Skip to main content

CoinLab Sues MtGox

Op-ed - CoinLab Sues MtGox

The partnership between CoinLab and MtGox that had been met with great fanfare when it was first announced at the end of February has now rapidly turned sour, as Coinlab opened a lawsuit against MtGox seeking $75 million in damages. The original plan had been for Coinlab to take over all of MtGox’s operations in Canada and the United States, using its business relationships and marketing experience, as well as a local banking presence, to better provide for North American customers while still using MtGox’s technical infrastructure and leveraging the company’s established brand. The monetary side of the agreement, as we now know, is a revenue sharing arrangement in which revenues from existing MtGox customers in the US and Canada are split 60/40 between MtGox and Coinlab (in MtGox’s favor), and revenues from new customers are split 90/10 in Coinlab’s favor. However, almost right from the start it was obvious that things were not quite going according to plan. Coinlab’s takeover of MtGox’s existing US and Canadian customers was supposed to have concluded by March 22, but the date came and went and nothing appeared to change. Coinlab was quiet about the details of the process, and throughout the rest of March and April progress continued to stagnate, and Coinlab and MtGox were both silent on the matter. Now, it appears as though the delays have pushed Coinlab itself to the breaking point, and now in this way the company’s executives have decided to take action.

There are two main parts to Coinlab’s claim. First, the company claims that MtGox has utterly failed at living up to its side of the bargain in helping the transition go smooothly. Excerpting from the relevant section of the lawsuit:

28) Mt. Gox has failed to cooperate in facilitating the timely and seamless transfer of CoinLab Customers to Coinlab since the Agreement took effect.

30) 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.

32) 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 CoinLabmay assume operation of the Bitcoin exchange services for customers in the United States and Canada in case of a service interruption.

The list goes on, giving a series of contractual duties that Coinlab claims MtGox has failed to comply with. The other major claim in the suit is more interesting. In the original contract between Coinlab and MtGox there is a clause stating the following:

F. 1 During the Term, MtGox and Tibanne shall not grant anyone the right to use the Licensed Materials to provide the Services, or any part thereof, in the Territory. The exclusivity granted herein shall apply strictly to Services targeting the Territory and the CoinLab Customers (as defined below) and advertised and sold as such. It shall not include the provision of Services to users of the Services who, depending on the interpretation or circumstances, may or may not be considered CoinLab Customers.

The contract also included a similar clause binding Coinlab, preventing Coinlab or its owners from operating another exchange independent of the agreement. These clauses are key; without them, MtGox or Coinlab could both attempt to draw customers from the Coinlab-operated North American MtGox to a separate exchange not bound by the revenue-sharing agreement, and so deprive the other of all revenue. Another clause later in the contract states that that “it may be impossible to determine the monetary harm suffered by the non-breaching Party” if Coinlab or MtGox violate either of these key clauses, and instead sets a specific figure that either party would be liable for in the event that they breach the contract: $50 million USD.

In the lawsuit, Coinlab claims: “Defendants have, in email and other written exchanges, and in public statementsto the press acknowledged that they have directly serviced customers in the United States and Canada since entering the Agreement. This conduct constitutes a breach of the Agreement, including the exclusivity provisions in the Agreement.” Combining this with MtGox’s alleged failure to transfer the necessary technical materials, the total value claimed in the suit is a sky-high $75 million.

MtGox’s defense against this claim will likely come in several parts. First of all, the transfer was never completed, and so there is no reason to believe tha Coinlab suffered actual damages from MtGox continuing to serve customers directly in the meantime. The $50 million figure in the contract does not depend on the transfer actually having taken place, but judges are known to cut down such pre-set damages in certain circumstances. Second, although the clause stating that “MtGox and Tibanne shall not grant anyone the right to use the Licensed Matrials to provide the services” certainly forbids MtGox from acquiring another partner and executing a second Coinlab-like relationship within North America at the same time, it is debatable whether “granting anyone the right” includes providing services to North American customers themselves. MtGox already had the right to use their own “Licensed Materials” to provide their own services, so it is not at all clear that exercising that pre-existing right constitutes granting the right.

