Does PayPal Need A Bitcoin Strategy?

by Russ Jones on June 27, 2013

in Bitcoin, PayPal, Russ Jones

Russ Jones - Glenbrook Partners

Because we live in a tweet-constrained world, the short answer is yes. But I think every player in the financial services industry needs a Bitcoin strategy — payments enablers especially.

By strategy I mean that every company involved in payments should evaluate whether Bitcoin, and digital currencies (math-based, virtual, etc.) more broadly, are friend or foe, evaluate what they should do about them (if anything), and assess whether – and when – action is required.

There’s a short list of questions to consider – and they’re all important questions:

  1. Are they a good thing for your long term business or a threat?
  2. Do they open up new market opportunities or, rather, threaten current revenue streams?
  3. Are they the next land grab opportunity or can you wait a couple of years and just see how things shake out?

For payments incumbents, Bitcoin may be both a threat but perhaps an opportunity as well. That may, as an example, be the case for PayPal.

Why a threat? At first blush, the Bitcoin value proposition is somewhat like the PayPal value proposition. Both PayPal and Bitcoin are used as payment systems to move value from person to person, buyer to seller, and business to business. Both systems support instantaneous transfers between end parties. Both have a similar funds flow in that real money moves into the system, moves around among counterparties within the system, and then moves back out. Both systems are designed to support the flow of money across borders. And, while neither is regulated like a bank, both fall under other types of regulatory scrutiny (PayPal, historically so; Bitcoin, increasingly so).

There are also key differences between the two payment systems, the most important of which is that there is no cost to move Bitcoins between wallets, although there is usually an ad valorem fee to convert Bitcoins back and forth between real currencies. While these conversion fees are not trivial, at the end of the day a lot of Bitcoin’s appeal is its low cost to users — especially compared to PayPal’s pricing schedule. Bitcoin also has its precious metal “store of value” aspect. While this digital commodity aspect is quite real for currency speculators, I think it’s a shiny-ball distraction from a pure payments perspective.

Another important difference is usability. PayPal is easier and simpler to use. Bitcoin feels like the early days of the Internet when nobody had a browser and Internet Service Providers didn’t exist. Everybody said it would get easier and it did, as evidenced by our instant on, always connected life style. So Bitcoin is cheaper, but harder to use for now. All that, of course, can change. It might change fast if easy-to-use Bitcoin wallets start to pop up in app stores.

If Bitcoin were to become a competitive threat to PayPal, it seems most likely as an alternative to PayPal for cross-border payments, which the company says is roughly 25% of its transaction mix. Oh, and these also happen to be the most lucrative of PayPal’s transactions because of the cross-border fees and the currency conversion spread.

But long term, Bitcoin might actually prove to be more of an opportunity than a threat. Digital currencies might be useful as a way for PayPal to open up payments to merchants in markets where the company doesn’t currently support the local currency. Bitcoin as the default currency, so to speak, when the local currency isn’t yet supported. If PayPal wants to look at Bitcoin as a market expansion opportunity, I see a couple of different options that might be available.

The easiest thing for PayPal to do would be to treat Bitcoin as another payment method and embrace it as a way to move funds in to and out of PayPal accounts. In Bitcoin terminology, PayPal could act as an exchange converting Bitcoin back and forth between any of the 25 currently supported currencies in the PayPal wallet. Essentially, PayPal could let a user in the U.S. convert Bitcoins held in a wallet into USD in a PayPal account. Or it could let the user withdraw USD funds out of their PayPal account into a Bitcoin wallet. I use USD as an example, but it could just as easily be any of PayPal’s 25 supported currencies.

This approach is conceptually similar to how PayPal has dealt with alternative funds-in methods like CoinStar cash vouchers, GreenDot MoneyPaks, and airline miles. PayPal’s argument has been that money in a PayPal account has more utility to the consumer because there are more places to use the funds with PayPal. The same story might work here.

The other interesting aspect of this approach is that it permits PayPal to leverage its existing “regulated money transmitter” status while other Bitcoin exchanges are still stumbling to get into the market. This could be an important advantage for establishing itself as a major player in the Bitcoin ecosystem. PayPal also has an established know-your-customer framework (for non-banked users that push cash into PayPal accounts) that could be repurposed for Bitcoin users.

