Internet person-to-person payments (P2P), aka email payments, has been a hotbed of activity in the three months since we first reported on the sector. The combined growth in the user bases of the two biggest players, PayPal and X.com¹, has been more than 6,000 accounts per day since launch. To put that in perspective, the entire US online banking user base across all financial institutions, has grown about 9,000 users per day during the past two years. Another way to look at it: PayPal gets as many accounts in one day as Net banking pioneer SFNB got in its first three years! ¹Disclosure: OBR Editor, Jim Bruene, had a minor consulting role in X.com’s initial product planning in mid-1999.  To recap some of the numbers:

•  300,000+ users signed on with PayPal in the 100 days from its mid-Nov launch, a success chronicled in a Wall Street Journal Marketplace section cover story (2/16/00,
  p. B-1; includes a quote from OBR).
•  PayPal and X.com, which announced a merger on Mar. 2, 2000, are each adding 10,000 new users per day, and already have a combined user base of more than 600,000.
•  During Feb., X.com had more Web traffic than any other bank according to PC Data. Its 1.8 million unique visitors was 500,000 more than second place Wellsfargo.com, and more than third place Citibank.com (850,000) and fourth place Bankamerica.com (829,000) combined.
•  X.com, with more than 250,000 accounts, is now the largest Internet-only bank measured by number of accounts.
•  Nearly 8% (307,000) of the 4 million auction lots on eBay now feature PayPal or X.com payment options, with growth of more than 10,000 lots per day .

Since our Nov. 29 report four new P2P companies have launched: dotbank.com on Dec. 7; X.com on Dec. 15; Mambo.com, concentrating on the “event/fundraising payments” niche, on Jan. 19; and PayMe.com from idealab. In addition, Wells Fargo got into the game, purchasing a 35% stake in eBay’s P2P unit, BillPoint. Finally, X.com partnered with AuctionWatch for auction payments and agreed to merge with PayPal March 2.

PayPal banners run free-of-charge on thousands of auction pages .

We predicted P2P payments would be popular, but we didn’t expect it to be this fast. There are five reasons for the hypergrowth:

•  Liberal new account bonuses of $20, split 50-50 between the new account holder and the person that made the referral. PayPal users can earn up to $1,000 in referral fees.
•  New users can sign-up and use it in just minutes.
•  It completely reengineers the ecommerce sales cycle for smaller merchants and individual sellers lacking access to the Visa/MasterCard system, especially at online auctions. Compared to mailing paper checks and waiting for the check to clear, auction participants using PayPal can slash the turn-time from winning bid to shipment, from two or three weeks to just a day or less.
•  Competition: X.com and PayPal are subsidizing the hyper-growth with millions of venture capital dollars. PayPal landed more cash from idealab and Goldman Sachs in February, then merged with X.com on Mar. 2. The IPO can’t be too far away.
•  It’s free.

We are still waiting to hear how the credit card associations will react to this interesting application of their merchant rules. Essentially, anyone in the U.S. with a valid (or stolen) credit card number and postal address can immediately begin accepting credit cards without the hassle of applying for a merchant account, paying discount fees, and following credit card association rules including chargebacks.

Other developments at PayPal:

• Launched a “bill presentment” option so individuals can easily send email bills; once registered with PayPal, recipients can pay with a single click.

•  Added a Group Payments function that automatically splits a tab among numerous parties and allows it to be collected via PayPal.
•  Made it much easier to earn $10 referral fees by creating unique URLs that users can post on a Web site or email to others. The $10 bonuses have really boosted word-of-mouth advertising on eBay. Sellers don’t just casually list PayPal as a payment option, they actively sell it. We’ve seen listings where the seller uses more space praising PayPal than describing their auction item.
•  Made dozens of ease-of-use improvements including integrated email messaging, stored email addresses of past recipients, and so on.

PayPal has been adding tabs faster than Amazon.com. It seems as if every time I log in, the company has added new, useful functions. Most recently, the ability to select payee email addresses from a drop-down list of previous recipients.

From our personal experience using PayPal, there are a few rough edges behind the scenes. During the last two month we’ve had three problems:

1. In early January, it took two weeks for a colleague to withdraw funds by check. The company blamed it on lack of staffing, understandable at a company adding 10,000 accounts per day.

2. The more puzzling incident (as quoted in the Wall Street Journal, 2/16/00, p. B-1) occurred when sending two $1,000 payments to the same address within an hour of each other. Without giving us a chance to explain, our PayPal account was frozen, the transactions reversed, and we received a curt email explaining that it appeared we were attempting to take a cash advance in violation of company rules (ironically, the reason we sent two identical payments is that we wanted to make sure the first one went through before sending another).

We speculate that our account was flagged by PayPal’s audit department after sending two identical transactions within an hour; then a human assigned an incorrect code to the activity. The customer service rep would neither believe our explanation nor let us speak to a supervisor. Finally, after reluctantly playing the “reporter” card, PayPal unfroze the accounts, but told us they could not reinstate the transactions. So we repeated the payments and they went through without a hitch. All was fine until two weeks later when PayPal mysteriously, and without warning, reinstated the original transactions and we were temporarily out $2,000.

3. Finally, as we went to press, we repeatedly had a $10 transaction “declined by our credit card company” even though we were able to charge a $1,000 PayPal transaction to the same card in between denials of the $10 transaction. We haven’t figured that one out yet.

Newcomer X.com had similar growing pains, but unfortunately its dirty laundry was aired in the New York Times. During its first month in business, the company’s procedures for authenticating new accounts set up for user-initiated ACH credit transactions apparently were a bit lax. (ACH credit transactions are used to electronically transfer funds from an account at another bank into an X.com account.)

Here is how the problem was described in the
Jan. 28, 2000 New York Times article by celebrated tech columnist John Markoff www.nytimes.com/library/tech/00/01/biztech/articles/28secure.html

In what may prove to be a cautionary tale about the headlong rush into electronic commerce, (X.com) permitted customers for almost a month to transfer funds (out of anyone’s) account in the nation’s banking system.

Markoff reported that at least one person successfully defrauded an account in this manner. However, X.com CEO, William Harris, said that only five to 10 transfers among thousands handled by X.com were “problematic.” The processing flaw was quickly corrected after it was brought to light, but it was in place for about a month.

What the article fails to point out is that this was not a new “security hole,” but simply a thief exploiting a known weakness in the ACH system that could have been perpetrated at dozens of places online. We contacted NACHA for comment, but they weren’t willing to discuss the specifics of the X.com case, other than to reiterate NACHA’s policy that it is up to the initiating financial institution to authenticate transactions and that we could “draw our own conclusions.” I believe that is called “damning with faint praise.” In any event, the mini-fiasco doesn’t seem to have slowed X.com, which hit 250,000 customers by Mar. 1.