Article – How PayPal works
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Then create a list of questions and answers for that article.
Questions
1.
What is PayPal?
2.
What are the basic idea of PayPal?
3.
How many people have a PayPal account?
4.
Is PayPal free?
5.
What happens to the money when you send it to another PayPal account?
6.
Who created PayPal and what year?
7.
What is PayPal’s first name?
8.
In 2002, who bought PayPal?
9.
How many types of PayPal account are there?
10.
What are PayPal’s core features that every account has?
11.
What are the extra features in the business and premier accounts?
12.
How many percent of eBay sellers use PayPal as an option?
13.
Do you need a PayPal account for your friend to send you money?
14.
What currencies do PayPal accept?
15.
What is the two problems with PayPal?
16.
What are some complaints about PayPal?
How PayPal Works
by Ed Grabianowski
Browse the article How PayPal Works
Introduction to How PayPal Works
The simple idea behind PayPal -- using
encryption software to allow people to make
financial transfers between computers -- has
turned into one of the world's primary methods of online payment. Despite
its occasionally troubled history, including fraud, lawsuits and zealous
government regulators, PayPal now boasts more than 100 million accounts
worldwide [ref].
In this article, we'll show you how to use PayPal, find out how the
transactions are made, and learn something about the company's history.
We'll also examine some of the complaints about PayPal's business
practices. Let's start with the basics.
PayPal is an online payment service that allows individuals and businesses
to transfer funds electronically. You can use it to pay for online auctions,
purchase goods and services, or to make donations. You can even use it to
send cash to someone.
A basic PayPal account is free. You can send funds to anyone with an email address, whether or not they have a PayPal account. They'll get a
message from PayPal about the funds, and then they just have to sign up
for their own account.
Funds transferred via PayPal reside in a PayPal account until the holder of
the funds retrieves them or spends them. If the user has entered and
verified their bank account information, then the funds can be transferred
directly into their account. Other ways to withdraw your funds are listed
below:
Methods of withdrawing funds from a PayPal
account
Signing Up for PayPal
Signing up for PayPal is quick and doesn't even require you to enter any
bank account information, although a checking account or credit card is
required to use many of PayPal's features. From the PayPal homepage,
just click on the "Sign Up Now" button. At the next page, you'll choose
whether you want a personal, business or premier account. If you just plan
to use PayPal for the occasional eBay auction or online purchase, a
personal account is the right choice. If you intend to use PayPal to accept
payments for your own business, then a business or premier account would
be more suitable. If you select a personal account, you can upgrade in the
future.
Click on "Sign Up Now" to set up a PayPal
account.
From there, you will go to a page that asks for your basic personal
information -- your name, address, telephone number and e-mail address.
You will also be required to enter two security questions in case you lose
your password, and you have to enter a randomly generated series of
letters and numbers, which help prevent fraud. Once you confirm your
account by following instructions you'll receive via e-mail, the sign-up
process is done.
Adding a valid, current credit card to your account will allow PayPal to
confirm your address (if it matches where you receive your credit card
statements). Having a confirmed address shows both buyers and sellers
that you are less likely to be a scammer. You can also use your credit card
for PayPal's Expanded Use service, which allows you to draw money from
the credit card, instead of just from a bank account.
Get verified to move funds between your
bank account and your PayPal account.
If you want to add funds to your PayPal account from your checking
account, or vice versa, you need to enter and verify your bank account with
PayPal. When you enter your account number and routing number, PayPal
will make two micropayments to that account. These payments are usually
about 5 cents. PayPal will then ask you to enter those amounts in order to
verify the account (they'll show up on your bank statement). After you enter
them, your bank account will be ready for use.
PayPal Infrastructure
PayPal doesn't fundamentally change the way merchants interact with
banks and credit card companies. It just acts as a middleman. Credit and
debit card transactions travel on different networks. When a merchant
accepts a charge from a card, the merchant pays an interchange, which is
a small fee of about ten cents plus approximately 2 percent. The
interchange is made up of a variety of small fees paid to all the different
companies that have a part in the transaction -- the merchant's bank, the
credit card association and the company that issued the card [ref]. If
someone pays by check, a different network is used, one that costs the
merchant less but moves more slowly.
