After nearly a decade of exponential growth and a parabolic stock price, the stock lost 85% of its value in 2022.

This was caused by a multitude of factors, posing an existential threat to PayPal, such as the rise of competing payment methods like Apple Pay, as well as the stagnation of ecommerce as the pandemic subsided and people went back to brick and mortar shopping.

But in December of 2024, things went from bad to worse when it became the subject of massive fraud allegations.

A popular YouTuber released an investigation that exposed that one of PayPal's biggest acquisitions, an online coupon aggregator called Honey, was engaging in what could turn out to be one of the most blatant and shocking online shopping frauds by a major company in recent memory.

It is now facing a class action lawsuit seeking damages on behalf of thousands of victims.

In this video, we'll examine the realities of PayPal's fundamental business model, how it's dealing with the end of its exponential growth period, and why its days of hyper-growth are behind it.

PayPal is a digital wallet that ordinary consumers can use to pay for online purchases or transfer money.

They fund their PayPal wallets by transferring money from their bank accounts.

Then they can pay for online shopping directly from their PayPal account.

From the consumer's perspective, it's like using cash from a physical wallet at a physical store, except it's using PayPal at an online store.

PayPal can take a lot of credit for bringing casual consumer commerce into the internet age.

In the early 2000s, e-commerce and the internet were still in its early stages.

For technical reasons, many companies that wanted to sell their merchandise online were still unable to accept credit cards over the internet.

This was the main barrier to some companies, particularly smaller companies, but the biggest benefit that PayPal brought to online transactions was security.

Typing your credit card information into a website and authorizing them to charge your card was a risky proposition, particularly before the development of modern internet security protocols.

Consumers were understandably wary of handing over their credit card info to potentially untrustworthy vendors, or even to large, reputable vendors, for fear that their card info could be intercepted by hackers or malware.

With PayPal, you tell PayPal itself to make a payment to the seller, and they only send the amount of money that you authorized.

You only have to worry about the trustworthiness and security of your interaction with PayPal, a company that has built its reputation and business model around these issues.

This made paying for things online much more safe and secure, making PayPal a wildly successful innovation in the consumer finance space.

For most of the 2000s and early 2010s, PayPal was owned by the e-commerce giant, eBay. eBay was able to integrate PayPal as its primary payment method seamlessly, and PayPal's adoption by consumers grew steadily.

In fact, by the early 2010s, PayPal had become a business that had grown much bigger than just the native payment system for eBay, and earned almost as much revenue as the rest of eBay combined.

It was also clear that with the rise of e-commerce, it had great potential to grow even more.

People needed to pay for online purchases for much more than just online auctions for trinkets and used cars.

This was also around the time when Amazon and other e-commerce sites were really starting to take market share.

And yet, Amazon did not accept PayPal as a payment method on its site, in large part because it was owned by eBay, a key competitor.

In 2014, the activist investor Carl Icahn recognized this, and realized that there could be significant value separating eBay from PayPal.

He built up a position in eBay stock and wrote an open letter to shareholders, asking them to call for a spinoff of PayPal. eBay initially resisted, but eventually agreed to spin off PayPal in the second part of 2014.

The spinoff of PayPal has been a huge success.

On the day the decision was announced, eBay stock went up 7.5%.

As an independent company, PayPal pursued relationships with other e-commerce sites that eBay may have considered competitors.

It also expanded into new payments markets that eBay would not have been interested in, such as POS devices and brick-and-mortar retail establishments.

Throughout the rest of the 2010s, PayPal grew rapidly, with its revenue growing double-digit percentages each year.

Its net income exploded, increasing by five times in five years, from about half a billion dollars in 2014 to almost two and a half billion dollars in 2019.

In the years since the mid-2010s, PayPal has grown into a diverse business, but its core money-making operations have largely stayed the same.

To understand how PayPal makes the bulk of its money, we first have to understand how the traditional credit card system works.

The normal system can be broadly split up into five different types of participants.

The buyer, the seller, the credit card network, the issuing bank, and the merchant acquirer.

The buyer and seller are self-explanatory.

The buyer is the person who wants to buy something that the seller has to offer.

