How PayPal Works

PayPal is headquartered in San Jose, California. PayPal

Once associated mostly with payments on the online auction site eBay, PayPal has become a widely accepted method of payment both online and off. The idea is simple: Give people the ability to accept payment online quickly and securely without having to use a credit card. Although PayPal has occasionally had trouble with fraud, lawsuits and zealous government regulators, the company now boasts over 277 million active accounts [source: PayPal].

PayPal's core business is an online payment service that allows individuals and businesses to transfer funds electronically. Here are some of the things you might use PayPal for:


  • Send or receive payments for online auctions at eBay and other Websites
  • Purchase or sell goods and services
  • Make or receive donations
  • Exchange cash with someone

You can send funds to anyone with an e-mail address, whether or not your recipient has a PayPal account. To receive the funds, though, the recipient must have a PayPal account associated with that e-mail address. Basic PayPal accounts are free, and all purchases made in the United States with the service are also free [source: PayPal]. The company charges fees for sellers, international transactions, and sending money with a credit or debit card.

If you have a PayPal account, you can add and withdraw funds in many different ways. You can associate your account with bank accounts or credit cards for more direct transactions, including adding and withdrawing money. Other withdrawal options include using a PayPal debit card to make purchases or get cash from an ATM or requesting a check in the mail.

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. Let's start with how to sign up for your own PayPal account.


How to Sign Up for PayPal

Signing up for PayPal is quick, and doesn't even require you to enter any bank account information. However, if you want to use many of PayPal's features, you'll need to add and verify a checking account or credit card. To get started, just click the "sign up" link at the top of the site's home page.

In the next window, you'll choose whether you want a personal, a business or premier account. If you just plan to use PayPal for eBay auction or other purchases, a personal account is the right choice. If you intend to use PayPal to accept payments for a business, then a business or premier account would be more suitable. If you select a personal account, you can upgrade in the future.


From there, PayPal asks for some basic personal information: your legal first and last name, address, telephone number and e-mail address. You'll also need to check the box indicating that you agree to PayPal's user agreement, privacy policy, acceptable use policy and electronic communications policy. Once you click to create your account, you'll receive an e-mail with instructions for verifying your account and confirming your address.

From here, you should know what PayPal means when it refers to this verification and confirmation process. Having your information vetted by PayPal shows both buyers and sellers that you are less likely to be a scammer.

  • A PayPal account is verified if you've associated that account with a current bank account or credit card. This is more than just entering account information. PayPal will ask you to follow certain steps to complete the verification process. For a checking account, for example, PayPal will make two micropayments to that account, usually about five cents each. Then, you'll need to enter the amounts of those micropayments as verification.
  • A PayPal account is confirmed if you've completed one of three options to signal to PayPal that the address on your account is valid. The fastest of these is to verify a bank account or credit card matching the address you've entered as the PayPal account's address. As an alternative, you can request a confirmation code by mail after you've had the account for 90 or more days, or you can apply for a PayPal MasterCard which confirms your address by running a credit check.

In the next section, we'll examine what parts make up the PayPal Website and service.


PayPal Infrastructure

PayPal's mobile app can be used just like the website. PayPal

From a buyer's perspective, PayPal changed the way people exchange money online. Behind the scenes, though, it didn't fundamentally change the way merchants interact with banks and credit card companies. PayPal just acts as a middleman.

To understand what that means, consider that credit and debit card transactions travel on several different networks. When a merchant accepts a charge from a card, that merchant pays an interchange, which is a fee of about 10 cents, plus approximately 2 percent of the transaction amount. The interchange is made up of a variety of smaller 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. If someone pays by check, a different network is used, one that costs the merchant less but moves more slowly [source: Ellis].


What part does PayPal play in all this? Both buyer and seller deal with PayPal instead of each other. Both sides have provided their bank account or credit card information to PayPal. PayPal, in turn, handles all the transactions with various banks and credit card companies, and pays the interchange.