Another option would be to support btc (Bitcoin the currency) as another currency inside the PayPal wallet. PayPal already has a multi-currency wallet that can hold funds in any of 25 currencies with the ability for users to toggle currency balances back and forth as needed. Simply put, btc could be the 26th currency. In Bitcoin terminology, PayPal would act as both a Bitcoin exchange and a Bitcoin vault. The vault aspect, especially, would draw on the relatively high degree of trust that PayPal has earned with most users.

PayPal would have to think through how Bitcoin is exposed through its various products, but it seems like products that push funds between accounts (“Send Money” and “Mass Payments”) would both be natural fits. Economically, PayPal could monetize btc (the currency) the same way it monetizes all currencies–by earning currency conversion revenue when the user toggles their balance between currencies or when the currency is automatically converted by one of the transactional products.

Acting as a Bitcoin exchange would require PayPal to get comfortable managing the volatility of btc the currency. But PayPal already manages currency conversion risk between its other 25 currencies. Plus it views risk management as one of its core competencies. PayPal could probably figure better than most how to manage the volatility risk in Bitcoin.

There are other approaches to Bitcoin that PayPal might choose to take, but ultimately the company will have to decide whether the Bitcoin threat/opportunity is real and, if so, how soon it will need to act. In other words, they need a Bitcoin strategy. The strategy might be to ignore it for now, as the company has plenty of other opportunities it is pursuing. Or the strategy may be to wait and see what happens with Bitcoin over the next 12 months. But the good news for PayPal is that if it does decide to take action, there appears to be some credible options for leveraging digital currencies into something bigger. Not every company will be so lucky.

Of course, it’s not just PayPal that needs a Bitcoin strategy. Amazon, Google, Facebook, and others will as well. Each will need to figure out how to take advantage or respond to the rise of digital currencies.

What’s your Bitcoin strategy?

Want to learn more? Join Russ, Carol Coye Benson and Scott Loftesness for Glenbrook’s special Summer Payments Boot Camp on August 6-7 in Half Moon Bay, California – details here!

{ 6 comments… read them below or add one }

Bob Skattum June 27, 2013 at 3:14 pm

Russ,

All good points. I especially like the comparison of dealing with the price volatility of btc as just another currency conversion exercise, and the management of the price fluctuations as the ability to make/lose fees on the swing. Also, the fact that they have already obtained multiple money-transmitter licenses may be a way around that barrier. However, since the DHS seized the funds from Mt. Gox’s Dwolla (at WellsFargo) account because Mt. Gox wasn’t licensed, that may not fly in today’s regulatory environment where each and every state’s financial licensing bureaus and Attorney Generals vie for a piece of the pie.

And if folks need to consider btc as an option, they also should probably build in a few extra “slots” for Ripple and other as yet to announced (Clinkle?) non-fiat currencies.

Reply

Russ Jones June 27, 2013 at 4:16 pm

Bob, here’s a list of currently registered Money Transmitters in California. Mt Gox and Dwolla are, of course, not on the list because they are not licensed as Money Transmitters in the state. PayPal and others that are registered would seem to have a leg up if they wanted to become exchanges.

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Bob Skattum June 27, 2013 at 6:26 pm

Russ, Thanks … interesting list. And I agree from the perspective of CA not going after PayPal from that side. Although wasn’t the DHS seizing Mt. Gox’s money from Dwolla because Mt. Gox because they were not in compliance with the Federal law and not recognized as a money transfer service? And that they had “lied” on their application for the WF account. That adds another wrinkle/dimension as this plays out.

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Douglas H June 28, 2013 at 1:03 pm

I would suggest a fourth question to answer…. when do you think any of this is going to matter.
How many bitcoins exist to day? Too few to matter.
Who is using? geeks and/or illicit purchases?
I remained intrigued, but I continue to struggle to understand exactly what problem is being solved with this new trend, why I should believe it will matter, and when if ever it would reach scale.

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F.T. Cat June 28, 2013 at 4:38 pm

Without the anonymity aspect of Bitcoin I wouldn’t bother. Once “licensed” by a government…well, there goes anonymity, I’d expect.

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Augie Ray July 1, 2013 at 8:03 am

I am troubled that Bitcoin SEEMS to offer the benefits you suggest, but it has some serious drawbacks (at least, as far as I understand Bitcoin), doesn’t it? For instance, value isn’t created by doing something of value but by “mining” coins. Also, participants have to trust Bitcoin controls the Bitcoin supply, otherwise value can be created or destroyed almost at will. And then there’s the wild fluctuations of value that have occurred recently with Bitcoin. Are these problems, or am I failing to see that these are not issues to reliable, confident currency movement and exchange?

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