The issuing bank is the bank that the buyer has an account with, like Chase, Citi, or Bank of America, just to name a few of the biggest.

This bank holds the buyer's money that is eventually used to make the purchases.

The merchant acquirer is conceptually like the bank for the seller.

It receives payments made by the buyer on behalf of the seller.

Some well-known examples of merchant acquirers are Toast, Stripe, and Clover, but there are other large ones as well.

And finally, there's the credit card network, the biggest of whom are American Express, Visa, and MasterCard.

The credit card network provides the infrastructure and communication protocols for the merchant acquirer and issuing bank to communicate with each other to execute transactions.

PayPal rethinks this whole system.

Instead of having three separate middlemen in the issuing bank, credit card network, and merchant acquirer, PayPal can act as all three.

When a buyer pays a seller using PayPal, they can directly send money from their PayPal wallet to the seller's PayPal wallet.

The buyer's PayPal wallet replaces the issuing bank, the seller's PayPal wallet replaces the merchant acquirer, and the PayPal network replaces the credit card network.

PayPal gets to collect the fees that otherwise would have been collected by those elements that it replaces, which for most types of transactions averages a total of around 3%.

There are other ways PayPal inserts itself into the traditional credit card system as well.

For example, it can act like the issuing bank, it offers merchant acquirer services, and can even act as an extra middleman between the credit card network and merchant acquirer.

But the main thing to understand is the traditional credit card system, and that PayPal replaces or inserts itself alongside certain parts of it.

Because PayPal makes money in the same way as the traditional credit card system and indeed competes with it, its operating and financial results are similarly dependent on transaction volumes.

The two most important operating metrics for PayPal to measure the success of their product are total payment value and the number of payment transactions.

Like the traditional credit card system, the amount of revenue PayPal generates through charging fees on transactions is a fixed amount per transaction plus a percentage of the transaction size.

So both the number of transactions and the total size of all transactions determine the company's revenue.

As PayPal has gained adoption among ecommerce merchants and consumers, both of these metrics have been increasing exponentially every single year.

In fact, in the five years before the pandemic, both the number of transactions and total payment value grew at an annual rate of almost 30%.

With no end in sight for the company's remarkable growth, PayPal's stock price similarly went increasing nearly tenfold from its spinoff from eBay in 2015 to its peak in 2022.

In the years immediately following its spinoff from eBay, PayPal was able to grow extremely quickly by simply expanding its reach outside of eBay.

Companies like Uber, Walmart, and countless other companies both large and small started accepting PayPal.

Similarly, with more and more places accepting PayPal, more and more consumers found it worthwhile to open up a PayPal wallet.

The total number of active PayPal accounts more than doubled from 2015 to 2020, from 179 million to 377 million.

But following the pandemic, the growth in ecommerce hit a wall.

Additionally, competition from the likes of Apple Pay, Google Pay, and other consumer payment solutions began really heating up.

PayPal knew it would have to find new ways to augment its product offering.

It attempted to do so in a number of ways.

One of PayPal's biggest growth bets was the launch of its Pay in 4 program in 2020.

The Pay in 4 program is PayPal's entrance into the buy now pay later space.

Buy now pay later is one of the most rapidly growing parts of consumer finance.

Major players like Affirm and Klarna have seen their popularity among consumers skyrocket in recent years.

The reason that buy now pay later has become so popular is because it allows consumers to smooth out their consumption, which lowers the psychological barrier to making a single large payment.

It also offers credit to consumers who otherwise would not be credit worthy enough for traditional consumer loans.

PayPal's Pay in 4 offering is an additional payment method that is sometimes available when making a purchase with the merchant who accepts PayPal.

With Pay in 4, the full purchase price is spread out between four payments, 15 days apart, with no interest.

You have to be approved for each Pay in 4 installment loan you take out, but most applications get automatically approved within seconds.

PayPal does not make any money directly from its Pay in 4 program.

In fact, it costs a significant amount of money to run because it gives the consumer an interest-free loan, and incurs some risk of default on each loan it makes.

This has contributed to PayPal's credit losses increasing 42% from pre-pandemic levels, from $288 million in 2019 to $409 million in 2023.

But remember that PayPal makes the bulk of its revenue from the total number of transactions and total payment value.

