The past three years have been nothing short of disastrous for PayPal. After nearly a decade of exponential growth and a soaring stock price, the company suffered a dramatic 85% decline in its valuation in 2022. This downfall was driven by several factors threatening PayPal’s survival, including the rise of competing payment methods like Apple Pay and the slowdown in e-commerce as pandemic restrictions eased and consumers returned to physical stores.
However, the situation took an even darker turn in December 2024 when PayPal became embroiled in massive fraud allegations. A popular YouTuber's investigation revealed that one of PayPal's most significant acquisitions, Honey—a prominent online coupon aggregator—was allegedly involved in one of the most blatant and shocking online shopping fraud scandals in recent memory. This revelation has led to a class-action lawsuit on behalf of thousands of victims, seeking substantial damages.
In this article, we’ll dive into the intricacies of PayPal’s business model, analyze how it is grappling with the end of its rapid growth era, and explore why its days of hyper growth might now be a thing of the past.
The History of PayPal
PayPal revolutionized online payments, offering ordinary consumers a secure and convenient way to pay for online purchases or transfer money. Users fund their PayPal accounts by transferring money from their bank accounts and can then pay for online shopping directly from their PayPal balance. For consumers, this process feels similar to using cash from a physical wallet at a store, but in the context of an online transaction.
In the early 2000s, when the internet and e-commerce were still in their infancy, PayPal played a pivotal role in enabling casual consumer commerce online. At the time, many companies, particularly smaller ones, faced technical challenges in accepting credit card payments online. PayPal bridged this gap, becoming a critical solution for online transactions.
A significant advantage PayPal brought to e-commerce was enhanced security. Before modern internet security protocols were established, entering credit card information on websites was risky. Consumers hesitated to share their credit card details due to fears of hacking, malware, or untrustworthy vendors. PayPal addressed this concern by acting as an intermediary: users authorize PayPal to make payments on their behalf, ensuring only the approved amount is transferred to sellers. Consumers only needed to trust PayPal, a company whose reputation and business model centered on secure transactions. This innovation greatly improved the safety of online payments and contributed to PayPal's widespread adoption.
For most of the 2000s and early 2010s, PayPal was owned by eBay, the e-commerce giant, which integrated PayPal as its primary payment method. This seamless integration fueled PayPal’s growth, and by the early 2010s, PayPal had become a business generating almost as much revenue as the rest of eBay combined. However, as e-commerce expanded beyond eBay’s scope, PayPal’s potential to serve a broader market became evident.
One notable challenge was that Amazon, a major e-commerce player, did not accept PayPal, partly because it was owned by eBay, a competitor. Recognizing the untapped potential, activist investor Carl Icahn advocated for PayPal's separation from eBay. In 2014, after shareholder pressure, eBay agreed to spin off PayPal. The announcement boosted eBay’s stock by 7.5%.
As an independent company, PayPal pursued partnerships with other e-commerce platforms, including competitors of eBay. It also expanded into new markets, such as point-of-sale systems and brick-and-mortar retail. Throughout the late 2010s, PayPal experienced rapid growth, with double-digit annual revenue increases. Between 2014 and 2019, its net income soared from $500 million to nearly $2.5 billion.
Since its spin-off, PayPal has solidified its position as a leader in digital payments, continuously innovating and expanding its services to meet the evolving needs of global consumers and businesses.
How PayPal Generates Revenue
PayPal has evolved into a diverse business, but its primary revenue-generating model remains largely unchanged. To understand how PayPal earns most of its income, it's helpful to first examine the traditional credit card system. This system involves five key participants: the buyer, the seller, the credit card network, the issuing bank, and the merchant acquirer.
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The buyer is the individual purchasing goods or services.
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The seller is the entity offering those goods or services.
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The issuing bank (e.g., Chase, Citibank, or Bank of America) holds the buyer's funds used for purchases.
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The merchant acquirer acts as the seller's bank, processing payments on their behalf. Examples include Stripe, Toast, and Clover.
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The credit card network (such as Visa, Mastercard, or American Express) provides the infrastructure and protocols enabling the issuing bank and merchant acquirer to communicate and process transactions.
