It's estimated that up to 200 million consumers worldwide have transacted with Bitcoin (CRYPTO:BTC) in some way. As Bitcoin and other digital coins become more popular alternatives to holding cash, it's imperative for PayPal Holdings (NASDAQ:PYPL) to offer its more than 400 million active customers a means for transacting with Bitcoin, especially if it wants to keep up with the competition. 

Through the first half of 2021, Square's (NYSE:SQ) Cash App was downloaded at almost twice the rate of PayPal's Venmo. Furthermore, Square first offered its users the ability to buy Bitcoin four years ago.

A small flag with the Bitcoin logo stuck into a hundred-dollar bill.

Image source: Getty Images.

Toward the end of 2020, PayPal finally jumped on board the crypto train and offered the ability to buy, sell, and hold cryptocurrencies, including Bitcoin, Ethereum, Litecoin, and Bitcoin Cash. It followed up on that move by launching crypto in the Venmo peer-to-peer payment app in April. 

While crypto transactions are likely not impacting PayPal's profitability that much, there is clear evidence that they are meaningfully boosting user engagement, which could make the increasing popularity of Bitcoin and other digital currencies an important growth driver for PayPal.

PayPal users are engaging with the new crypto offering 

PayPal has made some major improvements to its apps this year. In addition to offering cryptocurrency, it recently overhauled the PayPal app with new shopping features, and announced other features coming soon, including a savings account and other investment capabilities. It's clear that PayPal users are taking a strong interest in the ability to buy crypto.

During the third-quarter earnings call last month, management noted that first-time users transacting with crypto in the PayPal app increased 15% compared to the old app's usage. In the second quarter, management reported "strong adoption and trading" of cryptocurrency after launching it for Venmo users in April. 

However, that's about as specific as management got with analysts on the earnings call. Unlike Square, PayPal doesn't disclose specific revenue amounts from processing fees for cryptocurrency transactions. Square said it generated $8 billion in revenue from processing Bitcoin transactions through the first nine months of 2021. But the costs to process those transactions amounted to nearly $7.9 billion, which leaves a very slim gross margin.

If PayPal's gross margin on its own Bitcoin transactions is about the same as Square's, then crypto is not impacting its bottom line that much. PayPal was already a very profitable business before offering crypto, generating $4.2 billion of net profit on $21 billion of total revenue in 2020.  

Still, the availability of cryptocurrency on PayPal's apps appears to be fueling a meaningful acceleration in how often customers are opening their apps, which is nearly as important.

Crypto brings enormous benefits to user engagement

The ability to buy Bitcoin through the PayPal and Venmo apps provides enormous benefits in attracting new users and maintaining high engagement with customers. CEO Dan Schulman said as much earlier this year during the first-quarter earnings call: "About half of our crypto users open their app every single day." 

We can see engagement across the platform continuing to march higher. The average number of transactions per active account reached a new high of 44.2 per year, representing a year-over-year increase of 10% in the third quarter. This basically means the average customer is opening the app almost once per week, but the rate of increase has accelerated significantly over the last year. This time a year ago, annual transactions per account grew just 1% year over year to 40.1.

Moreover, all the new features included in the overhauled PayPal app that launched in September are driving interest in other offerings, too. During the third-quarter earnings call, management noted that Cash Card enrollments were up 35% since launching the new app. 

Overall, I wouldn't expect cryptocurrency trading to be boosting PayPal's earnings significantly right now, but just as important, it seems to be driving engagement across the business. This way, it can fuel additional revenue and profit as users pop in to check out the cryptocurrency features but end up engaging with other services instead.

PayPal stock tanked following its third-quarter earnings report, as management's near-term guidance failed to impress. But the acceleration in engagement following PayPal's entry into the world of cryptocurrency shows why the share price will eventually bounce back, and why it's still a great investment for the long term.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.