Researchers have concluded that access to Buy Now Pay Later installment loans indeed has a causal effect on consumers increasing their spending.

In an article published by the Harvard Business Review in late 2024, two marketing professors shared the results of a study they conducted to determine the effect of Buy Now Pay Later on how much money consumers spend.

They compared the spending patterns of hundreds of thousands of consumers before and after adopting Buy Now Pay Later schemes.

The study found an immediate increase in spending among those consumers who adopted Buy Now Pay Later, to the tune of 17 to 26%.

This is the most convincing academic evidence yet that Buy Now Pay Later indeed causes consumers to spend more.

PayPal is uniquely positioned to benefit from this dynamic because their revenue is directly linked to how much money people spend using PayPal.

While the launch of Pay in 4 has been a massive success for PayPal, not all of its growth initiatives have worked out so well.

In 2023, PayPal tried to get in on the cryptocurrency hype with their own cryptocurrency called PiUSD.

PiUSD is a so-called stablecoin that supports PayPal's broader ambitions to build a successful crypto trading platform within the PayPal ecosystem, but these ambitions have largely been a flop.

As the main stablecoin of PayPal, PiUSD is a good proxy for broader crypto trading activity on PayPal.

As of the time of recording this video, PiUSD has a market cap of just half a billion dollars and trades about $10 million worth per day.

This is only a small fraction of the nearly $50 billion market cap and $5 billion of daily trading volume of the stablecoin USDC.

But more concerningly, PayPal has gotten into legal trouble for its PiUSD cryptocurrency.

In late 2023, the SEC subpoenaed PayPal pending an investigation into PiUSD.

If the SEC determines PiUSD to be an unregistered security, PayPal could be subject to enforcement action, fines, and significant reputational damage.

Another disastrous growth initiative has been PayPal's 2020 acquisition of a startup called Honey.

Honey created a web browser extension that automatically applies known coupon codes to your order when you shop on various ecommerce websites.

It was first released in 2012 and instantly went viral for its ability to seemingly save you money on your online purchases for free.

PayPal acquired it in 2020 for $4 billion, its largest acquisition to date.

But why would PayPal want to own a browser extension company?

The main reason PayPal was interested in Honey was to support its growth category, which it calls revenue from other value-added services.

They define this category as, quote, "Net revenues derived primarily from revenue earned through partnerships, referral fees, subscription fees, gateway fees, and other services we provide, etc."

Through Honey, PayPal establishes affiliate marketing partnerships with merchants.

Brands can pay a fee, usually around 3-5% of each transaction, to offer a Honey-specific coupon code, as well as offer consumers a reward currency called Honey Gold on purchases.

They also gain exposure on JoinHoney.com.

This partnership revenue is recognized in the revenues from other value-added services category.

This category has been a major part of PayPal's growth story since the pandemic.

While their transaction revenue growth decelerated to a 7% annual rate since the pandemic, their revenue from other value-added services has grown at a rate three times that.

Many Wall Street analysts have cited the growth in this category for their optimism about PayPal's growth prospects.

The problem is that this category still only accounts for about 10% of the company's total revenue.

The majority still comes from its traditional transaction revenue, the fees that it charges on each transaction made using a PayPal account.

If PayPal wants to maintain its stock trading at the multiples of a growth stock, it has to maintain a high growth rate in its revenue from other value-added services category.

They viewed Honey as a key part of this growth.

In late 2024, it was first revealed by a YouTube channel called Megalag that Honey has been engaging in business practices that are shady at best and possibly constitute illegal fraud.

If you haven't seen that video, you should watch it.

We've linked it in the description below.

According to the allegations, Honey scammed both content creators whom Honey sponsors as well as ordinary consumers who use Honey.

When a consumer clicks an affiliate link to purchase an item, for example, if their favorite YouTuber is sponsored by a product the consumer thinks is cool, that link can track the fact that the consumer purchased the item through the content creator's link.

The content creator frequently earns a commission on the sale.

This is how content creators are able to afford making expensive or time-consuming content for free platforms like YouTube.

The Honey browser extension pop-up is usually the last thing a consumer clicks before paying for something online.