WASHINGTON  The regulatory crackdown on Liberty Reserve is stoking fears that banks may soon begin severing relationships with digital currency providers and exchanges, effectively stifling their growth due to institutions' fears of potential prosecution.

Government officials targeted Liberty Reserve in part because it allowed users to anonymously exchange funds, a key aspect of many digital currency systems, including Bitcoin, the most popular virtual currency. That has led to widespread concerns that other systems, and the banks that assist them, might soon be in government's sights.

"There is fear from the government, and they are doing a lot to get in front of this," says John Byrne, executive vice president of the Association of Certified Anti-Money Laundering Specialists. "Any time a movement of value is outside of systems that are regulated, there is concern."

Government officials insist they are not trying to curtail the growth of digital currency. Jennifer Shasky Calvery, the head of the Financial Crimes Enforcement Network, says that Liberty Reserve was actively trying to assist money launderers and other criminals. Legitimate actors, she says, have no reason to fear the government.

"That action was against one financial institution and one type of financial service," she says. "It goes against a particular violator. I would be hesitant ever to paint a broad brush because of one criminal action against an entire industry. I don't think that's fair to an industry in any situation, let alone this one."

Yet experts fear the government's actions  intentionally or not  may scare bankers away from providing services to digital currency providers, an essential feature for any business trying to exchange currency.

They note that a decade ago, the government labeled money services businesses as high risk, a move that caused banks to begin dropping relationships with MSBs. That eventually sparked a backlash from government officials, who feared it was driving transactions underground, where they couldn't be monitored.

Many saw parallels between the situation facing MSBs, which still have trouble obtaining and maintaining banking relationships due to bankers' fear of added regulatory oversight, and digital currency outfits.

"It's akin to what happened with the MSBs where everyone lost their banking relationships because Fincen was being overaggressive," says Patrick Murck, general counsel at the Bitcoin Foundation. "It's the same thing  we're seeing it all over again, we're just seeing it with digital currency."

Under anti-money laundering regulations, banks must know their individual customers and the customers with whom client businesses interact. The result is often a headache for the banking industry, which feels like it has been forcibly deputized to act as law enforcement agents. Banks caught providing correspondent banking services without proper oversight can be fined and potentially face criminal prosecution.

Byrne, who was formerly an anti-laundering official for Bank of America, says the Liberty Reserve prosecution should serve as a wake-up call for banks that they need to be paying attention to relationships with digital currency providers.

"I see a clear corollary between the reaction to MSBs by the traditional banking industry to what can happen here," he says. "Banks have to do due diligence. I think it's safe to say that all banks should be looking at these" relationships.

Byrne and others agree, however, that this does not mean banks must abandon digital currency providers. Several argue that the digital currency providers that will survive will be the ones that find a way to comply with the existing anti-money laundering framework.

"It's a gold rush," says Michael Dawson, a former Treasury official who is now a managing director with Promontory Financial Group. "The difference between winners and losers will be that some will build a mine with the compliance infrastructure to support it and some just dig a hole in the ground  they may find some gold, but sooner or later the hole will collapse."

Moreover, banks that found a way to work with MSBs could have the upper hand here.

"You will see a similar cycle, but there will be some institutions that have already learned the lessons from that cycle," Dawson says. "The institutions that decided they wanted to bank embassies or MSBs are going to be farther along in the cycle. They won't be as inclined to overreact. They will try to differentiate those that are building the right infrastructure from those that aren't."

Calvery, the Fincen director, agrees, arguing that digital currency businesses can comply with existing regulations. Those that do, she says, will thrive.

"Every financial institution needs to be concerned about its reputation and to go out of its way to show it is an institution that is operating with transparency and integrity within the bounds of the law," she says. "Institutions that operate in that manner are going to be, not only not worried about action from the U.S. Treasury Department, but could be the kind of clients that others are going to want to associate themselves with, whether it's customers who want to use those services, whether it's banks that might want to help bank those services."

Others aren't so sure. Murck at the Bitcoin Foundation says Fincen's March guidance on virtual currencies was too broad and confusing to follow. Though the guidance was targeted at businesses that buy and sell virtual currency, he says, it's not clear what constitutes a "business."

"A fair reading of the guidance says anyone who sells Bitcoin for cash could potentially be an MSB," he says. "Fincen has to be careful because their actions can have a significant chilling effect on innovation in the space."

But Calvery disagrees, saying the guidelines were fair and clear, building off the agency's MSB rule issued a decade earlier.

"We have a lot of definitions in the laws and the regulations to help someone figure out what that means," she says. "There's plenty of statute  regulatory and common law  on what makes a business, including in the financial services area. I'm not worried about clarity with regard to that definition."

There are also clear differences between Liberty Reserve and other currency providers, something which may ease bankers' concerns. Liberty Reserve was a highly centralized system based in Costa Rica that charged high fees to make a transaction anonymous. Bitcoin, in contrast, is a decentralized system in which anonymity is possible, but not guaranteed. Bitcoin also carries very low fees, which makes it appealing to legitimate retailers and businesses looking to save money from high interchange and other transaction fees.

Liberty Reserve "ran a sham compliance operation," Murck says. "All the Bitcoin exchanges are spending lots of time and money building compliance programs. They really are trying to know their customers. Unlike Liberty Reserve, they are trying to be as white hat as possible to keep bad actors away."

Calvery says the government had to take action against Liberty Reserve, which is accused of running the largest money laundering operation in U.S. history. That doesn't mean banks should overreact when looking at other businesses, she says.

"We have obligation to take down the biggest U.S. money laundering in U.S. history, that $6 billion money laundering operation," she said. "If that ends up creating a broad-brush reaction that's inappropriate, that is something that would be first of all unanticipated. Secondly, that's something that would be addressed in the national conversation on the developing financial services industry in the weeks, months and years to come."