The growing industry of digital cash took another hit today. The U.S. Attorney’s office in New York indicted seven people for allegedly creating an Internet currency and laundering $6 billion of criminal funds.

The company  was called Liberty Reserve.In their indictment, federal prosecutors said its criminal activity was “staggering” and called the Costa Rica-based company “a financial hub of the cyber crime world.”

Here’s how it worked: A customer would set up a Liberty Reserve account under an alias, no matter how suspicious. One account was actually named named “Russian Hackers.” Then, middlemen, or “currency exchanges,” would convert the real money into LR currency. Neither party would necessarily care about the customer’s identity.

“So for example you might wire a bunch of money to a currency exchange point and then that currency exchange point would fund a Liberty Reserve account on your behalf,” explains Brian Krebs with krebsonsecurity.com

The LR currency was totally untraceable. 

Not only could Liberty Reserve customers get ill-gotten gains into the mainstream financial system as dollars or euros, they could pay others with LR accounts.

“If your main business is selling stolen credit cards, you’re not going to accept credit cards as payment,” says Krebs.   

Teams of hackers-for-hire peddled their services in Liberty Reserve currency.  Some websites even had Liberty Reserve icons advertising that they accept LR as payment, in the same way that most e-commerce websites have icons of Visa, MasterCard or PayPal.

According to Krebs, digital-currency services — of which there are many, including Webmoney and Perfectmoney – can be legitimate, especially for people trying to do international business from developing countries with limited financial systems.

But Liberty Reserve appears to “have gone down the wrong path” by attracting a money-laundering clientels, says Chris Vecchio, currency analyst with DailyFX.com.

Federal prosecutors say Liberty Reserve handled some 55 million transactions involving at least $6 billion worth of ill gotten gains.

The untraceability is what worries government regulators about digital currencies, including ones like Bitcoin, says Kieran Beer, who edits the website Moneylaundering.com for the Association of Certified Anti-Money Laundering Specialists.

“I don’t want to say that Bitcoin is the equivalent of this and that they’re one and the same, but this idea of anonymity that is so important to Bitcoin is going to be further challenged,” he says.

Beer, , points to the recent seizure of a Bitcoin exchange account by the Department of Homeland Security. The exchange violated anti-money laundering laws because it didn’t have a license to transmit money, and wasn’t keeping track of the real identities of its clients.

“Liberty Reserve is exactly what Treasury and Justice don’t want Bitcoin to be,” Beer says.

“That means that the thing many people like about Bitcoin won’t be permitted,” Beer says, referring to anonymity.

 Vecchio, with DailyFX.com, says the Liberty Reserve case shows any digital currency is vulnerability to regulation: There’s always a place where you have to convert your real money into digital money and back. 

Even though Bitcoin is a peer-to-peer transaction system, it, too, has exchanges where real dollars become Bitcoins. 

The Liberty Reserve indictment could scare away people who use or invest in other digital currencies, says Vecchio, “because you wouldn’t feel safe keeping your money stored in something that could be confiscated and deemed worthless one day.”

For today at least, there was no panic selling — Bitcoin’s price held fairly steady.