In what could be a bad sign for the future of Bitcoin, the feds have shut down Liberty Reserve, a virtual currency exchange system that prosecutors claim was a $6-billion money-laundering scheme designed to help criminals and hackers conceal the origin of their illicit money.

Liberty Reserve is a Costa Rica-based online payment network that U.S. authorities dubbed the "financial hub of the cyber-crime world." According to the indictment (.PDF) unsealed on Tuesday, the service was one of the world's largest digital currency systems with more than 1 million users and more than 12 million transactions.

For the feds, Liberty Reserve facilitated "a broad range of online criminal activity, including credit card fraud, identity theft, investment fraud, computer hacking, child pornography, and narcotics trafficking," and "was in fact used extensively for illegal purposes, functioning in effect as the bank of choice for the criminal underworld."

The indictment, first reported on by Internet security reporter Brian Krebs, and filed in the U.S. District Court for the Southern District of New York, accused Liberty Reserve's founder Arthur Budovsky, 39, and five alleged co-conspirators, of running the illegal money-laundering service.

The five were arrested on Friday in Spain, Costa Rica and Brooklyn, N.Y. The arrests culminated an operation that involved law enforcement agencies form 17 different countries, making it possibly the largest money laundering prosecution ever.

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Liberty Reserve's unregulated nature and almost complete anonymity attracted the likes of hackers and criminals.

Even two of the defendants charged in the indictment published today admitted Liberty Reserve's nature in an online chat. In a conversation intercepted by the authorities between Vladimir Kats and Ahmed Yasine Abdelghani, Kats wrote that "everyone in the USA," including the "DOJ," knows that Liberty Reserve is a "money-laundering operation that hackers use."

Even though Liberty Reserve was used by at least 200,000 American customers, it never registered in the U.S. as a money transmitting service, remaining on the edge of legality as an almost completely unregulated money transfer business. To use the service, a user had to provide name, address, and date of birth, but these were never verified.

For all intents and purposes, all a user had to provide to register was a valid email address.

In fact, a law enforcement agent told the New York Times that he was able to register under the name of "Joe Bogus," and even state that the purpose of his registration was "for cocaine."

And this was true for other customers, some even used blatantly fake names like "Russia Hackers."

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Liberty Reserve used a complicated system to transfer money across the globe, allowing its users to do it anonymously. The service used third party "exchangers" to avoid collecting cash directly. These exchangers were mostly unlicensed money transmitting services based in Malaysia, Nigeria, Russia, and Vietnam, according to the indictment.

For a senior law enforcement agent, Liberty Reserve was the "Paypal for criminals," as he put it to the New York Times.

The service was started in 2006 by the Ukrainian native Budovsky, who at the time had just been indicted by the feds for money-laundering charges relating to Gold Age, another money-transferring business. After the indictment, he incorporated Liberty Reserve in Costa Rica, and in 2011 he renounced his U.S. citizenship to become a national of the Central American country. In 2007 Budovsky was sentenced to five years of probation after pleading guilty to the Gold Age charges.

The system was used, among others, by the hackers behind the recent $45-million ATM heist.

As indicated by Tymothy B. Lee at the Washington Post, Liberty Reserve's anonymity features resemble those of Bitcoin, and it's thus not completely far-fetched to imagine the feds going after Bitcoin.

The main difference between the two is that even though Bitcoin potentially allows users to be anonymous, every transaction is unique and traceable, even years after it was made. Moreover, there's no one to charge if the feds decide that Bitcoin is illegal. Bitcoin's creator, the mysterious Satoshi Nakamoto, has completely disappeared since 2011, and it's widely believed that his name is just a pseudonym. And nobody really knows who hides behind it.

Image via iStockphoto, DNY59