What part does PayPal play in all this? Both buyer and seller deal with
PayPal, having already provided their bank account or credit card
information. PayPal, in turn, handles all the transactions with various banks
and credit card companies, and pays the interchange. They make this back
on the fees they charge for receiving money, as well as the interest they
collect on money left in PayPal accounts.
PayPal touts its presence as an extra layer as a security feature, because
everyone's information, including credit card numbers, bank account
numbers and address, stays with PayPal. With other online transactions,
that information is transmitted from the buyer to the merchant to the credit
card processor.
PayPal also offers a $5 PayPal Security Key -- a portable device that
creates a six-digit code every 30 seconds. The user links this key to his or
her eBay or PayPal account. The six-digit code is used in conjunction with
the user ID and password to create a unique security code [source:
PayPal].
All the money held in PayPal accounts is placed into one or more bank
accounts, where PayPal collects interest. Account holders do not receive
any of the interest gained on their money. Some PayPal critics claim that
one of the reasons PayPal locks accounts and puts people through a long,
frustrating appeal process is so they can keep the funds in the bank longer
to collect more interest.
Security
After a series of scams, PayPal formulated a
plan to prevent criminals from using computer
programs to open dozens of fraudulent accounts
with stolen credit card numbers. This system,
known as the "Gausebeck-Levchin" test, is now
widely used by thousands of Web sites [ref]. It
requires new account creators to type in a word
found in a small image file on the account
creation page. A script or a bot can't read this
word -- only a human can decipher it.
The Gausebeck-Levchin test on PayPal: The
sight-impaired (who use text-based Web
browsers) can listen to a recording of the
letters instead.
PayPal also uses special programs to detect
potentially fraudulent activity. These programs
watch for certain red flags that might be a sign of
fraud. These red flags include sudden increases
in volume or quantity of transfers, denied credit
card charges or invalid IP addresses.
PayPal History
Peter Thiel and Max Levchin founded PayPal in 1999 under the name
Confinity. The idealistic vision of the company was one of a borderless
currency free from governmental controls. However, PayPal's success
quickly drew the attention of hackers, scam artists and organized crime
groups, who used the service for frauds and money laundering. New
security measures stemmed the tide of fraud and customer complaints, but
government officials soon stepped in. Regulators and attorney generals in
several states, including New York and California, fined PayPal for
violations and investigated the company's business practices. Some states,
such as Louisiana, banned PayPal from operating in their states altogether.
PayPal has since received licenses that allow them to operate in these
places.
PayPal's Auction Tools page for eBay sellers.
Despite the initial turmoil, PayPal's market share continued to grow. At first
PayPal offered new users $10 to join, plus bonuses for referring friends.
The service grew so quickly that it soon became the default online payment
service. Buyers wanted to use it since so many merchants accepted it, and
merchants accepted it because so many buyers were using it. PayPal owes
much of its initial growth to eBay users who used the service to pay for
items and accept payments for their online auctions. PayPal even beat
eBay at the online payment business, trumping eBay's in-house payment
system Billpoint so thoroughly that in 2002, eBay bought PayPal. Then it
phased out Billpoint and integrated PayPal into its services. Sellers with
PayPal accounts can place icons in their auctions and buyers can simply
click on a PayPal logo when they win an auction to make an immediate
payment.
In early 2002, PayPal held its IPO, opening at $15.41 per share and closing
the day's trading above the $20 mark [ref]. eBay purchased PayPal that
same year for $1.4 billion in stock [ref]. Recently, eBay spent another $370
million to buy out another PayPal competitor, VeriSign.
PayPal Account Types
The three PayPal account types differ in some important ways. All have
access to PayPal's core features, which include:
 Send Money
 Request Money
 Auction Tools
 Website Payments
 Money Market
 Virtual Debit Card
 Account Insurance
 E-mail Customer service
Personal accounts give you access to the core features, but that's all.
Customer support is mostly via e-mail. There is a phone number available,
but it is not toll-free and it sends users to a low-priority line with long wait
times. There are no transaction fees for personal accounts, though there
are fees for some other features, such as currency exchange. Personal
accounts are also subject to volume limits of $500 per month. If you receive
more than that, you will need to upgrade to a Premier or Business account
(or deny the transfer that would have put you over the limit).