There is a distinction between a “sole license” and an “exclusive license” in intellectual property; as described by TransLegal, “a sole license is a type of exclusive license where the licensor remains entitled to use the licensed subject within the territory of exclusivity, i.e., unlike in a typical exclusive license, the licensor generally retains the right to use the intellectual property.” However, this distinction is an esoteric one, and if the word “exclusive” was used in the contract with this definition in mind it is not particularly well supported by the content of section F.1. It is quite likely that there was a genuine misunderstanding between Coinlab and MtGox regarding this matter.

Finally, there is the possibility of other technicalities. For example, the contract includes a clause stating that “CoinLab shall operate the Services in the Territory in compliance with all applicable laws after completion of the Transition Period and MtGox shall cooperate fully with CoinLab in achieving such compliance.” It would be difficult for Coinlab to be literally 100 compliant already; FINCEN’s March 2013 guidance essentially states that all exchanges serving the entire Unites States are required to have money transmitter licenses in all 48 states that require them, a process which requires millions of dollars in surety bonds. However, Peter Vessenes claims in the lawsuit that “CoinLab is registered with FinCEN to provide Bitcoin exchange services in the United States and has fully complied with FinCEN’s March 2013 guidance for digital currency exchanges.”

Coinlab CEO Peter Vessenes has written a personal statement (backup) on the matter, writing the following:

“In the last month, many of you have contacted me directly and asked for more details on our transition, and I would say (charitably) that I’ve been frustratingly vague — I just haven’t been able to talk about it …

What tipped us into filing was our complete inability to get Mt. Gox to deliver on the few simple things left that were needed for customers to move over en-masse; we were often left just apologizing to our alpha customers while their own businesses suffered …

What I hope is that Mt. Gox has this same interest in the good of Bitcoin, and Bitcoiners, and finds a way to work this out.”

Mark Karpeles has only provided a brief comment, writing in an email to Gawker: “We have not been served nor notified of such a lawsuit (except from your email), so it is difficult for us to comment at this point in time. We will review this within the next hours.”

The most harmful part of the ordeal to the Bitcoin community at large, aside from the drop in Bitcoin price and the negative press attention, is that this will prove to be a serious blow to the Bitcoin Foundation. Peter Vessenes is currently also the Executive Director of the foundation, and MtGox CEO Mark Karpeles is himself a board member. The fact that the official head of the Bitcoin Foundation is moving towards a lawsuit first, not even trying to resolve the dispute through any kind of internal arbitration within the Bitcoin community, suggests a striking lack of coherence within the foundation as a whole. The organization has already been relatively passive since the initial fanfare subsided in the later months of 2012, but this incident suggests that, in its present form, it exists nowhere but on paper. What the Bitcoin Foundation now needs the most is strong leadership; it is currently still the organization in the best position to unify the Bitcoin community and push it forward, but without clear direction it only risks falling further into idleness and internal strife. There have been increasing calls for Peter Vessenes to step down in part for this reason, and given the inherent conflict of interest between being a semi-official head of the Bitcoin community and having an active lawsuit against its largest business, the arguments for such a move have only strengthened. The main problem is, however, that there is nothing close to a clear consensus on who can replace him.

Hopefully, as Vessenes says, the two companies will be able to resolve their differences peacefully without resorting to further advances toward legal channels. The most likely explanation for MtGox’s failure to live up to its agreement is simply that the exchange was overwhelmed with a sudden influx of customers in March and massive spikes in usage and multiple denial-of-service attacks in April – the same reason why the exchange was unable to upgrade its servers in time for April 10. This does not fully excuse MtGox’s failures in both the Coinlab affair and their own exchange – it is clear that the company should have quickly taken on more staff in February and March if they were uncertain that they would be able to meet their responsibilities – but it does mean that the root cause of both failures was a simple mistake rather than willful malfeasance. As long as MtGox remains the most powerful exchange in the Bitcoin economy, their ability to serve customers around the world remains crucial to Bitcoin’s continued success, and so no matter what our personal feelings toward MtGox or Vessenes may be we should all wish for the best possible outcome.