The proprietors of a major Bitcoin exchange have filed a lawsuit in the Northern District of California alleging that racketeering, intentional misrepresentation, false advertising, breach of contract and other violations by payments startup Dwolla have cost them at least $2 million in damages, with the final amount to be decided by the court.
The plaintiff is TradeHill, a Bitcoin currency exchanger based in San Francisco and Chile that was at one time the second-largest processor of Bitcoin currency trades, but which recently shut down. The shutdown was largely due to losses sustained because of “chargebacks” or payments that cleared and then were rescinded by Dwolla, said TradeHill cofounder Jered Kenna, although other reasons were given at the time.
“We’ve been trying to resolve this for eight, nine months and they ignored all communication,” Pierre G. Basmaji, the Santa Monica-based attorney for TradeHill, told Betabeat by phone. “I have no idea why. I think… they don’t know how to handle it and were just hoping we would go away.”
Dwolla did not respond to requests for comment. UPDATE, 6:13 p.m.: Dwolla just released a statement.
Dwolla is a fast-growing, low-fee e-payments service that has been generating a ton of buzz from its headquarters in Des Moines, Iowa; the startup recently raised $5 million in funding led by Union Square Ventures. Dwolla was popular with Bitcoin exchanges because of its low fees.
TradeHill was one of the exchanges that allowed customers to purchase Bitcoins with Dwolla. But sometime over the summer, the relationship went sour.
According to TradeHill, Dwolla told merchants that transactions were not reversible, meaning money transfers would not be canceled after they had cleared. The practice of reversing transactions, known as “chargebacks,” is common among payments processors and unpopular with merchants. (If your wallet is stolen and a thief uses your Visa to buy $1,000 of drinks at the Ace Hotel, for example, you’re not liable for those charges: the Ace eats the cost thanks to a chargeback.) “[Dwolla] said all sales were final. Credits were as good as cash,” Mr. Kenna said.
In July, TradeHill noticed some discrepancies in its transaction records and wrote a program to track its Dwolla transaction history. After two weeks of tracking, it appeared Dwolla had been clearing transactions and then revoking them. The status of charges on Dwolla’s online transaction history would change from “pending” to “credited” and then back to “pending,” TradeHill said.
Basically, a customer would connect his or her bank account to Dwolla. Then the customer would head over to TradeHill, fill out an order for, let’s say, $100 in Bitcoins, and use Dwolla to pay. TradeHill would look at its records, see that Dwolla had sent $100, and credit the customer with $100 in Bitcoins. But in some cases, according to TradeHill’s complaint, that $100 from Dwolla might disappear after the Bitcoins had already been transferred, so TradeHill effectively ended up giving away Bitcoins.
Mr. Kenna said he believed the problem was due to people scamming Dwolla, and was not bad intent on Dwolla’s part. ”It is unfortunate that Dwolla is the victim of fraud and we would like to work with them to resolve this,” TradeHill said at the time. “We are confident that they will do the right thing.”
But when TradeHill tried to talk to Dwolla about the problem, the Bitcoin exchange was stonewalled.
TradeHill went public with its story on the made-for-web-TV Bitcoin Show on July 26. TradeHill also wrote about the dispute on its blog, alleging that “Dwolla has been scammed for at least $37,000 by our records and we have prevented an additional $27,000 from being scammed.”
TradeHill says Dwolla reacted by removing language on its website that promised customers did not have to worry about “chargeback concerns” and adding a clause to its Terms of Service aimed at Bitcoin:
Any purchase or transaction involving virtual currency or a virtual product is not eligible for a dispute or arbitration. This includes but is not limited to credits, downloads, PDFs, or mp3s.
After TradeHill’s public statements, Mr. Kenna said the stonewalling continued. Dwolla executives “refused to be around for the phone calls,” he said. “I would get them on the phone and they would say the CEO, COO is going to call you back. Then I’d get an email back that was basically a copy of the FAQ,” Mr. Kenna said.
