Should PayPal (PYPL) investors be worried about fraud on Venmo?

The popular payments app saw a spike in fraudulent activity earlier this year, according to a recent report -- which was linked to wider-than-expected losses for PayPal during the first quarter of 2018.

According to the Wall Street Journal, PayPal was caught off guard by a sudden increase in fraud on its popular peer-to-peer payments app. Its "transaction loss rate", an internal metric that includes fraud-related losses, rose from 0.25% to 0.40% of overall Venmo volume between January and March -- which factored into an operating loss of $40 million during the first quarter, the report said.

To stamp out the spike in fraud, Venmo suspended certain accounts and tools, including an instant transfer feature. It also raised changed to fee from a small flat fee to a percentage-based fee. "As loss patterns emerged, the Venmo team quickly updated the new features to prevent losses and protect customers," said Amanda Miller, a PayPal spokesperson who attributed the spike to the introduction of several new Venmo features around the same time. "With the new instant transfer feature, that meant suspending the new feature for a few days and then reintroducing it. Suspending that feature temporarily was the right thing to protect customers."

Fraud isn't uncommon in burgeoning payments products, and isn't itself necessarily a cause for worry among investors according to BTIG's Mark Palmer. "Incidents of fraud can happen earlier on, after which companies will put safeguards in place," Palmer told TheStreet. "If you look at the pace of monetization on Venmo, it's slower than what some would have liked, but that can be helpful in the bigger picture."

Though still growing as a peer-to-peer payments tool, Venmo is still in its relative infancy as a revenue driver for PayPal. In its October earnings report, PayPal reported $17 billion in transactions on Venmo during the previous quarter, representing an increase of 78% over the same period last year. Of the three ways Venmo is monetized -- instant transfer fees, integrations with merchants like Uber and a Venmo debit card -- PayPal executives said that 24% of Venmo users engaged with one of those monetization methods last quarter. PayPal doesn't break out revenue numbers for Venmo, but many investors are bullish on the app's long-term potential to drive revenue.

Meanwhile, in the absence of widespread monetization, losses from fraudulent activity are relatively contained: "I don't anticipate that PayPal will make any changes to their strategy," Palmer added.

It's unclear what the exact nature of the fraud that led to the spike in early 2018, but scams have been long present on Venmo, and have ranged from scammers reversing payments for goods to bad actors using stolen credit cards or hacked accounts to make Venmo transactions. 

Fraud issues aren't something that companies can ever fully solve, said Jeff Sakasegawa, a trust & safety architect for Sift Science who previously led fraud operations at Square (SQ) .

"Any fraud SME worth their mettle will tell you the same thing: fraud is always changing. The exact countermeasures that you institute to prevent fraud from happening are now providing those very same fraudsters with feedback that you've caught onto them," Sakasegawa said. "This requires ongoing investment, full stop." 

PayPal's stock was up 3.73% on Monday. 

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