PayPal makes its own money in two ways. The first is the fees they charge to a payment's recipients. Though most transactions are free for the average user, merchants pay a fee on transactions. PayPal also collects interest on money left in PayPal accounts. All the money held in PayPal accounts is placed into one or more interest-earning bank accounts. The account holder doesn't receive any of the interest gained on the money while it sits in a PayPal account.

PayPal touts its presence as an extra layer as a security feature. That's because everyone's information, including credit card numbers, bank account numbers and address, stays within PayPal. With other online transactions, that information is transmitted across all the networks involved in the transaction, from the buyer to the merchant to the credit card processor.

As an added layer of security, PayPal also offers a PayPal Security Key, a two-factor authentication (2FA) method that creates a temporary six-digit code when the user attempts to log in. PayPal sends the code to the user's registered phone. When entered, the code allows access to the PayPal user's account [source: PayPal].

Next, let's roll back the clock and see how PayPal came to be the biggest name in online payment services.


PayPal History

Max Levchin (L) and Peter Thiel (C) talk with TechCrunch co-editor Erick Schonfeld at TechCrunch Disrupt SF 2011 held at the San Francisco Design Center Concourse. Levchin and Thiel co-founded PayPal. Araya Diaz/Getty Images for TechCrunch

Peter Thiel and Max Levchin founded PayPal in December 1998 under the name Confinity. Operating out of Silicon Valley, the idealistic vision of the company was one of a borderless currency, free from governmental controls. When venture capital funding combined with eBay transaction partnerships, PayPal quickly shot up to 1 million users after just 15 months [source: PayPal].

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 attorneys general 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 [source: Jackson].


Despite the initial turmoil, PayPal's market share continued to grow. Initially, PayPal offered new users $10 to join, plus bonuses for referring friends. The service grew so quickly that it soon became the de-facto default online payment service. Buyers wanted to use it because so many merchants accepted it, and merchants accepted it because so many buyers were using it.

In February 2002, PayPal held its IPO, opening at $15.41 per share and closing the day's trading above the $20 mark. PayPal owes much of its initial growth to eBay users who promoted PayPal as a way to exchange money 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 October 2002, eBay bought PayPal for $1.5 billion in stock. eBay phased out Billpoint and integrated PayPal into its services. Sellers with PayPal accounts can place icons in their auctions so that buyers can simply click on the PayPal logo when they win an auction to make an immediate payment [sources: Kane, Wolverton, PayPal].

Since 2002, PayPal has remained a steady leader in providing online transaction services. It expanded its services in the United States to include such features as debit cards for its accounts. By 2019, PayPal had 277 million active users and was available in over 200 countries [source: PayPal]. This worldwide expansion has brought PayPal a little closer to Thiel's and Levchin's original idealistic vision.

In the next section, we'll learn about the different types of PayPal accounts.


PayPal Account Types

Earlier, we discovered that PayPal has three account types: personal, premier and business. All account types can send and receive money, but where PayPal appeals to individuals who want to make personal payments with security and flexibility, the company reaches out to professionals with a suite of other products, including online shopping carts, shipping assistance, and invoicing. PayPal also offers business loans to help fledgling companies get started [source: PayPal].

Besides these functions, the three accounts also share certain features and limitations. For example, if you have a verified account, you can send up to $10,000 in a single transaction, and there are generally no transaction fees for sending and receiving money between PayPal accounts. However, you'll pay a fee for something that requires a currency exchange. Unverified accounts, including those without an associated bank account or credit card, have more restrictive sending and withdraw limits.


The three PayPal account types differ in some important ways. First, personal accounts give you access to the core features, but that's all. PayPal handles customer support for personal accounts primarily by e-mail or through a virtual customer support agent at the PayPal website.

Premier and business accounts are similar, but business accounts must be registered with a business or group name, while a Premier account can be registered with a business, group or individual. Also, you can set up multiple users to access a business account.

In addition to PayPal's core functions, business and premier accounts provide these options:

  • Accepting debit and credit card payments
  • Allowing senders to set up recurring payments (subscriptions)
  • Unlimited use of a PayPal ATM/debit card

These extra features come at the cost of transaction fees, which we'll take a closer look at later.

