$75 million lawsuit could destroy bitcoin’s largest exchange—but might help the currency go mainstream

Telling: the damages are to be awarded in dollars, not bitcoins.
Telling: the damages are to be awarded in dollars, not bitcoins.
Image: AP/Rick Bowmer
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Coinlab, one of the best-funded bitcoin startups in the US, is suing Mt.Gox, the world’s largest exchange for bitcoin, for $75 million. According to estimates, that’s several times more than Mt. Gox’s entire annual revenue, which The Verge pegs at about $22 million a year. (My own calculations, based on periodic reports issued by Mt.Gox itself, suggest this is a reasonable estimate.)

Bitcoin, in case you haven’t been following, is a type of secure digital currency, known as a “crypto currency,” which some believe will become the world’s first stateless, fixed-supply, untraceable means of exchange. Considering that Mt.Gox, which is based in Tokyo, Japan, currently handles 66% of all exchanges of bitcoin for more conventional currencies, a court finding in favor of Coinlab would probably shut down the primary venue for turning bitcoin into hard currency.

That’s not necessarily a bad thing. Coinlab’s CEO and founder, Peter Vessenes, issued an impassioned personal letter to accompany the lawsuit, in which he wrote:

“Bitcoiners have, on average, lost more money due to technology difficulties, frozen / lost banking relationships and shady characters…than due to any part of Bitcoin’s fundamental economics. I hate this fact, passionately.”

Those “technological difficulties” probably include the multiple shutdowns of Mt.Gox that have occurred over the past year, whether due to overwhelming demand or attacks by hackers. One of the original motivations for the partnership between Coinlab and Mt.Gox was to add two things to the Mt.Gox system. The first was to give people in North America, where Coinlab was to be the exclusive partner of Mt.Gox, the ability to easily transfer hard currency into and out of the exchange. The second reason for the partnership was that Coinlab hoped to leverage its considerable technical expertise and computing platform to handle some aspects of bitcoin exchange in North America in a way that would make the Mt.Gox trading system more stable overall.

What went wrong?

The complaint filed by Coinlab against Mt.Gox is illuminating. First, there’s the apparent speed with which Coinlab opted for a legal remedy. The two companies announced their partnership fewer than three months ago, on February 28, but the complaint reveals that the agreement between them was actually signed on November 22, 2012. Mt.Gox then had four months, until March 22, to transition all US and Canadian customers of Mt.Gox onto Coinlab’s systems.

Coinlab claims that Mt.Gox breached their agreement in a number of ways, which ultimately led to a loss of customers, who were part of an “alpha” test and were relying on Coinlab to get up and running a US-based outlet for accessing the Mt.Gox system. Transferring money to and from Japanese banks (a current requirement of Mt.Gox) is expensive and time-consuming, and this was the primary issue Coinlab was supposed to solve, initially.

Briefly, here are the ways Coinlab says Mt.Gox breached their agreement:

  • “Mt. Gox has failed to cooperate in facilitating the timely and seamless transfer of CoinLab Customers to Coinlab since the Agreement took effect.”
  • “Despite repeated requests to do so, Mt. Gox has failed to deliver all passwords, Yubikeys, administrative logins and any other security information required so that CoinLab may assume operation of the Bitcoin exchange services for customers in the United States and Canada in case of a service interruption.”
  • “Mt. Gox has failed to timely deposit Liquidity Funds in the manner instructed by CoinLab.”
  • “Despite repeated requests to do so, Mt. Gox has failed to make available to CoinLab on-demand and read-only access to Mt. Gox’s databases and other related records and data pertaining to any and all accounts for customers in the United States and Canada.”
  • “Defendants have breached their promises to provide necessary technology, software, and know-how to CoinLab and have refused or failed to establish promised connections from CoinLab’s computer network to Mt. Gox’s computer network.”

If true, these accusations suggest a pattern of delay on the part of Mt.Gox. And while neither company has issued any comment beyond brief public statements (one from Coinlab, one from Mt.Gox), by coincidence I visited the offices of Coinlab in Mid-April. At the time, I was supposed to meet with Coinlab head Peter Vessenes, but at the last minute he had to cancel on account of a trip to Japan to meet with the people behind Mt. Gox. This is pure speculation, but it would make sense, given the timing of this announcement, that Vessenes’ mid-April trip to Japan was an attempt to make the deal with Mt.Gox work, before it fell apart completely.

Why would Mt.Gox allegedly violate its deal with Coinlab?

The original contract between Coinlab and Mt.Gox provides for a minimum $50 million penalty if it is breached. In addition, even after the contract between the two companies is terminated, for five years Coinlab is apparently entitled to a portion of Mt.Gox’s revenues earned from people in North America. Given these penalties, the question is, if Mt.Gox was in violation, why would the heads of the company take such a risk?

This, too, is speculation but there may be a hint in the rate at which Mt.Gox has lately been signing up new customers all over the world, including North America. According to a statement from Mt.Gox, the company is now signing up 20,000 new users a day—after adding a total of only 60,000 in March. And the complaint from Coinlab further alleges that Mt.Gox has continued to sign up new users in North America after the March 22 deadline for handover of all such customers to Coinlab.

How a takedown of Mt.Gox could ultimately be a boon to bitcoin

Immediately after the partnership between Coinlab and Mt.Gox was announced in February, the price of a bitcoin recovered from a months-long slump, and subsequently shot up to record levels. Everyone I’ve interviewed about bitcoin, and countless sources in news stories on the currency (like this comprehensive take from Quartz’s own Simone Foxman) have noted that bitcoin, like any other currency, needs to have robust, liquid exchanges in order to become more widespread.

Despite being one of the most secure bitcoin exchanges ever (thefts by hackers have plagued others), Mt.Gox has had ongoing issues with handling the sheer volume of requests it receives from both users and hackers. And yet it continues to carry out the majority of bitcoin exchanges. Many startups, Coinlab included, are angling to make the exchange of bitcoins a more reliable experience, and there’s no reason to believe that their ability to throw more bandwidth and computing hardware at the problem won’t solve it.

So what happens if Mt.Gox is crippled by this lawsuit? Maybe, as other, more stable exchanges rise to take its place, bitcoin gains more of the credibility that is essential for any means of exchange to become widely accepted.