Special Agent in Charge James Hayes announces the Liberty Reserve indictment, via ICE

Federal prosecutors in New York this week announced the crackdown of a $6 billion online money laundering scheme, the largest such case in history.

According to the indictment handed down by federal courts in Manhattan, Liberty Reserve, a digital currency exchange, was “the predominant digital form of money laundering used by cyber-criminals worldwide,” handling 55 million transactions over years of operation. The site served millions of customers, ranging from black hat hackers to international crime syndicates, siphoning profits from drugs, child pornography, theft, human trafficking, among other nefarious activities.

As the head of the Internal Revenue Service’s criminal investigation puts it, we’ve entered the “cyber age of money laundering.”

“If Al Capone were alive today, this is how he would be hiding his money,” Weber said at the news conference. The Costa Rica-based Liberty Reserve was able to subvert mainstream financial institutions, thus maintaining user anonymity, by relying on a dubious network of exchangers in Russia, Nigeria, and Vietnam.

It’s not hard to see the criminal attraction of an anonymous digital currency and naturally, many are focusing on bitcoin, including not only prosecutors and bitcoin supporters, but also the criminals who have just lost their primary medium for illicit transactions, which some likened to the Napster of cybercrime. Others are already predicting bitcoin’s inevitable demise, given the cryptocurrency’s own predilection toward the illegal.

But while both Liberty Reserve and bitcoin offer similar features, it’s not a like-for-like comparison. If Liberty Reserve is Napster, bitcoin is the mp3. A better analog would be a bitcoin exchange, like the Tokyo-based Mt.Gox, which is under investigation by the Department of Homeland Security for being an unlicensed money transmitter, or even the Silk Road, the notorious online marketplace for drugs, guns, and even rare animals.

As such, predictions of bitcoin’s imminent doom are premature. Governments could shut down the Pirate Bay, but the BitTorrent protocol would live on. Even that is easier said than done. Both the Pirate Bay and the Silk Road continue to operate, despite conspicuously breaking the law.

The Liberty Reserve case, however, is a clear warning to anyone operating a bitcoin business. If you break the rules and try to subvert the US government and in turn abet criminal activity, you’re going to get pwned. The Bitcoin Foundation echoed these sentiments. “I think [the Liberty Reserve indictment] is just another giant, flashing warning light to bitcoin exchanges,” Patrick Murck, the foundation’s legal counsel, told the Wall Street Journal. “If you’re not compliant, there are some serious risks, both at the federal and state levels.”

These developments have still spooked some in the community. Payment processor OKPay has suspended all transactions with any exchange dealing in bitcoins. Others remain pragmatic, and believe such crackdowns to be necessary on the tempestuous road towards legitimacy, and some hope, mainstream acceptance. As the project’s lead developer Gavin Andresen told me at the Bitcoin conference, “my experience with bitcoin has always been three steps forward, two steps back.”

From the many bitcoin business owners I’ve spoken with, regulatory compliance is something they take very seriously and most of the prominent companies, in the US at least, like Coinbase, BitInstant, and Tradehill, already comply, procuring licenses as money servicing businesses or MSBs and adhering to anti-money laundering laws, which means requiring identification and setting transaction limits.

One anecdote I heard a couple months back soon after the US Treasury’s anti-money laundering arm, FinCEN, released guidance on virtual currencies: When the company began requesting AML-compliant identification from its customers, one user, who had ~$100,000 worth of bitcoins and fiat in his account, told them to keep the money. Then he disappeared. For Liberty Reserve castaways, simply transitioning into bitcoin won’t be a straightforward proposition.

And given the amount of venture capital, the only way forward is to follow the rules. Silicon Valley isn’t looking to build the next Napster, they have their eyes set on the iTunes store. But the situation does indicate the US government’s strategy of attack against bitcoin, short of an outright ban. By cutting it off from the global financial system, bitcoin has little utility if it can’t be easily converted into dollars.