PayPal reimagines this system by consolidating these middlemen roles into its own platform. Instead of relying on separate entities like the issuing bank, credit card network, and merchant acquirer, PayPal serves as all three. When a buyer makes a payment using PayPal, funds are transferred directly from the buyer’s PayPal wallet to the seller’s PayPal wallet. In this setup:
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The buyer’s PayPal wallet replaces the issuing bank.
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The seller’s PayPal wallet replaces the merchant acquirer.
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The PayPal network replaces the credit card network.
This streamlined process allows PayPal to collect fees that would traditionally be divided among the replaced entities. These fees average around 3% per transaction for most types of payments.
In addition to its role as a substitute for traditional payment intermediaries, PayPal also operates alongside the traditional credit card system in various ways. For instance, it can function as an issuing bank, provide merchant acquirer services, or act as an intermediary between credit card networks and merchant acquirers. Despite these diverse roles, PayPal's revenue model closely mirrors that of the traditional credit card system, relying on transaction volume.
PayPal’s financial performance is heavily influenced by two key metrics:
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Total Payment Value (TPV): The total dollar value of transactions processed through PayPal.
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Number of Payment Transactions: The total number of individual transactions completed.
PayPal charges a fixed fee per transaction plus a percentage of the transaction amount, meaning both the volume and size of transactions drive its revenue.
As PayPal’s adoption among e-commerce merchants and consumers has grown, these metrics have increased exponentially. Between 2015 and 2020, both TPV and the number of transactions grew at an annual rate of nearly 30%. This rapid growth has fueled significant financial success, with PayPal’s stock price rising nearly tenfold from its spin-off from eBay in 2015 to its peak in 2022.
PayPal’s Recent Performance
Since its spin-off from eBay, PayPal experienced rapid growth by expanding its reach beyond the eBay ecosystem. Major companies like Uber, Walmart, and countless others began accepting PayPal, encouraging more consumers to create PayPal accounts. Between 2015 and 2020, the number of active PayPal accounts more than doubled, rising from 179 million to 377 million.
However, after the pandemic, e-commerce growth stagnated, and competition from alternatives like Apple Pay, Google Pay, and other payment solutions intensified. To remain competitive, PayPal sought to diversify its offerings, launching several initiatives to boost engagement.
One of PayPal's most significant bets was the introduction of its Pay in 4 program in 2020, marking its entry into the rapidly growing Buy Now, Pay Later (BNPL) space. BNPL services, offered by major players like Affirm and Klarna, have gained immense popularity by allowing consumers to spread the cost of a purchase into smaller, manageable payments. This approach reduces the psychological barrier of making large, upfront payments and provides access to credit for individuals who might not qualify for traditional consumer loans.
PayPal's Pay in 4 allows consumers to split the purchase amount into four interest-free installments, spaced 15 days apart. While users must be approved for each loan, most applications are automatically approved within seconds. Despite its growing adoption, the Pay in 4 program does not directly generate revenue for PayPal. Instead, it incurs operational costs, including the risk of defaults, which has led to increased credit losses. PayPal's credit losses rose by 42% from pre-pandemic levels, climbing from $288 million in 2019 to $490 million in 2023.
The rationale for introducing Pay in 4 lies in its indirect benefits. PayPal’s primary revenue comes from transaction fees, which are tied to the volume and value of transactions. Research supports the notion that BNPL services drive consumer spending. A 2024 Harvard Business Review study analyzed the spending behavior of hundreds of thousands of consumers before and after adopting BNPL. The study found that consumers who used BNPL increased their spending by 7% to 26%.
This data underscores how BNPL services like Pay in 4 can enhance PayPal’s bottom line by driving higher transaction volumes. With its business model directly tied to consumer spending, PayPal is uniquely positioned to capitalize on the growing popularity of BNPL and maintain its relevance in the competitive payment solutions market.
Challenges and Controversies
While PayPal’s Pay in 4 program has been a major success, not all of its growth initiatives have fared as well. Some, like its cryptocurrency and acquisitions, have sparked criticism and underperformed.
