Tuesday, September 12, 2023

There are now two types of PayPal dollars, and one is better than the other

PayPal now offers its customers two types of U.S. dollars. In addition to having the option of opening a traditional PayPal account to maintain a balance of dollars, PayPal customers can now hold something new called PayPal USD, a crypto version of a dollar. Whereas PayPal USD uses a crypto database, Ethereum, to host U.S. dollar balances (which in industry-speak is sometimes known as a stablecoin), the first sort of dollar relies on a conventional database.

There are currently around $45 million worth of PayPal USD in circulation, as the chart below illustrates:

Source: CoinMarketCap

Which type of PayPal dollar is safer for the public to use?

If you listen to Congresswoman Maxine Waters, who in response to PayPal's announcement fretted that PayPal's crypto-based dollars would not able to "guarantee consumer protections," you'd assume the traditional non-crypto version is the safer one. And I think that fits with most peoples' preconceptions of crypto.

Not so, oddly enough. It's the PayPal dollars hosted on crypto databases that are the safer of the two, if not along every dimension, at least in terms of the degree to which customers are protected by: 1) the quality of underlying assets; 2) their seniority (or ranking relative to other creditors); and 3) transparency.

Here is a bit of commentary on each factor:

The quality of underlying assets

PayPal's crypto dollars, which are managed by a third-party called Paxos, are 100% backed by the safest sorts of short-term collateral: U.S. Treasury-bills, reverse repo (backed by U.S. government securities), and commercial bank deposits. In finance lingo, these assets are known as cash and cash equivalents. A big reason for this conservative investment approach is that Paxos is subject to a set of strict investment limits as determined by its regulator, the New York State Department of Financial Services (NYDFS). You can read about the NYDFS's stablecoin regulatory framework here.

By contrast, PayPal's regular dollars, which are regulated piecemeal under each U.S. states' own peculiar version of a money transmitter license, can almost always be legally backed by riskier assets. (Here is PayPal's list of state-issued licenses.)

For instance, if you comb through the fine print at the back of PayPal's annual report, the total amount of customer funds held in the form of regular PayPal dollars comes out to $36 billion at year-end 2022. Of this $36 billion, PayPal has invested $11 billion in "cash & cash equivalents." Put differently, just 30% of its dollars are backed by top notch assets, far less than the 100% ratio for PayPal's crypto dollars. PayPal invests another $17 billion of its customer's billions in something called available-for-sale debt securities which, if you dig further, is made up of stuff like government bonds, commercial paper, corporate debt securities, and more. See the list below:

Source: PayPal 2022 annual report

These available-for-sale securities assets are not as reliable as cash and cash equivalents, particularly treasury bills. First, they have riskier issuers, as is the case with commercial paper and corporate debt, both of which are emitted by companies. Second, they are characterized by longer terms-to-maturity, as is the case with government bonds and corporate debt securities. Prices of long-term debt are much more volatile than short term debt. 

It would be illegal for PayPal to back its new crypto-based dollars with the assets listed above, yet for some reason it is fine if it backs its traditional dollars with them.

Customer's ranking relative to other creditors

The second drawback of PayPal's regular dollars is that the assets underlying them don't really "belong" to customers in any strong sense of the word. They belong to PayPal. 

More precisely, PayPal's terms of service has this to say: "...any balance in your Balance Account and any funds sent to you which have not yet been transferred to a linked bank account or debit card if you do not have a Balance Account, represent unsecured claims against PayPal..."). The bold is my emphasis.

To understand what this means, let's say that PayPal goes bankrupt. You, a long time PayPal customer, hold $1000 worth of PayPal dollars. You might think that you are guaranteed to be made whole because there exists a corresponding set of underlying customer assets that has been specially earmarked for you and other PayPal customers. But that's not the case. Customers are what is referred to in finance as an unsecured creditor of PayPal, which means you'd be relegated to having to fight with PayPal's other creditors (banks, bond holders, etc) to get a piece of the pie, and that's only after PayPal's secured creditors – those highest in the pecking order – get first dibs. That could potentially mean getting maybe $600 or $700 instead of your original $1000.

The reason for this, as explained here by Dan Awrey, is the fairly lax state-by-state regulatory frameworks under which PayPal's regular dollars are issued, which "often do not require that permissible investments be held in trust for the benefit of customers—thus potentially forcing customers to compete with an [money services business]’s other unsecured creditors in the event that it is forced into bankruptcy."

By contrast, the regulator of PayPal's crypto-based dollars, the NYDFS, specifies that the reserves backing any crypto-based dollar "shall be held at these depository institutions and custodians for the benefit of the holders of the stablecoin, with appropriate titling of accounts." To translate, the assets underlying your $1000 in PayPal USD cryptodollars are not PayPal's assets. Nor are they Paxos's. They are yours. No need to squabble with competing vultures for what's left.

