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David Smith

David is on track to retire in two years from investing in bitcoins. David wants to help you understand the once in a lifetime opportunity this digital currency revolution provides. The digital...

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PayPal Should Use Bitcoin, Not Compete

Analyst Robert Wagner created a bit of a stir in the blogosphere recently, in an article he published at Seeking Alpha  -- titled: eBay's Paypal Has The Potential To Topple The Bitcoin.

Here is an excerpt that sum's up Wagner's reasoning: “The benefit of the Bitcoin is its ease of use, security and low costs/transaction fees. That benefit however is immaterial when compared to the costs and risks involved with its volatility.”

Wagner makes what seems like a logical case for PayPal, a subsidiary of eBay (NASDAQ: EBAY),being positioned to create a Bitcoin killer. But the argument only sounds logical because it presupposes benefits, and ignores the costs and risks. It is similar to stating casinos will get more business by making everyone a winner. True, but that argument won't work.

PayPalCoin: Bad For Consumers

Wagner's article presupposes a PayPal digital currency, that will provide benefits greater than PayPal's existing value proposition. When I use PayPal as a consumer I see no fees, fast transaction times, and my transactions are denominated in USD.

Related: Is Bitcoin Your Chance To Profit Like A VC?

If I were to use a PayPalCoin, what would be improved? Instead of having my account balance in dollars, would it be in USD and PayPalCoins? Would a PayPalCoin be irreversible, like bitcoin, so when using it as a consumer I have no recourse to get a refund? Would PayPalCoin be advertised as a way to gamble overseas or for illicit activities?

I fail to see how a PayPalCoin would benefit consumers more than PayPal's existing offerings without running afoul of the law.

PayPalCoin: Bad for PayPal

Wagner's analysis also fails to address how PayPalCoin would benefit PayPal profits. First of all, PayPal would incur costs to create and maintain a PayPalCoin. Then, to provide price stability, PayPal would need to provide settlement to another asset like the U.S. dollar.

Bitcoin's security comes at a cost. This year it is estimated the bitcoin network will pay the miners 1,312,500 bitcoins (about half-a-billion U.S. dollars at today's prices). Then there are liabilities. Will PayPal ignore robbed customers? It is hard to imagine PayPal not being involved in the ongoing Mt. Gox lawsuits, if Mt. Gox had traded PayPalCoin instead of bitcoin. Lastly there have been privately-issued digital currencies since the 1990s. All have run into trouble with criminal activity on their network, and some ended with jail-time for their executives.

These liabilities and additional costs beg the question: how would PayPal profit from PayPalCoin? Will PayPal charge customers to convert between PayPalCoin and USD? As pointed out by Wagner, one of bitcoin's key advantages is the low transaction fees. Will PayPal take the fee credit card companies would get, thereby eliminating the PayPalCoin cost advantage compared to bitcoin?

I fail to see how PayPal can profit from a digital currency that is cheaper than bitcoin. That seems similar to Encyclopedia Britannica competing with Wikipedia.

Keep it Simple –- Just Use Bitcoin

I agree with Wagner when he states, “Paypal can either get in front of this Bitcoin bandwagon or get run over by it.” PayPal can get the advantages of a PayPalCoin by simply using bitcoin. This avoids the costs of creating a coin, maintaining a coin network and assuming legal liabilities -- all while benefitting from bitcoin's ease of use, low transaction fees and security.

PayPal would increase profits by transmitting money at a lower cost, having faster settlements and having the ability to eliminate fraud when receiving funds. These abilities would open up new PayPal use cases.

Despite Wagner's assertion that volatility is inherent to bitcoin, that volatility only exists because the technology is new, liquidity is low and adoption is low. Microsoft, Google, Apple, Facebook: all these companies have had high volatility, and that volatility has decreased as the companies have become bigger and more established.

The same thing is happening with bitcoin. As usage increases, volatility decreases and bitcoin becomes more valuable, leading to a virtuous cycle.

Similar to how Apple's OS X benefitted from open source, PayPal should use bitcoin to better compete with companies like Western Union and Visa.

Disclosure: At the time of this writing David Smith has a long bitcoin position.

Tags: Bitcoin digital currrencies

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