Given that the people who are great supporters of bitcoin often talk about its key characteristic being that it is person-to-person, uncensorable value transfer you do have to wonder who will be using the new PayPal service that will allow them to pay merchants using the cryptocurrency. My good friend Ron Shevlin drew on a survey of 3,000 US consumers conducted by Cornerstone Advisors and FICO which found that around two-thirds of US smartphone users have the PayPal app installed (as I do), a seventh of all PayPal users already own some form of cryptocurrency and of those PayPal users, half of them used Bitcoin to buy products or services in the past year. So does this mean that the mass market use of cryptocurrency for payments is just around the corner?
I think not. The overwhelming majority of all cryptocurrency transactions are purely speculative and the people who think that bitcoin is a good investment* are never going to use it for payments. Bitcoin was originally billed as an elecronic cash system but most bitcoins aren’t used as currency in transactions for goods and services. Surveys have shown that the majority of bitcoin are held for speculative purposes and while some retailers accept Bitcoin, they see cryptocurrency purchases having a higher drop-out rate than cards and cash payments.
So this can’t be much of a payments play. Think about it. If you think that the bitcoin is going to the moon (and will be worth $1 million each within five years, as this former Goldman Sachs hedge fund person has just predicted) then why would you waste even a tiny fraction of a bitcoin buying the pizza or a Pez dispenser? No, the people who will use their PayPal wallet to exchange bank dollars for PayPal bitcoin are simply investing. If they choose to pay a merchant using bitcoin from their wallet, PayPal gives the merchant dollars anyway. Neither the consumer nor the merchant ever has any actual bitcoins in their possession.When people do use bitcoin to buy things it tends to be things they can't buy using PayPal anyway. Click To Tweet
The amount of cryptocurrency spent on “dark markets” rose two-thirds to reach a new high in the final quarter of 2019, according to Chainalysis and the New York Times says that this data is likely to understate the number transactions for illegal purposes because the company cannot identify all activities relating to drugs, ransomware, tax evasion and money laundering. If I use bitcoin to buy illegal drugs, example, because of its “anonymity” and uncensorability, then I am hardly likely to start buying drugs using PayPal. The example of adult services makes this point rather well. Adult performers who are engaged in a perfectly legal business complain that PayPal refuses to allow payments to them and so they are forced to use third-parties who, according to the New York Times, take anywhere from a third to four-fifths of performers earnings in fees. Those people still won’t be able to use PayPal, whether in dollar or bitcoin, so the new service won’t make any difference to them.
PayPal’s Big Picture
Well, since the people who run PayPal are much richer and much smarter than I am, I am forced to conclude that they must have a plan that goes beyond earning some spreads from buying and selling cryptocurrency for retail speculators. I have no knowledge what PayPal are doing or why, but I do have some experience looking at strategies for financial institutions exploiting new technology, so I think I can make some informed guesses.
First of all, PayPal’s move is to be admired purely in marketing terms. The announcement put five percent on their stock price and garnered gazillions of column inches, links and commentary such as this. Even if they never turn a profit on bitcoin itself, their investment in software and licences has already paid off. I worked on a project for a global financial services financial services organisation a couple of years ago and I can remember the calculations around brand and exposure. To old-timers like me, PayPal is the grandparent of fintech, an upstart storming the walls of the entrenched incumbent financial services giants. But to youngsters, such as the son who I just asked about the company, PayPal are part of the establishment, no different to Wells Fargo or Barclaycard. A bit of cryptocurrency glitter does not hurt the brand, even if it is cosmetic.
Secondly, the technologies of cryptocurrency (shared ledgers, cryptographic proofs and so on) are going to be the foundations of a longer term shift to the trading of digital bearer instruments that are exchanged without clearing or settlement networks so building up institutional expertise is valuable. It’s reasonable to imagine that these instruments might well be implemented as tokens traded across decentralised networks, so exploring the trade-offs around infrastructures and interfaces is a good investment of time and effort.
Thirdly, and much more importantly though, I suspect that PayPal are making two much more strategic and long-term plays around the wallet and its contents. They are no doubt looking enviously across the water to the Asian “super apps” and thinking about the impending Alipay IPO. Turning PayPal from being a repository of balances to fund payments into a financial hub managing a number of different assets for a broad range of consumers is attractive to them. In their scenario planning, PayPal undoubtably started to think about the opportunities that will arise from the trading and management of digital assets (in the form of tokens) in the not-too-distant future. By gaining expertise in decentralised alternatives to commercial bank money and the regulation that does with them, PayPal is being very smart.
I don’t think PayPal’s experiment with bitcoin is really much about bitcoin at all. I think this is a measured and intelligent step towards the transactional environments of the future where digital assets compete with digital fiat across a payments landscape that is utterly different to that of today. As Ajit Tripathi pointed out, crypto-believers might feel they have occupied Wall Street but the reverse is true. Banks (and their regulators) have won and some of these interesting new digital assets are on their way to becoming part of the financial mainstream.
There is one particular category of digital asset that is inevitable: Central Bank Digital Currency (CBDC). In the run-up to the biggest IPO in history, Jack Ma talked about how digital currencies may play an important role in building the type of a financial system that will be needed for the coming generation and said that digital currency could “create value and we should think about how to establish a new type of financial system through digital currency”. Just as the Chinese government have begun to distribute their digital currency through third parties, including commercial banks and apps, so PayPal might reasonably expect to be an invaluable partner to the US government when it finally gets its act together to deliver some sort of digital dollar. If PayPal were to pivot away from the traditional infrastructure of banks and accounts, payments cards and interchange towards an infrastructure of wallets exchanging digital dollars (or perhaps, as Meltem Demirors speculates from a very well-informed perspective, their own alternative to Facebook’s Libra private currency) that would be a significant shift in the dynamics of the payments sector.
* I am not saying that I do or do not think cryptocurrency is a good investment. I am not making any comments that might be misconstrued as financial advice. Please note that any comments I make about cryptocurrencies as an asset class are for entertainment purposes only.
[This is an edited version of a piece that first appeared on Forbes.com, 25th October 2020.]