Cryptocurrency and the Launch of Pi USD
In 2023, PayPal ventured into the cryptocurrency market by launching its own stablecoin, Pi USD, as part of its broader ambitions to create a thriving crypto trading platform. However, these ambitions have largely faltered.
As PayPal’s main stablecoin, Pi USD serves as a key indicator of the platform's crypto trading activity. As of now, Pi USD has a modest market cap of just $500 million and daily trading volumes of $10 million—insignificant compared to larger stablecoins like USDC, which boasts a $50 billion market cap and $5 billion in daily trading volume.
More concerning is the legal scrutiny surrounding Pi USD. In late 2023, the SEC subpoenaed PayPal as part of an investigation into whether Pi USD constitutes an unregistered security. If found guilty, PayPal could face enforcement actions, fines, and significant reputational damage, casting a shadow over its foray into cryptocurrency.
Acquisition of Honey
In 2020, PayPal made its largest acquisition to date by purchasing Honey, a browser extension known for automatically applying coupon codes at checkout, for $4 billion. Honey was intended to bolster PayPal's "revenue from other value-added services", a category encompassing revenues from partnerships, referral fees, and subscription services.
Through Honey, PayPal established affiliate marketing partnerships with merchants. Brands would pay a fee (typically 3-5% per transaction) to offer Honey-specific coupons or rewards, such as Honey Gold, to consumers. While this revenue category has grown rapidly—tripling the rate of PayPal’s core transaction revenue since the pandemic—it still represents only about 10% of PayPal’s total revenue.
To maintain its growth stock valuation, PayPal relies heavily on expanding this revenue stream, with Honey being a pivotal piece of the strategy. However, allegations surfaced in 2024 that threaten to tarnish Honey’s reputation and impact its growth.
Allegations Against Honey
A YouTube channel, Mega Lag, exposed alleged unethical and possibly fraudulent practices by Honey:
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Misappropriating Affiliate Commissions: When a consumer clicks on a creator's affiliate link to purchase an item, the content creator typically earns a commission. However, Honey allegedly replaces the affiliate tracking with its own, taking credit for the sale and pocketing the commission—even if it provided no discounts or value to the consumer.
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Failing to Offer the Best Coupons: Despite claims to provide the best available coupon codes, Honey is accused of frequently failing to do so, misleading consumers.
These allegations, if true, reveal potentially exploitative practices that not only harm content creators but also deceive consumers. This controversy raises serious questions about Honey’s business ethics and PayPal’s role in overseeing its operations.
Implications for PayPal
The controversies surrounding Pi USD and Honey highlight significant challenges for PayPal. The cryptocurrency venture has yet to deliver meaningful results and now faces legal risks, while Honey’s alleged practices could undermine consumer trust and tarnish PayPal’s reputation. Both initiatives were critical to driving PayPal’s growth beyond its core transaction revenue, making their struggles particularly concerning for the company’s long-term outlook.
PayPal’s Future Outlook
When PayPal spun off from eBay as an independent company, it experienced several years of explosive growth. The platform rapidly expanded its share of the consumer finance market, gaining millions of users and processing increasing amounts of money. This resulted in exponential revenue and profit growth, securing PayPal a premium stock valuation with a high price-to-earnings (PE) multiple befitting a high-growth tech company.
However, by 2022, PayPal's rapid growth began to decelerate. New account growth was a modest 2% that year, and in 2023, PayPal experienced a historic milestone—it lost active accounts for the first time since becoming a public company. This stagnation in growth significantly impacted its valuation, leading to a sharp decline in its stock price.
Management has attempted to reignite growth through new initiatives and diversifying its revenue streams beyond transaction fees. However, these efforts have been overshadowed by high-profile setbacks, such as the recent Honey controversy. Even without such controversies, these new ventures contribute only a small fraction to PayPal’s overall revenue and profits, limiting their ability to offset slowing growth in its core business.
PayPal now faces the challenge of adjusting to its new reality as a mature business. While it remains profitable and generates solid revenues, it can no longer sustain the hypergrowth narrative that once defined its trajectory.
What are your thoughts on PayPal’s current state? Do the Honey controversy and similar issues reflect deeper challenges within its business model?
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