On Oct. 21, Paypal announced that it had received a “conditional Bitlicense” from the New York State Department of Financial Services (DFS). This means that four cryptocurrencies—Bitcoin, Ethereum, Bitcoin Cash, and Litecoin—that are on DFS’s greenlist will initially be available for Paypal customers’ purchase and sale.
But perhaps what is more interesting is the fact that a customer’s cryptocurrencies can be used toward transacting with over 26 million merchants in Paypal’s network.
This license was granted in connection with Paypal’s partnership with Paxos Trust Company, a New York state-chartered trust company.
Cryptocurrency enthusiasts imagine a world where cryptocurrencies can be used to settle all types of everyday financial transactions, eliminating the need for intermediaries and middlemen and lowering transaction costs. And some may believe we are one step closer to achieving cryptocurrency’s mainstream adoption thanks to Paypal’s new services. But is that really the case?
A Look at the Approval
Before tackling this question, it is worth exploring the strong arguments for DFS to approve this partnership. Paypal is a money service business (MSB) registered with the U.S. Financial Crimes Enforcement Network. As an MSB, it is required to perform stringent anti-money laundering/combating the financing of terrorism (AML/CFT) review of each of its customers and their transactions in accordance with the U.S. Bank Secrecy Act (BSA).
Moreover, as a global financial institution, Paypal faces compliance obligations under the BSA’s so-called “Travel” rule, which obligates financial institutions to send certain customer information to a recipient financial institution when its customer transacts.
Paxos, on the other hand, is a regulated trust company. As a trust company, it offers cryptocurrency custody and, through its exchange arm itBit, brokerage services. Paxos faces its own AML/CFT compliance obligations imposed by DFS, as well as strict requirements related to customer fund protection and capitalization. Together, Paypal and Paxos represent a partnership that can withstand one of the highest levels of regulatory scrutiny. Therefore, it is not surprising that this partnership has won the coveted approval from DFS.
Mainstream Adoption Still a Ways Away
Paypal’s new services, however, do not usher in a new age or contribute to cryptocurrency’s mainstream adoption. They merely enable a customer to use any purchased or held cryptocurrency as a funding source rather than allowing such cryptocurrency to be used toward transaction settlements.
Paypal’s FAQ states that a private key will not be given to a customer, which means that Paypal—or Paxos, to be precise—will purchase, sell and hold cryptocurrencies on such customer’s behalf. Once purchased, no cryptocurrency can move to an external wallet (customer’s, merchant’s or otherwise), including cryptocurrency received by a merchant as payment for goods or services.
There may, however, be good reasons for this. First, this type of arrangement can reduce or eliminate Paypal’s and/or Paxos’ compliance burdens relating to the Travel rule. The rule imposes customer information sharing requirements between financial institutions. Under the FATF’s proposed Travel rule guidelines, the rule will be expanded to virtual asset service providers (VASPs) involving any transfer of virtual asset exceeding a certain threshold. VASPs have suggested that this extension of the Travel rule will be notoriously difficult to comply with.
Second, this type of arrangement relieves regulatory pressures on the part of the merchants, which might otherwise need to worry about whether they need to obtain requisite licenses under applicable jurisdictions for being involved in a cryptocurrency activity. On a more practical note, a merchant may not want to receive cryptocurrencies at all, given the operational burdens related to converting them into fiat or economic risk associated with their price volatility.
Whatever the considerations are, the simple truth is that, based on the information currently available, all customer-to-merchant transactions are settled in fiat, which weakens the argument that Paypal’s new services are making any contribution toward cryptocurrency’s mainstream adoption. That said, Paypal’s new services will likely create new demands for certain cryptocurrencies, helping their prices and trading volumes.
Customers Charged Fees
Another issue to consider is whether Paypal’s new services provide the benefits of blockchain technology to its customers. Paypal notes in the same FAQ that it will charge each customer looking to purchase or sell cryptocurrencies a “spread (or margin) between the market price [of cryptocurrency] we receive from [Paxos] and the exchange rate between US dollars and the [cryptocurrency] displayed to the user.”
Such fees will be disclosed to a customer at the time of transaction. It is unclear what these fees will amount to. Moreover, it seems likely that Paypal will apply its standard transaction-based fees, which in the U.S. is 2.9% + $0.30 per transaction, when a customer converts his or her cryptocurrency holdings into fiat to transact with merchants. If the fees charged by Paypal in the aggregate are high, then it is hard to argue that its customers are enjoying a critical benefit of using blockchain technology—namely, fewer intermediating institutions leading to lower transaction costs.
But perhaps Paypal is building a path toward a cryptocurrency’s mainstream adoption in the future. At this moment, countries are considering implementation of central bank digital currencies. International organizations such as the International Monetary Fund, the World Bank, and the Bank of International Settlements are leading this discussion.
If and when CBDCs are launched, it is possible that Paypal’s announcement is a first step toward a payments infrastructure for customers-to-merchants CBDC settlements.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Joon Kim is the general counsel of O(1) Labs, which leads the building of lightweight blockchain project Mina. His prior experiences include working at Goldman Sachs, Lightyear Capital (a New York-base private equity firm), and Kirkland & Ellis LLP.