Alexander Bechtel

By Alexander Bechtel

With the introduction of the PayPal stablecoin, there are two different types of dollar payment methods at Paypal: the conventional, account-based dollar and the blockchain-based stablecoin. A comparison of the two variants reveals some interesting findings.

In August, the payment service provider PayPal announced that it would be issuing a dollar stablecoin called PayPal USD (PYUSD for short). This is a dollar-backed cryptocurrency token that can be held at PayPal as an alternative to conventional account-based US dollars. At around 160 million dollars, the adoption of the stablecoin has so far been rather limited- especially in comparison to the 36 billion account-based dollars held in conventional PayPal accounts.

PayPal has so far kept a low profile regarding the specific use cases of the PYUSD stablecoin. The website states that the stablecoin is intended to create an open payment infrastructure to which developers of new blockchain-based products and services can connect. The PayPal stablecoin is issued on the Ethereum blockchain and is therefore not only programmable, but also compatible with the most important exchanges, wallets and decentralized applications in the blockchain ecosystem. It remains to be seen to what extent the PayPal stablecoin will actually be used for these applications and thus be able to compete with its major rivals Tether (USDT) and Circle (USDC). At least for customers in the United States, it is already possible to use the PYUSD for payments via the Paypal and Venmo app. It can also be used to purchase cryptocurrencies and carry out peer-to-peer transactions.

Initial reactions from American politicians suggest a certain skepticism towards the stablecoin. The Republican chairman of the Finance Committee in the House of Representatives, Patrick McHenry, welcomed PayPal’s innovation, but also took the opportunity to emphasize once again the need for a regulatory framework for stablecoins in the United States. His Democratic counterpart, Maxine Waters, was much more skeptical and questioned whether consumer protection was guaranteed with PYUSD. On November 2, PayPal also announced that it had been subpoenaed by the US Securities and Exchange Commission (SEC) to provide certain documents for the stablecoin.

These reactions and the fact that there are now two different types of US dollars at PayPal inevitably lead to the question of whether and how the two differ. When comparing the PayPal stablecoin with its conventional, account-based counterpart, two dimensions should be analyzed: the quality of the money and the quality of the payment channels through which this money is transferred. The following section will focus on the question of which of the two PayPal dollars is of higher quality. If we compare the quality of the PYUSD with that of the conventional PayPal dollar, interesting and unexpected findings emerge, some of which have already been presented by financial journalist John Paul Koning in his blog, which is well worth reading.

PayPal uses a white-label solution from the financial services provider Paxos, which is regulated by the New York State Department of Financial Services (NYDFS), to issue and manage the PYUSD. The NYDFS has already created a framework for stablecoins, which sets strict requirements for the collateralization of stablecoins. For example, the PYUSD reserve consists of 100 percent high-quality liquid assets such as short-term US government bonds. An attested report on the composition of the reserve is published once a month. According to Koning, the assets in the PYUSD reserve are treated as segregated assets so that end users have access to their money even in the event of PayPal or Paxos becoming insolvent.

The conventional PayPal dollar, on the other hand, is regulated at the level of the individual US states via the respective implementation of the money transmitter license. This results in a patchwork of different requirements and obligations, which almost always means that the conventional PayPal dollar can be collateralized by riskier assets than its stablecoin counterpart. A look at the PayPal Annual Report 2022 reveals that only 30 percent of the reserve of the traditional PayPal dollar is of a similar quality to that of the PYUSD. In addition to US government bonds, investments are also made in corporate bonds and commercial paper. This not only results in greater counterparty risks, but the maturities of these securities are longer and therefore the price sensitivity is higher than for the assets in the stablecoin reserve.

Another disadvantage of the US money transmitter licenses is that the conventional PayPal dollars are not treated as segregated assets. Instead, they are a liability of PayPal towards the stablecoin users. According to Koning, this means that the conventional PayPal dollar is part of the insolvency estate in the event of insolvency. Last but not least, there are also deficits in terms of transparency, as audited financial information is only published once a year instead of once a month.

The situation surrounding the two PayPal dollars in the US allows two main conclusions to be drawn. Firstly, many of the preconceptions about blockchain-based financial instruments in politics and society are not necessarily true. The blockchain version of the PayPal dollar is the higher-quality means of payment and offers a high level of consumer protection. Secondly, regulators are still finding it difficult to deal with blockchain technology. It seems contrary to the goal of technology neutrality in regulation that tougher rules apply to one form of money simply because this money is stored on a blockchain database instead of a conventional database. Ultimately, the blockchain has no influence on the quality of the money, such as collateralization, but rather determines how this money can be used. This will actually result in new challenges for regulatory authorities – for example in connection with the prevention of money laundering. An exciting topic for one of the future articles.

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This article was originally published in Frankfurter Allgemeine Zeitung (FAZ) in German. For the original version, click here.

Disclaimer: The contents of the article reflect private opinions of the author and not directly those of DWS.