A bitcoin ATM machine is shown at a restaurant in San Diego Thomson Reuters SYDNEY (Reuters) - A top Australian law enforcement agency is investigating bitcoin's role in organized crime, a senior official said, just as politicians and financial regulators embrace the digital currency as a legitimate part of modern business.

The investigation into bitcoin's crime links by one authority as others embrace it highlights the crossroads governments have reached as they struggle to regulate the five-year-old "cryptocurrency", a method of making anonymous payments which has surged in popularity around the world.

Australian Crime Commission Executive Director Judy Lind revealed for the first time that investigators will monitor "misuse of virtual currencies to facilitate criminal activity" at a national and international level, under an operation named Project Longstrike.

"We know that virtual currencies including bitcoin are used as payment methods to facilitate illicit trade on the darknet," Lind told Reuters in a statement, referring to a hidden part of the Internet where information can be shared anonymously and without revealing the location of its source.

"Organized crime groups continue to make use of darknets to harbor trading in illicit commodities, including child exploitation material, illicit drugs and firearms, stolen credit card and identity data, and hacking techniques."

Project Longstrike is just the latest example of Australia's determination to crack down on bitcoin-enabled crime. Last month, Australia said it extradited to the United States the alleged primary moderator of Silk Road, a website where people bought illegal drugs like heroin using bitcoins.

In October, police seized Queensland state's first bitcoin automated teller machine five months after it opened, with media reporting police believed it was being used by a former motorcycle gang member to deal crystal methamphetamine.

Regulators around the world are wary after the Mt Gox bitcoin exchange filed for bankruptcy in Tokyo earlier this year, saying it lost some 850,000 bitcoins - worth about $300 million at current prices - in a hacking attack.

Like many countries, Japan has allowed bitcoin trading to continue without establishing a full set of rules on its legal status. U.S. authorities are yet to agree to cohesive laws, while the United Kingdom is seen as a world leader because it has classified bitcoins as a currency.

Australian authorities are also trying to facilitate legal bitcoin trades in a country where use of the currency is exploding. Between its 23.6 million people, Australia has an estimated 7 percent of the $5 billion worth of bitcoins now circulating, with reports of online retailers, real estate agents and even pubs accepting bitcoin payments.

The Australian Taxation Office has published a guide for bitcoin traders on how to declare their investments, and a parliamentary inquiry is trying to lay the groundwork for a broader regulatory approach to the digital currency.

But David Glance, director of the University of Western Australia's Centre for Software Practice, said Australia appeared to be sending mixed messages.

"Politicians singularly fail to understand what (the digital economy) is all about. They latch onto trends and buzzwords," he said, referring to the tax office guidelines and parliamentary inquiry.

"There still isn't a problem that bitcoin solves, other than buying drugs," he added.

Darknet sites including Silk Road and its successor Silk Road 2.0 did about $3 billion of turnover annually in the year to November, Glance said, equivalent to more than half the total bitcoins now in circulation.

Jeff Hudson poses for a picture in front of, according to co-founders of Vancouver Bitcoiniacs Trading Company, the first bitcoin ATM machine in a Waves Coffee House in Vancouver, British Columbia October 28, 2013. REUTERS/Andy Clark

WILD WEST

Senator Sam Dastyari, who is running the parliamentary inquiry, said bitcoins offered a way to "shake up" Australia's "stale" banking industry. A regulatory system is needed that policed crime without restricting the currency, he said.

"There is going to be a place for some kind of digital-style currency. There is inevitability that it will play some kind of role," Dastyari said.

"Do you go and start regulating it first, or wait for the IMF to do it first and come on board?"

Australia could soon see the world's first direct share market listing of a virtual currency exchange, in a sign of how rapidly bitcoin businesses are entering the mainstream.

Melbourne-based start-up Bitcoin Group hopes to raise A$20 million ($17 million) and plans to file a prospectus by Christmas which will not include financial forecasts.

Bitcoin Group Chief Executive Officer Sam Lee compared the currency to the early "wild, wild west" days of the Internet, and shrugged off concerns that it mainly served as a vehicle for illegal transactions.

"We've moved far beyond that now," he said.

"We expect (bitcoin currency) to clean itself up as more capital and more smart people flow into the ecosystem."

(Editing by Stephen Coates)