A Bitcoin logo is seen at the window of Nara Sushi, a restaurant that accepts Bitcoin, a form of digital currency, as payment in San Francisco, California October 9, 2013. REUTERS/Stephen Lam

By Emily Flitter

NEW YORK (Reuters) - Two men who operate bitcoin exchange businesses have been charged with money laundering for helping drug merchants exchange $1 million (603.2 thousand pounds) in cash for bitcoins, the digital currency, U.S. prosecutors said on Monday.

Federal prosecutors in New York announced charges against Charlie Shrem and Robert Faiella, both operators of bitcoin exchange businesses, for attempting to sell $1 million in the digital currency to users of the underground black market website Silk Road, which was shut down by authorities in September.

According to the charging document, Shrem, 24, chief executive officer of the exchange BitInstant.com, changed cash into bitcoins for Faiella, 52, who ran an underground bitcoin exchange through the username BTCKing on Silk Road's website. The criminal complaint says that Shrem, in addition to knowing that Faiella's business was funneling money into Silk Road, also used Silk Road himself to buy drugs.

The U.S. Attorney's office in Manhattan said in a statement that authorities arrested Shrem on Sunday at New York's John F. Kennedy International Airport. Faiella was arrested on Monday at his home in Cape Coral, Florida.

The tech investors Cameron and Tyler Winklevoss invested $1.5 million in BitInstant last year. A spokeswoman for their firm, Winklevoss Capital, did not immediately respond to a request for comment.

The case against Shrem is likely to deal a blow to the burgeoning community of bitcoin businesses because Shrem is a high-profile advocate for the technology. In addition to running BitInstant, he is vice president of the main bitcoin-focused trade group, the Bitcoin Foundation, according to the foundation's website and Shrem's LinkedIn profile.

A spokeswoman for the foundation declined to immediately comment on Shrem's arrest.

Shrem and Faiella were charged with conspiring to commit money laundering and operating an unlicensed money transmitting business. A spokeswoman for Preet Bharara, the U.S. attorney for Manhattan, said there was no information about legal representation available for either of the two men, who are expected to appear in court in New York and Florida. respectively.

Shrem has a home address in the Brooklyn borough of New York.

According to the charges, Faiella, going by "BTCKing" online, sold bitcoins to Silk Road users and passed on purchase orders he received from the site to Shrem, who filled them, transferring funds to Faiella's account at another bitcoin exchange service based in Japan.

The Japan-based exchange business is not named. One of the largest bitcoin exchanges in the world, MtGox, is based in Japan.

The charging document says that Shrem, who also ran BitInstant's compliance program for a little under two years, failed to report suspicious activity to regulators "with respect to numerous Bitcoin purchases" Faiella made from BitInstant.

Shrem's lawyer, Keith Miller at Perkins Coie in New York, was not immediately available for comment

Bitcoin is a digital currency whose value fluctuates according to demand by users. It is currently trading on MtGox at a level of $985 per unit. Users can transfer bitcoins to each other over the internet and store the currency in digital "wallets."

(Reporting by Emily Flitter; Editing by Leslie Adler)