The popular Costa Rica-based virtual currency exchange Liberty Reserve appears to have been shut down permanently, while its founder has arrested on suspicion of using the site for money laundering purposes. The news has caused uproar within the Web’s underground cybercrime community, with hundreds of people reporting that they’re no longer able to access funds stored on the site, which in some cases amount to thousands of dollars.

Security website Krebs on Security reports that Arthur Budovsky, the founder of Liberty Reserve, was arrested in Spain last Friday in a joint operation between US, Costa Rican and Spanish law enforcement agencies. Krebs claims that Budovsky is now likely to be extradited to the US, citing Costa Rican news sources.

For those who’ve never heard of it, Liberty Reserve is a notorious online money exchange that uses its own virtual currency, known as the Liberty Reserve, or simply “LR”, to provide anonymous payment processing services for online customers. The ‘currency’ is somewhat similar to Bitcoin, only it has a far more sinister side to it due to its total lack of regulation. With customers able to open an account anonymously using nothing more than an email address, it’s said to be a haven for thousands of cybercriminals across the world.

Liberty Reserve offers benefits besides its anonymity – its fees are extremely low, with users being charged just 1% of each transaction, whilst the service protects its users from credit card chargebacks. On the downside, the exchange has been somewhat vulnerable at times – for example in August 2012 a script problem left hundreds of users locked out of their accounts, some of which possessed thousands of dollars.

On top of this, founder Budovsky has had his fair share of brushes with the law in the past. Bitcoin Magazine reports that the founder was arrested alongside partner Vladimir Kats in 2006 for carrying out money transmittals without a license, before being convicted and sentenced to five years probation. This prompted Budovsky to flee to Costa Rica, where he set up Liberty Reserve.

Now, it looks as if Liberty Reserve has even bigger problems. According to Krebs, the site first went down on Thursday night:

“The outage set off increasingly anxious discussions on several major cybercrime forums online, as many that work and ply their trade in malicious software and banking fraud found themselves unable to access their funds.”

Worried cybercriminals bemoaning their bad luck

Almost simultaneously, a number of other suspect online currency exchanges were taken offline, including asianagold.com, echangezone.com, moneycentralmarket.com and swiftexchanger.com. Since being taken offline, all of the above sites are now pointing to domains owned by Shadowserver, a non-profit organization that fights against cybercrime. This, more than anything else, suggests that Liberty Reserve’s fall from grace is a permanent one, and that its users will be unlikely to recover their funds.

Liberty Reserve’s demise might be a disaster for the web criminals and anyone else unfortunate enough to have funds stored with it, but for the more respectable Bitcoin it could well be a blessing. Bitcoin Magazine speculates that with Bitcoin now being one of the few remaining payment processing platforms around that still doesn’t accept chargebacks, it’ll become even more appealing to online marketers whose businesses are at risk from chargeback fraud.