PayPal (NASDAQ:PYPL) says its peer-to-peer mobile payments app, Venmo, ended the third quarter with a $400 million annual revenue run rate. That number's quite impressive, up from a $200 million run rate at the end of 2018. Still, it falls short of the $540 million adjusted revenue run rate Square (NYSE:SQ) posted for Cash App during the second quarter.

Square has paved the way for Venmo's early monetization, with PayPal copying several of its strategies and products. Importantly, though, Cash App hasn't seemed to cut into the growth in payment volume on Venmo. Increased engagement on Venmo despite Cash App's surging popularity indicates it's well on the path to profitability.

A person sending a payment using Venmo on iMessage.

Image source: PayPal.

The importance of payment volume for Venmo

PayPal says total payment volume on Venmo increased 64% year over year in the third quarter to $27 billion. That puts it on target to reach the $100 billion in TPV for 2019 that management said it was on pace for at the end of last year.

Again, juxtaposing Venmo's TPV growth with Cash App's is disappointing. Square says Cash App volume increased 2.5 times during the first quarter (compared to a 73% jump for Venmo in the same period). Management didn't provide an update in the second quarter.

Venmo is likely growing off a much larger base, however, which would provide a much bigger revenue opportunity for PayPal long-term. Management expects digital payments to businesses through its Pay with Venmo product to be the primary revenue source in the long term, cannibalizing its core PayPal business. It's willing to do so because Venmo users often leave balances in their accounts, which allows PayPal to cut down on fees associated with processing card payments. Pay with Venmo accounted for the smallest portion of Venmo's revenue when the company provided an update at the start of the year.

Venmo accounted for 15% of PayPal's total payment volume last quarter. As that percentage increases, Venmo's opportunity to bring on more merchants to use Pay with Venmo increases as well.

Venmo is already moving toward profits

PayPal has seen a notable expansion in its operating margin this year, which came in at 23% last quarter, up from 21% in Q3 of last year. Management forecast another 50 basis points of margin expansion in 2020 despite expectations of losing a considerable amount of business from eBay over the next year.

A key piece of that profit margin expansion is Venmo is becoming less of a drag on profits. "Venmo used to have more and more money that we would have to put into Venmo each year," CEO Dan Schulman said during the company's third-quarter earnings call. "Now, instead of a drain on our margin structure, [it's a] help on our margin structure as we go forward. And I would expect that to continue to happen."

Venmo's $100 million in revenue in the third quarter is still tiny compared to the $4.4 billion PayPal brought in overall. The app will have a much smaller impact on the company's bottom line compared to the impact of Cash App on Square. Cash App accounted for nearly one-quarter of Square's adjusted revenue in the second quarter.

But the relatively small size of Venmo compared to its parent company gives it an opportunity to be more patient with monetization and keep growing payment volume and engagement. Ultimately, that could present a bigger opportunity in the long term. It's hard not to make direct comparisons between Venmo and Cash App in the present, though.