It is easier than ever to buy bitcoin. But be careful which platform you choose, because you may not actually own the bitcoin that you are buying.
The digital payments company made a big push into crypto last year, and the platform now allows users in the U.S. to buy, sell, hold, and checkout with cryptocurrencies, including bitcoin, ethereum, bitcoin cash, and litecoin. Venmo, the mobile wallet owned by PayPal, also lets customers buy and sell cryptocurrencies.
Sounds pretty great, right?
But those coins you're buying are not technically yours.
"PayPal manages the wallets, which means that you don't necessarily hold your own bitcoin," said Mike Bucella, general partner at BlockTower Capital.
Holding the keys
Typically, when you purchase bitcoin, you are given two things to make that ownership official: A public and a private key pair. The public key is your wallet address, and the private key gives you control of that wallet. With PayPal, you have access to your public address, but the company controls the private key. In the "Crypto on PayPal FAQ" section of the app, the company explains that "the crypto in your account cannot be transferred to other accounts on or off PayPal." It is a limitation which feels odd, given that this is meant to be an asset you own. You can think of the custodial arrangement as a kind of IOU for your bitcoin. "It's similar to when you deposit U.S. dollars with Bank of America," said Asheesh Birla, a general manager at Ripple. "You're trusting that Bank of America actually has your U.S. dollars in their bank accounts, and they're giving you an IOU." This means that customers can't move their bitcoin to cold storage, nor can they transfer tokens to a wallet outside of the PayPal ecosystem. Bucella explained that while the user is very limited in terms of what they can do with the asset, from a business perspective, it makes perfect sense for PayPal. "It reduces a lot of the Know -Your-Customer (KYC)/anti-money laundering (AML) potential issues that some of the larger players had in managing wallet-to-wallet transfers that are not within their platform."
Storing your bitcoin
To be fair, not everyone wants the responsibility of safeguarding their crypto holdings. "If you lose the public and private key, you lose your coin," said Birla. "If you're a novice in the crypto space and you're not comfortable holding your own private and public key, then it might be safer to delegate that access to PayPal." Ripple's former CTO, for example, lost his private key, forfeiting about $400 million worth of bitcoin at today's token price. PayPal's interface itself is pretty easy to use. As soon as this service launched on PayPal, Bucella tested it out. "It is a fairly seamless UX...If I plan on doing nothing but buying and holding my bitcoin, and I don't want to custody my own crypto, then it makes sense." If you already have a PayPal account, essentially all it takes to get in the crypto game is clicking a little button under bitcoin that says "Buy."
"There's very low friction," explained Birla. "And if you're going to buy just a bit, and you trust PayPal, that's fine." People who care about self custody "are obviously not going to be using the service," said Mati Greenspan, portfolio manager and founder of Quantum Economics. As with any centralized exchange, you do assume a certain amount of risk. PayPal has a long history of freezing accounts, much to the annoyance of some users. Centralized exchanges are also inherently vulnerable to threats that could potentially affect an entire network of users. Mt. Gox, once the leading bitcoin exchange, was the first high-profile hack in cryptocurrency history. The exchange filed for bankruptcy and lost 750,000 of its users' bitcoins, plus 100,000 of its own. "There isn't one right answer here," said Birla. "It really depends on your use case and your risk appetite."
Changing the rules
There is nothing to stop PayPal from changing its mind about the walled garden it's built around its crypto assets. Revolut, often characterized as the PayPal of Europe, capitulated earlier this week and now allows clients to withdraw bitcoin. "I think that can very likely play out with PayPal, as well" said Greenspan. But regulation remains a barrier to entry. In December, the Treasury Department proposed new KYC requirements that would require companies like PayPal and Coinbase to link user identities to their cryptocurrency wallets, should they want to send cryptocurrencies from a centralized exchange to a private wallet.
"It's hard to imagine that PayPal – being more conservative by nature – is going to enable that without having some sort of solution in place to make it compliant with the regulations that are being proposed by the U.S. government," said Birla.
Making a profit
Purchasing bitcoin via PayPal has been compared to buying a financial contract. Because you can't remove your coins from the platform, nor can you send them anywhere, it is almost as though you are buying a derivative of bitcoin, instead of the real thing. As with any options contract, the buyer stands to gain – or lose – quite a lot of money. The price of bitcoin hit its all-time high above $63,000 last month, and some analysts say the cryptocurrency still has a lot of room to run higher. Tom Fitzpatrick, global head of CitiFXTechnicals, said the charts signaled that bitcoin could reach $318,000 by the end of the year, in a report meant for Citibank's institutional clients and obtained by CNBC in December. Surging cryptocurrency prices could also prove critical to PayPal's bottom line. In an April 19 note to clients, Deutsche Bank estimated that PayPal's crypto trading volume will reach $20 billion this year, amounting to an additional $350 million in revenue.
The company makes money by taking a percentage cut each time fiat is exchanged for a cryptocurrency, and vice versa. Those fees can be steep. Users pay 2.3% for transactions below $100.
Though PayPal did not specifically break out income from its crypto portfolio, the company did beat Wall Street's expectations for Q1, earning $1.10 billion on revenues of $6.03 billion.
Despite short-term gains, Greenspan cautions that cryptocurrencies allow people to circumvent PayPal's services. "In essence, by embracing it, they [PayPal] clearly see that this is the future. But at the end of the day, what they're doing is essentially sowing the seeds of their own destruction."