If you're starting your own PayPal account for a business, compare the fees and services from PayPal against other credit card transaction services to determine which works best for your needs. Consider that with PayPal, most of the code you'll need to add to a website is automated for you, too. Shopping cart functions or "pay now" buttons may not be as easy to implement through other services.

Once you have your account, you're ready to send and receive money. Next, let's look at how to use PayPal for sending money.


Using PayPal: Sending Funds

Though PayPal rose to stardom via eBay, one of the keys to PayPal's success has been its ability to expand beyond that market. You can use it to send money to a friend, donate to charity and buy items online. In order to send money using your PayPal account, you'll need one of two things:

  • Funds already transferred to your PayPal account before the transaction
  • An instant transfer account, usually a checking or savings account, from which PayPal will withdraw the necessary funds to cover the transaction

From there, it's just a matter of knowing your recipient. To send money to a person, all you need is the email address associated with that person's PayPal account. For an organization or business, you can usually send money from a PayPal link at its website.


From the sender's perspective, PayPal is a free service. In fact, if you send money directly from a checking or savings account, there are never any fees involved. The one exception would be if you pay for something by taking a cash advance from your credit card. While PayPal might not charge you for this service, your credit card provider probably will.

After you send money, the record of your transaction should appear on the Activity page at If necessary, you can search that history for a specific time in the past. If you click the "details" link for a transaction, you can view all the details, including the amount, date, recipient and a unique transaction ID used by PayPal to track your transaction. If you ever dispute a transaction, customer service will use this transaction number when handling the dispute from both sides, sender and recipient.

If a website only accepts credit cards and not PayPal, you can still use funds in your PayPal account to make a purchase. To do this, you'll need to request a PayPal debit card which operates on the MasterCard network. 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 but has a daily spending limit of $3,000. That debit card can also be used at ATMs to withdraw up to $400 in cash daily from your PayPal account, and it can earn 1 percent cash back on purchases if you're enrolled for PayPal Preferred Rewards [source: PayPal].

In the next section, we'll see how both personal users and merchants can use PayPal to accept payments.


Using PayPal: Receiving Funds

PayPal-owned Venmo is very popular with millennials as it has a public feed where you can see all transactions your connections have made. PayPal

If you want to use PayPal to receive money, you have a range of options available. If you give someone the email address associated with your PayPal account, that person can send you money from their own PayPal account. If you're selling items on eBay, you can select PayPal as an option for accepting payment. If you're selling from your own store or website, there are a number of options available for completing sales transactions with PayPal, including the following:

  • Adding a PayPal "buy now" button for each item you want to sell
  • Integrating a PayPal shopping cart with your website using the PayPal application programming interface (API)
  • Accepting payments offline or off-site to process later using PayPal's Virtual Terminal

When you're signed in to PayPal, click the "merchant services" tab to see all the options available to you as a seller. Cost and availability of these services depend on which website payments type you've selected for your account. You'll have the "standard" type by default as a recipient, but you can upgrade to the "pro" type for a $30 monthly subscription fee. Merchants with a moderate to high volume of transactions each month should choose the pro type to avoid some of the fees commonly charged by other payment processing services, such as gateway and downgrade fees.


From the merchant services page, you can select the wizard tools to set up new "buy now" or "add to cart" buttons for your site. This generates code you can simply copy and paste into the HTML for your web pages. When a buyer clicks one of these buttons, your site links to a shopping cart at PayPal's site to complete the transaction. This takes the burden off you, as a seller, of managing how that online shopping cart and checkout should look and function.

For more extensive integration, including hosting a PayPal-powered shopping cart from your own site, you'll need to use the PayPal API. If you're not savvy with computer programming or website development, this is a task you'll want to delegate to someone who is.

Once you're set up to receive money, the burden is on you as the recipient to cover the transaction costs. PayPal charges its business and premier account holders a per-transaction cost of 30 cents, plus 2.9 percent of the transaction amount. PayPal also charges fees for exchanging between the currencies it accepts in international transactions. All these fees help cover PayPal's customer support and other services reserved for business and premier customers.

