The clamor against PayPal is rising. AuctionWatch is flooded with critics arguing that PayPal must be "punished and terminated." Entire discussion lists are dominated by debate over the company, including one at E-Tailers Digest. Even former fans who have had no personal trouble with PayPal now help critics fight back against the company. In fact, one former PayPal evangelist, Izzy Goodman, set up a Web site that aims in part, he says, "to undo the damage I did in convincing folks to join PayPal." After seeing "complaints numbering in the hundreds," Goodman says, "I can't recommend it."

PayPal also faces a serious threat from more established financial players. When it comes to financial transactions credit-card companies and banks still have the upper hand, says David Chaum, the digital currency inventor. "I originally went to banks and asked them to be the custodians of the cash because that's what they did," he says. "It was safer and it made the most sense." At some point, Chaum predicts, the banks will recognize that they belong in PayPal's market. By directly tying already existing financial accounts to digital currency, they'll eventually create a more convenient service that renders PayPal obsolete, says Chaum.

Banks have the advantage of consolidation, says Tom McGrath at BEI. "Credit cards took off because you could use one piece of plastic to do what a whole wallet of store cards used to do," he says. Similarly, consumers will embrace bank-based e-currency systems because "we simply don't need more payment methods. Too many already exist."

PayPal could attempt to trump the banks by becoming a bank itself, but PayPal appears to want to avoid getting under an official institutional umbrella. Its terms of use emphasize that PayPal is "not a bank ... not subject to banking regulations," and while the company considered buying a bank charter last year, executives ruled against it. "The cost and regulatory burden was too high," Thiel says. The paperwork and all the restrictions of law were just too much. "Consumers didn't want another bank account, they want to move money," he says.

That may be the case, but at some point, banking experts argue, both users and PayPal might need to think beyond their next purchase of an antique lamp. E-payment providers aren't the only unregulated financial institutions -- Western Union and American Express, for example, also run outside banking laws -- but "there isn't much of a chance that they'll go out of business," says Jeff Baker, an analyst at W.R. Hambrecht, an investment bank.

PayPal and its ilk, on the other hand, are far more fragile. Banking experts argue that the very novelty factor that they're using to ask for special treatment puts the company at greater risk. Fraud, consumer backlash, new competitors and an industry wracked by failure all highlight the shaky state of PayPal's prominence and the potential need for more consumer protection. "Considering the public policy issues involved," says Thomas at Wharton, "it appears that this is an area where some type of regulation would be appropriate."

The FTC, the catch-all regulator of Western Union and other businesses that fall outside specific corporate laws, has yet to call for tighter new legislation. The agency is trying to balance the potential for deception against the benefits of letting a new economy business grow unstifled, says Tracy Thorleifson, a staff attorney who has studied e-payment providers. "It's still up in the air about whether more laws are needed," she says.

But while the drama plays out among PayPal users, in the courts and perhaps in Congress, Thorleifson is offering some somber advice. "I suggest that people keep their PayPal balances low," she says.

This article has been clarified.

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