All in all, TradeHill alleges Dwolla unjustifiably reversed $94,878.72. The complaint also alleges Dwolla prevented TradeHill from withdrawing an additional $70,000 from its Dwolla account, because Dwolla told its partner Veridian that TradeHill was a fraudulent business.
The losses snowballed. Cash flow problems due to these losses caused TradeHill to shut down and lose some valuable domains including bitcoin.com, bitcoin.co and bitcoin.co.nz, TradeHill says, for which it had traded $1 million in equity.
TradeHill believes Dwolla is at fault because flaws in the Dwolla system allowed maliciously-intentioned customers to defraud TradeHill, and Dwolla simply passed the cost onto TradeHill via 45 chargebacks in total—and then neglected to notify TradeHill of said chargebacks.
TradeHill’s attorney told Betabeat that the $2 million in damages “is conservative.” “I’m pretty sure we can prove that much, but it will be proven in court,” he said.
UPDATE, 2:20 p.m.: TradeHill just put out a press release announcing the lawsuit.
Based on public statements by Dwolla about the company’s transactions, Mr. Kenna believes Bitcoin at one time accounted for a very large percentage of Dwolla’s transactions. TradeHill was processing about $1 million in payments and withdrawals through Dwolla in June, he said, before the dispute, and another Bitcoin exchange, Mt. Gox, was doing almost seven times that amount: $6.8 million in deposits and withdrawals in June in 16,640 transactions, the exchange said in July. UPDATE, 4:53 p.m.: Mt. Gox sent more recent numbers to Betabeat that are lower. The exchange did $2,5 million in 9,948 Dwolla transactions in February.
On June 17, Dwolla said it was doing about $1 million in transactions per week, suggesting Bitcoin could have accounted for a majority of the transactions at the time. (Dwolla did not respond to an email asking for comment on this specific point.)
“Given Bitcoin’s recent explosion, it would stand to reason that at least part of Dwolla’s explosive growth is being caused by the ease of compatibility between it and the Bitcoin currency system,” Brad McCarty of The Next Web wrote in July.
Dwolla, it seems, is pretty sick of hearing about Bitcoin. “I can’t go a day without talking about it or being asked about it,” CEO Ben Milne wrote in a guest post for Silicon Prairie News. A representative for Dwolla told Betabeat in January that Bitcoin traders “now make up an extremely small amount of our daily transaction volume.” Dwolla is itself a disruptive payments system and Mr. Milne would rather talk about that. He also made vague references to fraud related to Bitcoin. “Someone obviously figured out how to game it,” he wrote, and “Have we found suspicious and fraudulent activity? Yes. Do we deal with it accordingly? Yes.”
At least two smaller Bitcoin exchanges, Bitcoin7 and ExchangeBitcoins.com, also stopped using Dwolla. Another Bitcoin-related merchant who did not want to give his name because he is currently raising funding, said Dwolla has “holes” in its security ”which allow for customers to scam them easily.” About four to five times a month, he said, Dwolla will claim funds and then change its statement after the fact without warning or notification. Dwolla credited the funds back once, he said, but usually the startup does not take responsibility. “It’s a love/hate relationship,” he told Betabeat. “They have a failed system, so we have our own verification, but still get scammed a few times a month.”
However the largest Bitcoin exchange, Mt. Gox, has continued accepting Dwolla. “While Dwolla’s sudden increase in reversed transaction and the way they did it (the transactions just disappeared from the history at first, without any notice) did hurt us, the damage was limited to less than $5000, which is more than reasonable,” Mt. Gox cofounder Mark Karpeles said in an email. “Each time we needed to confirm something with Dwolla they were able to communicate with us, and helped us fix any issue we ever had. Now cancellations are shown properly in Dwolla’s export files and transactions do not just disappear without any trace anymore.”
Dwolla said it’s moving between $30 and $50 million in transactions per month, Mr. Milne told Business Insider in November, and just announced a highly requested feature: the ability to cancel pending deposits before they clear.