PayPal Holdings Inc. (PYPL-$296.53, NASDAQ). The Evolution of a Cryptocurrency “Interchange”.

What is the end game for the holder of cryptocurrency stored on that thumb drive in their bank safety deposit box?

Anonymity is important but liquidity is paramount and that is the current issue for holders of the equity-like product known as cryptocurrency. The ability to convert massive volumes of cryptocurrency into US dollars, Euros or something fungible, is the stumbling block at this time for holders of bitcoin. Cryptocurrency paper billionaires desire, above all, the prospect of being able to convert large volumes of bitcoin into currency that they can readily spend, on anything that they desire.

The ability of a firm to offer a reliable and scalable bitcoin exchange for something, anything in fact, that could then be turned into US dollars readily; that would be very desirable to a cryptocurrency holder. They would be willing to pay a handsome fee for that opportunity.

PayPal seems to be working toward a resolution of the issue and has announced a tentative foray into providing bitcoin access of parts of the Paypal platform. This represents the first step, of what I consider to be a two step solution, for cryptocurrency holders seeking to launder their funds, into truly fungible currency.

The second step for PayPal would be to set up an equity stock, discount, online brokerage program, similar to Robinhood, whereby a PayPal account holder could open up a stock trading account in order to buy listed equities and the array of products, including US treasuries, money market funds and bond products, similar to that of any conventional online broker. With a cryptocurrency platform already established, PayPal could ultimately permit buyers and sellers of equities to settle their purchases, in the variety of currencies already permitted with conventional online accounts + bitcoin.

A platform along the lines I envision would enable a holder of millions, hundreds of millions or billions held in bitcoin to buy shares of an ETF, a highly liquid equity or some sort of US dollar denominated security. A holder of bitcoin would buy that security utilizing the PayPal equity account, settle the purchase with bitcoin, at a handsome exchange fee, hold it for a short duration (although there would be nothing preventing one from making a legitimate long term investment), sell that equity product and settle the sale in US dollars. This would complete the desired “laundering” of the funds while simultaneously providing the exchange into a fungible, globally accepted currency.

PayPal needs to develop a higher margin source of revenue.

In 2021, PayPal will likely surpass the revenues of Visa Inc., the largest processing interchange network. Visa has a market cap of about $450 billion. Mastercard has a market cap of about $334 billion. PayPal has a market cap of roughly $345 billion. If FinTech companies were valued solely on top line sales, taking into account the growth rate reported by PayPal to date and the current acceleration of volumes, the difference between the market caps of Visa and PayPal would not be justified. However, investment markets don’t look just at receipts, they consider the earning potential of each dollar of those revenues. What PayPal needs to do, to potentially surpass the market cap of Visa, is to do more than simply grow its revenues faster, it also needs to increase the profit contribution on each dollar of sales.

The PayPal platform is presently constrained, on an EBITDA front, by its requirement to complete most of the conventional retail purchases done on its platform using the Mastercard or Visa global interchanges. Contracts between PayPal, Mastercard and Visa provide fantastic revenues for MA and Visa but serve to cap the PayPal EBITDA contribution on credit card retail transactions at about 20% (terms are confidential). Consequently, PayPal generates about a 20.8% EBITDA margin which compares very poorly to the EBITDA margins of 50%-60% routinely earned by Mastercard and Visa. Losses on purchase chargebacks, disputes and credit losses account for about 8.1% of annual PYPL revenues.

The current business model of PayPal provides tremendous revenue growth, considerably higher than Visa or Mastercard, but generates an vastly inferior EBITDA margin plus carries a significant transaction and credit loss risk. What PayPal needs, more than V and MA, in order to demonstrate its ability to move into the FANGMAN group of highly desired equities, is to add a significant, fast growing and highly profitable source of revenue. In effect, PayPal needs to create its own global interchange. It cannot be accomplished on retail purchases as Visa and Mastercard control that market in a tight duopoly.

A nascent and unexploited conversion market does exist, the cryptocurrency market.

The potential creation of an equity brokerage purchase platform on PayPal, with the existing customer base in excess of 350 million consumer accounts, would be a reasonable profit center by itself and would reduce dependence upon the current interchange network agreements. Add to that the ability of PayPal to monetize cryptocurrencies into hard currency, using equity purchases as the avenue to “wash” bitcoin, could produce fabulous EBITDA margins, similar or greater than are presently earned by Visa and Mastercard on retail interchange transactions. The market cap of bitcoin alone is closing in on $1 trillion USD. Assuming an overall conversion fee of about 5% to launder all the bitcoin into USD listed equities could provide revenue of about $50 billion. Then, there would be the revenues earned from the equity order flows, cross border exchange rate income earned on the reconversion of USD into other foreign currencies, etc. Finally, the ability of PayPal to provide an effective laundering service for bitcoin would aid in growing the remainder of the PayPal platform quite dramatically. PYPL would become the de facto global interchange for bitcoin and would earn monopoly type profits. $1 trillion USD of bitcoin pales in comparison to the aggregate value of fungible global currencies, but the profit margin on conversion of cryptocurrencies into USD, using an equity investment account as a clearinghouse, would be very high.

By 2026, at current forecast rates of growth, PayPal revenues might be roughly the size of that of Visa and Mastercard combined. However, PayPal will always suffer on an EBITDA comparison front due to its requirement to utilize third party interchange networks. The creation of its own interchange, under the guise of an equity investment platform, will, if developed, provide a uniquely useful service for a certain type of cryptocurrency holder, a holder that would not blink at paying exchange transaction fees of 5% or thereabouts, in order to be able to obtain a totally liquid asset.

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