Although PayPal itself isn't an FDIC-insured bank, it does keep your funds in various FDIC-insured banks across the country (Go here to see which ones PayPal currently uses). According to PayPal, your funds are eligible for something called pass-through insurance. Basically, this means that you can recover your money even if the bank fails. This insurance does not protect you if PayPal fails, although the company claims that "your funds will also be protected from any claims of PayPal's creditors and will be returned to you even in the unlikely event of a PayPal insolvency" [source: PayPal].
Problems with PayPal
Though PayPal does have millions of seemingly satisfied customers, not all users have had such a pleasant experience. In fact, so many people have felt slighted by PayPal that entire Web sites exist to discuss problems about PayPal and mock its business practices. The most prominent is PayPal Sucks.
The biggest criticism of PayPal is that it acts like a bank, but it isn't regulated like one. This means that PayPal offers none of the protection that real banks offer, and it isn't required to maintain any of the security, customer service or dispute resolution services that banks provide. At the same time, 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 [source: Wolverton]. 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. Other complaints against PayPal include rude customer service representatives, a long and confusing User Agreement and loose hiring practices that may have led to account fraud [source: PayPal Community].
Despite these criticisms, PayPal continues to be the most popular money transfer service for online transactions. For more information on PayPal and related topics, check out the links on the next page.