PayPal account types
Premier and Business accounts are almost the same. The main difference
is that a Business account must be registered with a business or group
name, while a Premier account can be registered with a business, group or
individual. Business accounts can also be set up for multiple users.
Business and Premier accounts allow access to all of the core features,
plus the ability to accept:
 Unlimited Credit Card Payments
 Payment Receiving Preferences
 Subscriptions
 ATM/Debit Card
 Mass Payments
Business and Premier Accounts also get a toll-free customer service
number and extended customer service hours.
These extra features come at the cost of transaction fees. Sending money
is still free, but 2.9 percent is charged for funds received. Extremely highvolume accounts get a break -- after $3,000 has been received in a month,
the percentage drops to 2.5 percent. Above $10,000, it goes to 2.2 percent,
and money in excess of $100,000 received in a single month is only
charged at 1.9 percent. In addition, all transactions in which money is
received, regardless of volume, have a $0.30 fee added.
Sending Limits
One confusing part of PayPal is the sending
limit that they place on new accounts. These
limits are typically $2,000 for new users, but
sometimes users outside of the United States
can't use the account to send money at all until
they go through a verification process that lifts
the limit. It's a lifetime limit -- once you hit that
level, you can no longer send until you verify
the account. However, the limits aren't
consistent and some transactions don't count
towards the limit. PayPal's user agreement
does not make clear when or why the limits
change, or what charges don't count towards
the limit.
Using PayPal: Sending Funds
More than 70 percent of all eBay sellers offer PayPal as a payment option,
and a large chunk of PayPal's business still comes from online auctions
[ref]. However, one of the keys to PayPal's success has been its ability to
expand beyond the eBay market. You can use it send money to a friend,
donate to a charity and buy items from online merchants.
Sending money via PayPal is simple.
If you want to donate to a charity using PayPal, the process is just like
sending money to anyone else. You need the charity's email address, or
they might have a button on their website that allows you to make a
donation directly. The main difference lies in the "Category of Purchase"
entry on the PayPal payment page. Technically, this would be a quasi-cash
transaction. However, such a transaction could be subject to fees,
depending on the source of the money -- if you draw your PayPal funds
from a credit card, you might be charged cash advance fees. You can just
as easily select "Service" as the category, and the donation will work with
no problems or fees.
The PayPal Shops page includes online merchants
that accept PayPal.
You can use PayPal to purchase goods from non-eBay merchants who
have set up a PayPal storefront. Once you've selected your items, go to the
Web site's checkout page. You will have the option of selecting a credit
card or PayPal to pay for your purchase. Selecting PayPal may send you to
a login page for your PayPal account. There you can transfer the
appropriate amount to the merchant, who will then complete the sale.
Some merchants integrate PayPal into the Web site, meaning that you put
your PayPal information directly into their site.
Just click on the PayPal button to use it as a
payment method.
If a Web site only accepts credit cards, you can still use funds in your
PayPal account to make a purchase. PayPal users can use the "PayPal
Debit Bar" to get a virtual MasterCard number. You can use that card
number with any merchant who accepts MasterCard, and the funds will be
deducted from the PayPal account. This service is free.
For example, you might want to use your PayPal account to buy something
from Amazon.com. However, Amazon doesn't accept PayPal as a payment
method. You can activate the Debit Bar from within your PayPal account.
Assuming you are carrying enough of a balance in your account to cover
the purchase, PayPal will give you a 16-digit number, just like a credit card
number. Then you will select MasterCard as your payment method from
Amazon's payment page and enter the Debit Bar number.
Using PayPal: Receiving Funds
Merchants who want to use PayPal to accept payments have a wide range
of options available. For basic payments, such as online auctions or simple
Web site sales, the merchant can simply provide buyers with their e-mail
address, and buyers can make the appropriate payments to the merchant's
PayPal account. eBay sellers can place PayPal buttons on their auctions,
and the checkout invoice PayPal sends to auction winners will include a
link to pay via PayPal.
You can use PayPal to request money from
anyone.
PayPal also provides extensive services for online merchants. Prior to
services like PayPal, someone who wanted to accept credit card payments
online had to set up a merchant account through a credit card company.
