The former CEO of a top Bitcoin exchange and one of his customers pled guilty today in Manhattan on charges relating to operating an unlicensed money exchange that provided Bitcoins to customers buying illegal drugs on the Silk Road.

Charlie Shrem, formerly the CEO of BitInstant, and Robert Faiella, a bitcoin seller, were arrested earlier this year and charged with exchanging more than $1 million worth of Bitcoins that authorities say the two knew would be used to buy illicit drugs and other paraphernalia on the Silk Road. To make matters worse, while Shrem was CEO he was simultaneously BitInstant's compliance officer, responsible for ensuring that his company followed the law.

Between December 2011 and when the Silk Road site was taken down in a raid by federal authorities in October 2013, Faiella, a 54-year-old operating under the user name BTCking, obtained Bitcoins through BitInstant, then sold them at a profit to Silk Road users. He did so without registering his operation as a money-transmitting business.

Authorities asserted that the 24-year-old Shrem knew about Faiella’s activities and even personally processed his orders, giving Faiella a discount on high-volume trades of Bitcoins that he purchased for Silk Road buyers. Shrem also availed himself of Silk Road’s drug services, according to court documents, though he was not charged with buying drugs.

“Robert Faiella and Charlie Shrem opted to travel down a crooked path—running an illegal money transmitting business that catered to criminals bent on trafficking narcotics on the dark web drug site, Silk Road," Manhattan U.S. Attorney Preet Bharara said in a statement. "The approximately $1 million in Bitcoins Faiella and Shrem sold to these outlaws cost them a lot more than they bargained for and bought them today’s convictions.”

The charges against them came three months after the underground drug emporium was shuttered by law enforcement and its alleged founder, Ross Ulbricht, arrested.

Shrem, a well-known figure in the Bitcoin community, is the co-owner of a bar in New York that takes Bitcoin payments and is a founding member of the Bitcoin Foundation, which advocates Bitcoin as a currency. He's also known for having engraved the private key for one of his Bitcoin stashes on a ring that his jeweler father made.

BitInstant closed in July 2013, citing plans to revamp the business, but never re-opened.

How They Pulled It Off

To purchase Bitcoins for use on Silk Road, Faiella submitted orders to BitInstant specifying the number of Bitcoins he wanted to purchase and providing an email address. A third company, which handled the cash transactions, replied with an email instructing where to deposit the cash. The latter included a handling fee that was designed to help the company identify each transaction to the proper purchaser.

Customers would then deposit the cash in person at the specified local bank, directing the money to a bank account owned by the cash-processing firm. Once the cash deposit was verified, the Bitcoins were transferred to the customer’s Bitcoin account of choice.

Shrem and Faiella began doing business directly in December 2011, when Shrem contacted Faiella about an order he had submitted, court documents show. One of the deposits for Bitcoin had been made with a check instead of cash. When Shrem contacted Faiella and realized he was responsible for a number of orders BitInstant was receiving and further realized Faiella was reselling Bitcoins on Silk Road, he sent Faeilla an email banning him from using BitInstant, and copied the cash processor on the email.

Faiella, concerned that BitInstant planned to keep $4,000 he had already deposited to purchase Bitcoins, threatened to contact the feds to report BitInstant. Shrem wrote back threatening to report Faiella for operating an unlicensed money exchange on Silk Road.

But authorities say Shrem then contacted Faiella privately and instructed him in how he could continue to use BitInstant surreptitiously. Although Faiella’s email address was banned from being used to conduct transactions at BitInstant, Shrem told him to simply use a different email address to secretly bypass the ban.

Faiella pleaded guilty to one count of operating an unlicensed money transmitting business, which carries a maximum sentence of five years. Shrem pleaded guilty to aiding and abetting Faiella's business, which carries the same sentence range.

The two are scheduled to be sentenced in January.

*Update 9.5.14: To clarify Shrem's association with the Bitcoin Foundation.