year before Budovsky was extricated from Spain, the co-founder of the site, Vladimir Kats, plead guilty in federal court to money laundering and operating an unlicensed money transmitting business. In the Justice Department’s news release about the plea, it said Liberty Reserve is thought to be the source of laundering more than $6 billion. Multiple others connected to Liberty Reserve have plead guilty to their role in the site — including the IT manager, the CTO and a Deputy.

At least in the case of Budovsky and his “underworld,” we’ll soon learn a little bit more if it truly was a way to introduce the “PayPal for the unbanked,” or it was, in fact, the haven for global money laundering and the hub of illegally traded goods. We’ll learn if LR served a larger purpose than moving “dirty money,” or it was created for exactly that purpose.

Or perhaps the full intentions of Budovsky’s empire may never be revealed. But come Sept. 21, 2015, when Budovsky is scheduled for trial, we’ll surely learn a lot more about the “underworld” he’s accused of serving via his digital currency service.