Ripple Labs today earned the dubious distinction of being the first virtual currency exchange to be fined by FinCEN for failing to comply with anti-money laundering rules.

This is sure to send a chill through the world of virtual currency.

The San Francisco-based company, which allows for rapid inexpensive movement of value across its ledger-based network, was slapped with a $700,000 fine by FinCEN today. FinCEN is the federal government’s enforcement arm for financial services regulatory compliance.

From the FinCEN news release (PDF):

Ripple Labs willfully violated several requirements of the Bank Secrecy Act (BSA) by acting as a money services business (MSB) and selling its virtual currency, known as XRP, without registering with FinCEN, and by failing to implement and maintain an adequate anti-money laundering (AML) program designed to protect its products from use by money launderers or terrorist financiers. XRP II later assumed Ripple Labs’ functions of selling virtual currency and acting as an MSB; however, like its parent company, XRP II willfully violated the BSA by failing to implement an effective AML program, and by failing to report suspicious activity related to several financial transactions.

“Virtual currency exchangers must bring products to market that comply with our anti-money laundering laws,” said FinCEN Director Jennifer Shasky Calvery. “Innovation is laudable but only as long as it does not unreasonably expose our financial system to tech-smart criminals eager to abuse the latest and most complex products.”

Ripple Labs is notable in the world of virtual currency for its partnerships with banks such as Fidor, CBW Bank and Cross River Bank.

The company agreed to engage in remedial activities to ensure compliance with AML/CFT obligations going forward, and to perform XRP transactions through a registered money services business (MSB). Ripple Labs will also allow external auditors to review its compliance going forward, as well as looking over the previous three years of activity. There will also be enhancements to the Ripple Protocol, which governs activity across the Ripple network.

This is something of a knife-in-the-gut for Ripple Labs. Cheryl Gurz, managing director of the emerging technology segment at Bank of New York Mellon Treasury Services, an all-star in corporate banking, has said publicly that “protocols like Ripple and Stellar are ‘getting rid of bilateral legacy processes that banks have been using for years to keep money in their pockets.” Well, this FinCEN action certainly appears to put a damper on Ripple’s ascension.