Peter Thiel, a former hedge fund manager, conceived of the idea that became PayPal in the fall of 1998, after giving a speech at Stanford University. After the speech, he met up with Max Levchin, a 23-year-old programmer with experience at three start-ups. After throwing around a few ideas for how to mix their talents, they decided to focus on digital payments.

The field was littered with casualties: Close to a dozen companies had tried and failed to make digital currency happen. But Thiel did some research and speculated that the strategies of his precursors were too broad, too technologically and socially idealistic. "No one ever used their products because they were too inconvenient," he says. "And even if they were useful, they had these utopian business models. It was like they were trying to get everyone to speak Esperanto."

PayPal would be different, Thiel and Levchin decided. Person-to-person payments would be the target, dollars would be the only currency, drawn from checking accounts or credit cards, and accounts could be settled in two ways, through e-mail and infrared rays passed between Palm Pilots. They launched both services in the fall of 1999.

To further set themselves apart from the competition, they added a bonus program. Since the key to every financial service's success lies in attaining high levels of liquidity -- lots of money moving between lots of users -- PayPal decided to literally give its currency away. Users could earn $10 for opening a new account and for getting friends to sign up.

The viral marketing technique brought mixed results. Almost immediately, the Palm Pilot application "fell into the gee-whiz bucket of applications that didn't catch on," says James Van Dyke, a senior analyst at Jupiter Communications. But the e-mail service showed promise. More than 10,000 people signed up before Jan. 1, 2000. The winter and spring brought further growth as the eBay faithful started recommending the service as superior to BillPoint, the auction giant's own payment system. Users raved that it was easier to sign up, and even though PayPal shrunk the bonuses to $5 per new account, the expansion kept going. New accounts poured in: 100,000 by Feb. 1; 1 million by Easter. No one -- not Thiel, not Chaum, not the analysts who covered electronic finance -- saw it coming. But instead of cheering, Thiel and Levchin found themselves trying to deal with a crisis. How on earth could a company that started with only two customer service representatives handle what had become a backlog of 100,000 e-mails seeking technical support?

"We wildly underestimated the degree to which this would scale," Thiel explains. "Things ramped up like crazy. It just snowballed."

Meanwhile, as Thiel was in the process of hiring hundreds of new employees for a service center that now sits in Omaha, Neb., another problem arrived -- criminals. Throughout the spring, scammers operating from computers with Indonesian, Russian and Nigerian Internet addresses started bombarding PayPal's servers, launching small computer programs that automatically set up accounts with stolen credit cards and fake names. The Secret Service and FBI helped staunch much of the financial damage from "the mafias," as Thiel put it, but at the time, PayPal's technology was unable to differentiate questionable charges from legitimate ones. So anyone who accepted PayPal funds from one of the dubious accounts -- even if they didn't realize it was fraudulent -- ended up without access to their money. Customers fumed. Even today, many people say they'll never return to the company after their experiences last summer. Watching PayPal treat "suspected fraud like actual fraud and blame the receiver [and] not the sender," says Donna Locke, who used PayPal for her computer-training business, turned her away.

Thiel says he regretted having to freeze the accounts, and wishes he didn't have to put in place other anti-fraud measures that incited further complaints, such as a more complicated sign-up and verification system. But he says PayPal had no choice: "PayMe, PayPlace, PayPro, ExchangePath -- they all went out of business because of the fraud issue. The fact of the matter is that people use our service because it's easier to use than anything else. As a result, there are more responsibilities that people have to assume," says Thiel.

Specifically, he argues, both buyers and sellers need to grasp that PayPal's very nature dictates that it must be more aggressive than both credit-card companies and banks. It's all a matter of convenience. PayPal's genius lies in large part in its low barriers to entry; a few clicks and you're through. Instead of fighting fraud at the front end with the credit checks and the paperwork that's common for anything bank-related, PayPal employs a gather and sift model -- grab as many people as possible, then weed out the good from the bad. "The flipside" of open access, Thiel explains, "is more aggressive anti-fraud measures further down the road. We're trying to balance two things: convenience and security. It's an ongoing struggle."

Indeed, some analysts stress that PayPal should be treated with a greater degree of understanding. "They're defining a new way of doing something," says Jupiter's Van Dyke. "They're doing a lot of positive things for online payments. You can't remove the factor of trial and error; there's no way that any company could move online payments ahead without angering customers."

Even the occasional digital currency veteran agrees, and sympathizes with PayPal's plight. Take Jim McCoy. A former DigiCash enthusiast and the founder of Mojo Nation -- a peer-to-peer service that uses digital currency as payment for downloads -- McCoy has been evaluating and working with digital payment for almost a decade. He argues that PayPal must use aggressive anti-fraud tactics. "From a business perspective, it's the only way they could have gone," he says. "They're trying to become the standard for open market, person-to-person transactions but now that they're bigger, they're going to run into the same problems as larger institutions. The larger you get, the more people you're going to have who are trying to cheat the system."

Plus, McCoy adds, PayPal actually has a financial incentive to ignore its customers, to act swiftly and without discussion. "Customer support costs will eat you alive," he says. They pose the greatest threat to any bottom line so "the less you have to get involved in customer disputes, the better off you are," he says.

Still, what if what's good for business also damages PayPal's chances for survival? Thiel believes that the vast majority of the people whose accounts have been closed or back-charged deserve some of the blame for taking money from "sketchy" customers. Thiel noted that one of the companies that Stoney Brody purchased gold from was e-Gold, an offshore company based in the Caribbean that had been a favorite target of the previous summer's gangsters, many of whom attempted to launder funds by buying e-Gold gold certificates.

"While I doubt this person [Brody] is engaged with the Russian mafia, I don't think [he and other e-Gold merchants] are totally innocent either," Thiel says. "They certainly know that much of the money they're receiving is from suspicious sources."

Brody denies any such knowledge. He still believes PayPal is in the wrong. More to the point, he's spreading his criticisms as vigorously as he can, raising the question of whether the same viral marketing that made PayPal a success could eventually be its undoing. Could he and other critics topple PayPal? Could perceived injustices -- which PayPal defends as necessary -- become the cause célèbre for public abandonment of the service?

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