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News today that the FBI had arrested a man on suspicion of running the notorious online marketplace Silk Road, where bitcoins were traded for illegal drugs, sent many people scurrying to watch how the value of the bitcoin reacted. After an initial 20 percent plunge in the value, the currency soon recovered–which some virtual-currency enthusiasts saw as proof that the bitcoin economy could easily handle the bad press and loss of Silk Road.

In fact, it’s too early to make that call. There’s good reason to believe that the Silk Road bust may cause a freeze in bitcoin transactions that could trouble its still-nascent economy. Silk Road was popular in part due to bitcoin’s reputation for providing anonymity. But the FBI may now have evidence that could lead it to people who traded on the site. Such investigations could be helped by recent research showing that it is relatively easy to track the flows of bitcoins and identify their owners. Anyone that has earned or spent bitcoins on Silk Road should now be understandably wary of spending their bitcoins.

There is evidence suggesting that could have a significant effect on the bitcoin economy. Research by Nicolas Christin of Carnegie Mellon University published this year suggested that Silk Road alone comprised between 4.5 and 9 percent of daily bitcoin transactions. Figures in the criminal complaint published today underline that the marketplace was a giant in the bitcoin economy. Silk Road is said to have brought in 9.5 million bitcoins since 2011. Although some of the cryptocoins will have passed through the marketplace twice or more, that’s a striking figure given that only 11.75 million bitcoins have ever been created.

We learned earlier this month that law enforcement could likely already identify many people that had done business on Silk Road thanks to the way bitcoin transactions are publicly logged (see “Mapping the Bitcoin Economy Could Reveal Users’ Identities”).

Sarah Meiklejohn, the University of California San Diego researcher who led that research told me that she had briefed a law enforcement agency on her techniques. She also demonstrated their power by tracing a Silk Road transaction made by Forbes journalist Andy Greenberg. Such techniques, combined with the information the FBI gathered through its Silk Road investigations and seizures, could allow even people that tried to hide their tracks to be traced.

Whether or not that leads to a string of secondary arrests in coming days, weeks or months, there are good reasons to expect bitcoin transactions and spending to fall.

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Tagged: Web, EmTech2013

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