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PayPal, we've got a problem

If you are not from Mars, or even if you are, you've surely heard that Paypal has launched a stablecoin in partnership with Paxos (or an "E-Money Token", based on the MiCA classification).

To give you some background, Paxos was the same issuer that issued BinanceUSD (BUSD), but had to stop issuing it in February of this year, due to the SEC legal action against Binance, the largest exchange in the world.

The new token, called PYUSD, is linked to a dollar in short-term deposits or government bonds, and is issued on the Ethereum blockchain according to the ERC-20 market standard, the most widespread, interoperable and compatible with the largest number of applications.

PayPal will enable free US dollar to PYUSD conversion and balance transfer services within the app within PayPal, and will allow tokens to be sent to an external Ethereum address at no surcharge more than transaction fees charged by the network.

This transaction fees, in fact, does not depend on Paypal, and serves to remunerate the validating nodes for the work and capital employed to secure the network.

In this time of low congestion, and for most of the network's history, this transaction fees averages less than a dollar per transaction, regardless of the amount sent, and is therefore very competitive with the fees applied to traditional money transfers. An international money transfer, to give you some references, can have a strong impact in term of fees, i.e.:

up to 20% applied to payments with remittance services

up to 4% applied to credit card payments

up to 2% applied to international wire transfers

Sending via the Ethereum network, in addition to being therefore usually more convenient, is also immediately finalized (and not reversible) within a couple of minutes, while the methods mentioned above in some cases require several days for the transfer to be completed.

But if Ethereum transaction fees are now relatively cheap, this has not always been the case: in moments of maximum market euphoria, typically in moments of "bull run", the network tends to become congested and the fee market becomes like an auction: whoever pays the most has the right to write on the blockchain, the others wait.

Fig. 1 - costo medio per transazione

We therefore note that, during the first half of 2021, when many wanted to write on the Ethereum blockchain (to create and exchange NFT collections), the average commission was around $20, with peaks exceeding $50.

To date, in fact, the Ethereum network is capable of processing 20 transactions per second, far from the maximum of 24,000 transactions per second that, for example, the Visa network is capable of processing. Without getting too technical, these "limits" of distributed solutions based on Blockchain are not easily resolved unless comprimising on other points of strength that distinguish this technology: which are in summary security, immutability, resistance to censorship , openness (without national borders), the “trust-less” and decentralized nature (this is the so-called “Trilemma” of the blockchain).

If PYUSD, or even other stablecoins or e-money tokens that many institutions are planning to launch these days, really want to become the future standard of payments, they will have to solve this problem.

They are working on some solutions , but none of them at the moment seems final:

· launch the stablecoin also on other chains, the so-called "Ethereum killers" but which we would more prudently call "Ethereum companions", given that they simply offer themselves as alternatives in times of congestion or in any case at a lower cost. For example, the stablecoin Tether uses “Tron” as the second blockchain for exchange after Ethereum

· use "sidechains" which are blockchains that rely on a first level blockchain inheriting its security but which expand its functionality and performance. Examples of this type are Polygon for Ethereum or Stacks for Bitcoin.

· use direct scalability solutions, so-called "layer2", which rely on "layer1" to inherit its security, but expand its scalability and performance. Examples would be Arbitrum and Optimism for the Ethereum blockchain or Taproot Asset for the Bitcoin blockchain. If these solutions are very promising, at the moment they are still "immature" and experimental

· launch a proprietary “layer2”, as Coinbase did with the launch of “Base”. If in this case a security compromise is necessary based on the fact that it would be necessary to place trust in the administrator of this "layer2", one could reply that those who invest their funds in PYUSD have already placed their trust in Paypal in any case.

Therefore, dear PayPal, if your project is successful, and we are sure that it has what it takes to succed, it will have to face the problem of scalability of the Ethereum network, better sooner than later, otherwise it could turn out to be a boomerang that backfires against.

Our advice is to create your own proprietary Layer 2, on which to run your PYUSD and other third-party stablecoins, without precluding the possibility of creating DeFi pools to exchange this stablecoin with other tokens, even from other networks.

The Diaman Partners Research Team

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