The last option shown above is accepting offline and off-site payments. This means you've taken the buyer's name and credit card information outside of PayPal. You can enter that information and process the transaction using PayPal's virtual terminal service. Unlike other fee-based services at PayPal, virtual terminal requires a subscription of $30 per month, or the equivalent of upgrading to a website payments pro account. The per-transaction costs mentioned above still apply in addition to this fee [source: PayPal].

As a recipient, you can remove money from your PayPal account by making a withdrawal. These are your options for making the withdrawal:

  • Transfer money to a bank account associated with your PayPal account
  • Request that PayPal mail you a paper check for a certain amount
  • Make purchases using a PayPal debit card

So far, we've covered how to send and receive money with PayPal and how PayPal accounts work. Next we'll take a closer look at the challenges PayPal has faced and the continued controversy over its business practices.


Problems With PayPal

Though PayPal does have millions of customers, not all users have had such a pleasant experience. In fact, so many people have felt slighted by PayPal that entire websites exist to discuss problems about PayPal and mock its business practices. Perhaps the most prominent is PayPal Sucks.

One of the biggest criticisms of PayPal is that it acts like a bank, but it isn't regulated like one. Critics maintain 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 that follow.


PayPal FAQ

Is a PayPal account free?
Basic PayPal accounts are free, and any purchases made in the United States with the PayPal service are also free. PayPal only charges fees for sellers, international transactions and for sending money with a credit or debit card.
How do I log into my PayPal account?
The primary method of logging into your PayPal account is through PayPal's website. You can use any web browser on your phone or computer to visit the site. Now all you have to do is enter your email address or mobile number and your password to log into your account. If an ad pops up, you'll have to click "Proceed to Account Overview" to reach your account.
Can you be scammed on PayPal?
Despite having 361 million active users and an international reputation for safety and security, PayPal has occasionally had trouble with fraud, lawsuits and zealous government regulators.
What is PayPal and how does it work?
PayPal is an online payment service that allows people and businesses to transfer funds electronically. While you can send funds to anyone with an email address without any need for them to have a PayPal account, the recipient has to have a PayPal account associated with that email address to be able to receive funds.
How do I go to my PayPal account summary?
On your PayPal account, your most recent activity appears on the "Summary" page under "Recent activity." If you want to see the complete summary of your previous transactions, you have to click the arrow next to "Recent activity" or click "Activity" at the top of the page.

Lots More Information

Related Articles

More Great Links

  • Balko, Radley. "Who killed PayPal?" Reason Magazine. August/September 2005. (Apr. 24, 2019)
  • Carnegie Mellon University (CMU). "CAPTCHA: Telling Humans and Computers Apart Automatically." (Apr. 24, 2019)
  • Ellis, Blake. "Why banks are fighting over 12 cents." CNN Money. Cable News Network. March 11, 2011. (Apr. 21, 2019)
  • Jackson, Eric M. "The PayPal Wars: Battles with eBay, the Media, the Mafia, and the Rest of Planet Earth." World Ahead Publishing, Inc. 2004.
  • Kane, Margaret. "PayPal shares make strong debut." CNET. CBS Interactive. Feb. 15, 2002. (Apr. 24, 2019)
  • PayPal. "About." (Dec. 20, 2011)
  • PayPal. "What is the PayPal Security Key?" (Apr. 21, 2019)
  • PayPal. "PayPal Fees." (Apr. 17, 2019)
  • PayPal. "Who We Are." (Apr. 22, 2019)
  • PayPal. "Purchase Protection: Transaction Monitoring." (Apr. 29, 2019)
  • PayPal Community. "PayPal Community Help Forum: Disputes and claims." (Apr. 24, 2019)
  • Wolverton, Troy. "Billpoint failure a lesson for eBay?" CNET. CBS Interactive. July 8, 2002. (Apr. 24, 2019)
  • Wolverton, Troy. "Feds: PayPal not a bank." CNET. CBS Interactive. March 12, 2002. (Apr. 24, 2019)