Creating a Web interface to use this account could be confusing and
difficult. PayPal bypasses this problem. Business or Premier PayPal
accounts can set up a Buy Now button, a PayPal shopping cart, or options
for ongoing subscriptions and recurring payments.
A Buy Now button allows merchants to paste a small piece of HTML code
into their site, creating a button for buyers to click when they want to
purchase an item. This takes the buyer to a secure payment page, where
they enter their credit card information and shipping address. Once the
transaction is complete, the money, minus PayPal's fees, is transferred
directly into the merchant's account.
The PayPal shopping cart is more involved, but it has the same result.
HTML code for various buttons (add to cart, view cart) is added to lists of
items, and the item details are added by the merchant. Buyers can add the
items they want to purchase to their cart, and when they check out, they'll
go to a secure payment page, just like a Buy It Now page.
The transaction process for a Standard Merchant
account
PayPal's two main merchant account types, Standard and Pro, offer slightly
different packages. With a standard account, when a customer checks out
at the shopping cart page, they go to the PayPal site to log in and make the
payment. With a Pro account, PayPal processes the transaction in the
background -- the customer makes the entire sale on the merchant's site. A
Pro account has higher percentages on transactions (2.2 to 2.9 percent
versus 1.9 to 2.9 percent) and a $20 monthly fee. It also requires
knowledge of Web services and APIs (Application Program Interfaces), as
well as a minimum of two days for installation.
The transaction process for a Pro Merchant
account
PayPal also streamlines transactions for merchants who sell to
international users. It can convert funds to whatever currency the merchant
wants for 2.5 percent. Currently, PayPal accepts funds in the following
currencies:
 Canadian Dollar
 Euro
 Pound Sterling
 U.S. Dollar
 Yen
 Australian Dollar
Problems With PayPal
Not every PayPal user has come away satisfied
Money Market Fund
with the company's business practices. In fact, so The only way for
many people feel the company has abused them
PayPal users to make
that entire Web sites exist to discuss problems with money on their own
PayPal. The most prominent is PayPal Sucks.
funds is to apply for its
The biggest criticism of PayPal is that it acts like a money market fund.
bank, but it isn't regulated like one. This means
Unlike money market
that PayPal offers none of the protection that real accounts, money
banks offer, and it isn't required to maintain any of market funds are not
the security, customer service or dispute resolution insured by the FDIC.
services that banks provide. At the same time,
Learn more here.
PayPal holds large amounts of their customers'
money, makes millions of financial transactions, and even offers credit and
debit cards.
So why isn't it considered a bank? In 2002, the Federal Deposit Insurance
Corporation (FDIC) declared that because PayPal didn't meet the federal
definition of an entity accepting deposits as a bank, hold any physical
money, or have a bank charter, it was not a bank [ref]. In other words,
PayPal isn't a bank because it doesn't call itself a bank. As a result, most
states license PayPal as a "money service."
One of the most common problems encountered by PayPal users is the
sudden and inexplicable freezing of their accounts. If your PayPal account
is frozen, you can't add or withdraw any funds from your account, and
you're required to go through a long, complicated process to verify your
identity. Some users claim that PayPal has simply seized their funds and
never returned them.
I had my PayPal account frozen with about $50 in it in 2003. Apparently, a
change of address caused a red flag that led to the account freeze,
although I followed the proper steps for changing the address on the
account. A phone call to PayPal customer service resulted in a sudden
unfreezing of the account.
Reports by former PayPal employees indicate that this freezing and
unfreezing is arbitrary and not subject to any serious scrutiny. They also
claim that company executives look at this process as a revenue stream.
Some feel that PayPal intends to make money to cover losses due to fraud
by seizing funds from customer accounts [ref].
You can find a thorough and open-minded (if slightly outdated) examination
of various complaints against PayPal here. Other charges levied against
PayPal include:
 Lax security, despite their claims as a secure method of making
online transactions
 A long and confusing Terms of Service Agreement that tricks users
into giving up both their right to sue the company and their
protections under credit card laws
 Rude customer service representatives
 Poor hiring practices that have led to a number of scams committed
as "inside jobs"