How PayPal Works

PayPal History
Peter Thiel (pictured here) and Max Levchin founded Confinity in 1998 which became the foundation for PayPal.
Peter Thiel (pictured here) and Max Levchin founded Confinity in 1998 which became the foundation for PayPal.
Araya Diaz/Getty Images

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 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.

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 $1.4 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 the account. By the end of 2011, PayPal was available in over 100 markets for transactions in 25 international currencies. This worldwide expansion has brought PayPal a little closer to that original idealistic vision from Thiel and Levchin [source: PayPal].

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