Bitcoin, the alternative currency based on a clever application of cryptography, has had its fair share of problems lately: first the dominant Mt. Gox exchange got hacked back in June, and now Tradehill, another major exchange, is suspending trading following the exit of e-wallet service Paxum from the Bitcoin market and a $100,000 loss from a fraudulent payment processor.
While Bitcoin was conceived as a peer-to-peer system, the difficulty in manually managing your own transactions, safeguarding your stash, and exchanging your digital wealth for hard cash led to the rise of exchanges like Tradehill, which use PayPal-like online wallet services such as Paxum and Dwolla to move real money around when their users buy and sell the digital stuff. Not just anyone can perform money transfers, though: they're regulated, and governments (state governments in the US) require licenses for the companies that perform them. Paxum was the primary money transmission service used by Tradehill, providing an important link between the digital and the real, and its exit from the market is leaving some high and dry, with few options to withdraw their dollar balances from their Tradehill accounts. PayPal is shunned by Bitcoin users who claim its chargeback policies increase the risk of fraud.
A representative from Paxum spoke with Betabeat on the company's decision to stop handling transactions with Bitcoin exchanges, saying, "we simply must cease all business with Bitcoin based on our banking partners / Mastercard etc. We don’t have a choice in the matter I’m afraid," adding, "in the end, it is converted to a legal tender (generally USD), but it is unclear to them (meaning Paxum's partners) how this currency is supported and who pours actual money into it, and more importantly, why." Paxum is required by one or more of its partners to be audited, and these same partners have made it clear that doing business with Bitcoin exchanges would mean the end of their relationship. Even though Paxum doesn't deal directly in the digital currency, mere exposure to the exchanges is apparently enough to send the more conservative crowd packing.
So what's next? According to Tradehill's blog, the company needs to raise some more capital — presumably to offset the $100,000 loss while it pursues legal action against the payment processor that defrauded it. So far, Tradehill hasn't named the fraudulent processor, or even so much as disclosed the date the fraud took place. On top of its money problems, it also needs to sort out its money transmitter licensing situation, particularly in the state of California, where licensing is "in depth, expensive, and not trivial."