05/24/2013 02:12 pm ET Updated Jul 24, 2013

Federal Court Takes a Bite Out of Bitcoin

Last week, a federal judge ordered the seizure of funds from a mobile currency exchange called Dwolla, belonging to an account held in the name of Mt. Gox aka Mutum Sigillum, LLC, (Latin for silent signals). Tokyo-based Mt. Gox is the largest bitcoin "bank" in the world and is run by Mark Karpeles, a French self-proclaimed techy, software developer, and International Mensa member. Dwolla, a barely three-year old online payment company developed to rival Paypal and eliminate the need for commercial banks, is the fastest and cheapest method of transferring funds to buy or sell bitcoins in the United States.

And that's about as close as US financial authorities can get to actual bitcoins because they don't exist. Even in cyberspace. They are what techies call crypto-currency. Bitcoins are to dollar bills what avatars are to flesh and blood human beings. Forget the gold standard, fiat money, or anything else you ever thought you know about what made a dollar a dollar. A bitcoin exists because the owners of millions of CPU's worldwide want them to exist.

Six months ago, not many people knew what a bitcoin was. Now lawyers are accepting them and bloggers are living on a bitcoin diet. But where did the first bitcoin come from?

On November 1, 2008, in the wake of the global near financial collapse, someone calling himself Satoshi Nakamoto, published a spare and elegant nine page paper announcing he was creating a peer to peer electronic payment system based on "cryptographic proof instead of trust." Like the bitcoin he was creating, Nakamoto exists only on the web. But whoever Nakamoto is or is not, he or she explained that the world needed bitcoins because banks and other financial service institutions were a terribly imperfect mode of value exchange because they operated on a system based on trust. In a post-Orwellian manifesto, Nakamoto insisted the only currency that could be trusted was an electronic coin created by digital signatures.

The birth of the bitcoin was the ultimate open-source project controlled by a finite number of bitcoin platfoms capable of harnessing a virtually infinite amount of CPU processing power. A bitcoin is created by what most reporters call data-mining but really is the creation and re-creation of thousands of blocks of verification calculations which are harnessed by ASIC processors. The process and processors are decentralized and this is the basis for bitcoin's elusiveness and anonymity.

Confused? You should be. Bitcoins are meant to be universal, immediately transferrable, dependable, and anonymous. For reasons which remain entirely unclear, only 21 million bitcoins may ever be made and it is this cap on cyber-minting which gives bitcoins their relative and shifting value. But the daily price is determined as much by demand as supply. There are two main types of demand: speculative and transactional. As more e-businesses, non-profits, and people accept bitcoins for payment, demand will increase and so will the price of bitcoins. Likewise, as more people speculate on the future popularity of bitcoins by saving or hoarding them or investing in bitcoin exchanges like Mt. Gox, which are the only places where bitcoins may be purchased, the price goes up as well.

There are approximately 11 million bitcoins in circulation at present, and with a current approximate price of over $100 per bitcoin, even after the seizure of the Dwolla account, the total value of the currency has surpassed the $1 billion mark. In April of this year the bitcoin traded for as high as $266 and emulating US financial regulatory authorities, Mt. Gox halted trading as the price of the bitcoin tumbled 77% in an effort to let the market "cool down."

But even before April's bitcoin madness, the US Department of the Treasury Financial Crimes Enforcement Network ("FinCEN") recognized the need to look more closely at this virtual currency that was taking the global economy by storm. FinCEN issued regulations in March, 2013 explaining that a mere user of bitcoins is not a money service business because it acquires them or uses them to pay for real or virtual goods or services. However, FinCEN found that administrators or exchanges of bitcoins are money transmitters subject to regulation. This FinCEN ruling formed the basis for the seizure action brought against Dwolla last week.

Even before FinCEN's regulations, the FBI last year issued an internal report warning that the anonymous bitcoin payment network was a growing haven for money laundering and other cyber-criminal activity including terrorism financing, human trafficking, kiddie porn, illegal internet gambling, and theft of the bitcoins themselves from their anonymous owners' virtual wallets. In the report, the FBI notes that because bitcoin combines cryptography and a peer-to-peer architecture to avoid a central authority, law enforcement agencies will have more difficulty identifying suspicious users and obtaining transaction records.

But law enforcement agencies can take heart. Financial seer Warren Buffet has no confidence in it as a form of universal currency and does not believe bitcoin is here to stay. Mark Karpeles, CEO at Mt. Gox, which controls approximately 70 percent of the global trade in bitcoins, has his doubts, too. In a rare interview with Reuters aired in April after bitcoin's roller coaster ride, he said, "If people want to stay safe, don't buy bitcoin right now.....Bitcoin is a high risk investment.... Its value could be zero the day after tomorrow."