One of Square's (SQ 0.15%) most successful strategies has been the expansion of its financial services business through Cash App and Cash Card. Outgoing CFO Sarah Friar has even said she thinks Square has an opportunity to replace a traditional bank account for most people. In particular, Square is addressing the needs of the unbanked and the underbanked.

Well, PayPal (PYPL -1.12%) CEO Dan Schulman doesn't think that's a bad idea. At a recent investor conference, he noted that the underbanked "spend an inordinate amount of time waiting in line to do a transaction: cash a check, send money to someone they love, pay a bill. Kind of ridiculous in this day and age where you've got a smartphone in your hand." He estimates PayPal could cut the costs on those kinds of services by 80%, which could dramatically reduce the cost of being underbanked.

Earlier this year, PayPal launched the Venmo card, its answer to Square's Cash Card, but that could be just the start of its plans to serve the underbanked. And PayPal may have some advantages over Square to catch up quickly.

A person holding a phone running the PayPal app.

Image source: PayPal.

PayPal's advantages

PayPal's biggest advantage is that it already partners with some of the biggest banks in the world. Ever since it started working with credit card companies, enabling users to make their preferred credit card their default payment option in PayPal, it's seen a lot of great benefits. Banks now incentivize their customers to sign up for PayPal, which has enabled it to grow transaction volume much faster than the overall e-commerce market.

PayPal could lean on those banking relationships to expand into simple banking transactions, or it could partner with a smaller bank. PayPal can't cash checks on its own, but a bank could help get those funds into a PayPal or Venmo account. There's also no way for PayPal to accept a cash deposit directly, but it's partnered with Walmart and other retailers to help make that possible.

However, PayPal has everything it needs to send money to friends or family or to pay bills, even across borders. Its acquisition of Xoom in 2015 gave it a strong position in digital remittance.

But putting together an entire ecosystem for the underbanked could be key to adoption. Everything from being able to load funds to an account via check, cash, or direct deposit to being able to send money to wherever the account holder needs it to go. Putting together that ecosystem will require at least some reliance on the traditional banking industry, and PayPal has the relationships to pull it off.

Square's biggest advantage

Square still has a big advantage over PayPal. Square works closely with merchants, which can give it a direct line to employees. If an employee for a Square merchant doesn't have a bank account, they can accept direct deposits right in the Cash App. In fact, Square incentivizes merchants to get their employees to sign up for Cash App deposits through products like Payroll.

If Square has a hand in a consumer's main source of income, it may be able to offer a better service to those customers. That could mean faster access to their money, more favorable consumer loans (for both parties), or better targeted offers on their Cash Card.

PayPal generally doesn't have as deep of a relationship with its merchants as Square does. It's not providing an entire ecosystem of services to run a business -- it's merely handling online payment processing. The lack of an ecosystem of merchant services puts it at a disadvantage on the consumer side, since Paypal lacks a relationship with consumers' main source of income.

That said, PayPal isn't looking to do everything exactly like Square's Friar has suggested for Square. "We don't want to do savings accounts. We don't want to do a lot of things," Schulman said. So, investors should expect PayPal to focus on serving the underbanked specifically in areas where it has an advantage. Square investors should keep an eye on product launches, but be mindful of areas where Paypal is able to better serve customers (hint: speed and data) to see if it's a true threat to the business.