Cryptocurrencies, besides being used mostly for speculative purposes, also have a promising real-world use cases via something called decentralized finance, or DeFi. And there is a ton of excitement among the crypto community regarding this potentially game-changing technology.
Crypto enthusiasts hope that DeFi can change the structure of the financial services industry. The electronic payments industry, in particular, is dominated by large organizations, such as PayPal (PYPL -1.56%), which make their money by charging transaction fees on the payments that run through their networks. DeFi is aiming to eliminate these expensive intermediaries.
PayPal, with trailing 12-month revenue of $25.4 billion and a market capitalization of $144 billion, certainly has the scale to try and defend itself from the growing popularity of DeFi protocols. Nonetheless, its management should at least appreciate the competitive threat.
An overview of decentralized finance
DeFi provides basic financial services, like borrowing, saving, lending, and spending money, in a peer-to-peer manner. This means there is no company between you and the party on the other end of the transaction. Enabled by self-executing smart contracts, like the ones that run on the Ethereum network, DeFi promises to provide users with more accessibility, better interest rates, and extremely low fees.
Aave and Compound are two popular protocols that allow users to deposit crypto and immediately begin earning interest daily on their balances. Additionally, users can borrow against their collateral at more favorable rates compared to what traditional banks offer.
A more direct threat to PayPal is Solana Pay, an exciting new development in digital payments. Solana Pay lets consumers and merchants transact with each other directly using SOL, the native token on the Solana blockchain, with instant settlement times and essentially no transaction fees, all from a QR code. The money that merchants now hand over to payments providers, in the neighborhood of 2% to 3% of each transaction, can trickle down to their own bottom line instead.
It's not difficult to see how this can disrupt PayPal's entire business model.
PayPal has a dominant position in digital payments
While DeFi is definitely an interesting, exciting trend for investors to keep an eye on, it's not even close to being mainstream. For starters, there is minimal user protection. For example, if the Solana network gets hacked, funds are stolen, and someone uses your wallet to make transactions at various merchants, it would be extremely challenging to try and get your money back. PayPal, on the other hand, lets its customers file disputes for unrecognized charges to their accounts.
What's more, PayPal is ubiquitous. It is accepted at 76% of the top 1,500 online retailers in North America and Europe. And the seamless user experience, with an elegant mobile application, is what makes it popular among customers, an issue that crypto has so far struggled to solve.
As mentioned, PayPal is a major force in the world of electronic payments. In 2021, the business processed a whopping $1.25 trillion in total payment volume (TPV). Management expects to handle $1.5 trillion in TPV this year. And as of Dec. 31, the company counted 426 million active accounts.
For the time being, it appears as though PayPal's dominant market position in the digital payments space is safe from being disrupted. Having a brand that is globally recognized for safety, ease of use, and ubiquity should keep the business protected from the growing threat of cryptocurrencies and DeFi, at least for now.