But oddly, PayPal is under no legal obligation to extend these very sensible protections to all of its regular PayPal dollars.  

Degree of transparency

The last big difference between the two types of PayPal dollars is that the crypto version offers far more transparency to customers. If you want to get current information about the assets underlying your crypto PayPal dollars, all you need to do is open up one of PayPal USD's soon-to-be published attestation reports. Published monthly, these reports must include market values of the assets backing PayPal USD's, both in total and broken down by asset class. These values must be recorded on two separate days each month, or 24 times per year. Furthermore, these attestation reports must be prepared by an independent auditor.

By contrast, the only way to get vetted financial information about the assets backing traditional PayPal dollars is to read its audited financial statements, which come out just once a year. For the rest of the twelve months, customers are left in the dark.

So where am I going with all of this?

This illustrates the absurdity of some of the rules we've created surrounding monetary instruments. The fact that one type of PayPal dollar has robust protections while the other is only haphazardly protected, and only because the first is managed with a crypto database and not a traditional database, seems incredibly arbitrary to me. 

Financial regulations exist, in part, to protect retail customers against shoddy financial providers. Shouldn't all PayPal customers, no matter what database technology they select, get to benefit from the same standard protections? What's the logic behind stipulating that one type of PayPal customer is to have the benefit of monthly attestation reports, for instance, while limiting the other type of customer to a black void of information? 

The problem here isn't just one of having a few bad standards. Doesn't having multiple standards add to people's confusion about how they are protected?

Just to make things even more absurd, there's actually a third type of PayPal dollar. It comes in the form of balances held in a PayPal Savings accounts. 

Unlike the two types of PayPal dollar described above, the third type is insured by the government up to $250,000. PayPal Savings dollars also pay interest, whereas the first two don't, or are prohibited from doing so. PayPal offers this product in conjunction with a bank, Synchrony Bank, which means this third type of PayPal dollar conforms to an entirely different set or rules than the other two: Federal banking law.

But this only reinforces what a Frankenstein of a monetary system we've created. Why are only PayPal Savings dollars protected by deposit insurance, whereas the other two types of PayPal dollars aren't? How does this cacophony of features (or lack of features) help retail customers who, amidst all their other duties in life, simply don't have time to peruse the fine print of each different dollar emitted into the economy?


  1. It seems like a risk that Paypal account holders would more likely be concerned about might be Paypal cancelling or restricting their account in some way that wouldn't let them withdraw their money. Any differences there?

    1. This time it's not "not your key, not your money", though. PayPal contractually provides the account, and they're required to reimburse that money. It's not decentralised, it's centralised but uses a crypto asset which is well-backed for some pretty bizarre reasons.

    2. "Any differences there?"

      PayPal identifies all of its regular account holders, whereas with PayPal USD it'll be possible to interact with it in a way that a user doesn't have to show their ID, so in theory there's less scope for restrictions. However, PayPal USD can still be frozen.

  2. There is also the risk of the smart contracts having a bug or user error leading to funds being stolen permanently.

    1. Yep. In my post I only discuss the degree to which customers are protected by the quality of underlying assets, their seniority, and transparency, but there are other dimensions over which the various types of PayPal dollars can be compared.

  3. Crypto is a scam and the only reason why there is an inconsistency is PayPal (and other techbros) stupid desire to move fast and break things. Please read ‘ Popping the Crypto Bubble’ by Darren Tseng, Stephen Diehl, and Jan Akalin.

    1. There are plenty of scams being run on crypto databases, but the crypto databases aren't themselves scams.

    2. paraphrased: "Open source, permission-less crypto is a scam, please read this book I just read written by someone who coincidentally benefits from private blockchain technology and sells it."

      Open public ledgers with large amount of redundancy are valuable, as shown by the market. Crypto-crticis hand wave around this about how its all a big bubble and a scam while it continues to grow and work. Economically its simple, they reduce the transaction costs of trust, and allows to simulate property rights on imaginary objects with some global state. It turns out this is useful for many money/finance/market things (stablecoins like PYUSD, AMMs to trade stuff, collateralized debt protocols etc.)

      Get over it already, you were marginally wrong

  4. Great piece. Congratulations!

    1. Second this. Really enjoyed it, thank you

  5. A bit of a random question - but do you know if this is how Venmo works as well? ie, Does any balance in ones Venmo Balance represent unsecured claims against Venmo?

    1. Venmo is owned by PayPal, so any Venmo balance is an unsecured claim against PayPal.