August 28, 2005

The Rise and Absorption of Paypal - a lesson for offshore

Over on Cato, there is an article bemoaning the fate of Paypal:

The company would no longer permit customers to use the service for purchases associated with "mature audiences," gambling, hate paraphernalia, or prescription drugs, along with a long list of other prohibitions. It would also fine its customers up to $500 for attempting such transactions. Those terms apparently applied to donations to blogs with content PayPal found objectionable.

That's a far cry from the libertarian vision founders Peter Thiel and Max Levchin originally had for PayPal, an online payment service that enables account holders to send money to anyone in the world with an e-mail address. Thiel and Levchin had hoped PayPal would grow to become an extra-governmental system of currency, something reminiscent of the world described in Neal Stephenson's novel Cryptonomicon, in which programmers use encryption to create an offshore data haven free from government control.

What follows in that article is mostly a review of The Paypal Wars, by Eric M. Jackson. I've not read it, but can offer my opinions: Paypal should have failed a dozen times over, and the book seems to agree. The fact that they survived is good testament to their persistence; hundreds if not thousands of their competitors failed in these and similar ways.

The book also reads as testimony to the offshore theory of early digital money pundits. Back in the mid 90s when we were building these things, the wiser voices amongst us realised that we should go offshore, not for any conceivable tax benefits, but for the simplicity of regulation and the cost savings in reduction in 'enemies' to use the Paypal meme.

Offshore is like that - it has a higher startup cost in capital because everything is more expensive there. But if you are to succeed, then it quickly becomes more effective, simply because there are far fewer external problems to deal with. It makes a difference when the jurisidiction is small: not only are the regulators somewhat limited in pandering to whoever has their ear, but you can also meet the entire team around a small coffee table.

So what about the payment systems that did go offshore? Primarily this would be the gold units (or, these are the ones I know well). e-gold, the leader in transactional volume, branched offshore in late 2000, splitting into e-gold Ltd as the issuance company in the Caribbean and G&SR as the trading company in mainland USA. In practical effect, e-gold then contracted all operations back to G&SR so the physical move was not of great import, but the jurisdictional move was quite significant.

It worked out quite well, notwithstanding the frequent criticism. Considering always that the market of choice was mostly the US and the major market maker was a monopoly provider there, this move created just enough of a jurisdictional separation to establish a suitable distance between the 'enemies' and the operators; there always remains a possibility that if an enemy pushes too hard then the stuff will really move offshore.

In a similar timeframe, goldmoney started up and is now the leader by value under management. It had a more fullsome offshore arrangement, including a more or less complete range of 5PM governance partners. An early decision to place itself in the heavy jurisdiction of Jersey put goldmoney under the beady eye of the regulators there, which I would count as a mistake. For this benefit of brand name offshore finance center, it had to adopt a very stringent due diligence regime that slowed spread down dramatically. As the DD was regrettably far more severe than a mainland USA bank or that of any other operator, this placed its survival in doubt in the critical years 2-4.

However, goldmoney may have overcame this deadweight drag by coupling up with Kitco, and now something like 80% of sales go through that US coins and bullion seller. Does the DD still slow them down? Yes, and in spades, but it would seem that the Kitco channel is so strong that it has overcome these difficulties.

What then to conclude for new operators? Doing the partial offshore thing seems like a good compromise. It's not a completely safe choice, as even e-gold faced many life threatening challenges (and, finding good offshore advice is like asking Don Juan to chaperone your daughters). But if you can appreciate the statistics of the Paypal story then it still makes sense to consider.

And, as a side note, the Financial Cryptography conference returns to Anguilla, our spiritual home for the 10th edition in 2006. Back in 1997 it seemed that Anguilla had a chance of being somewhere special, but two things killed the excitement that the conference generated: lack of any real net (Cable and Wireless had/has a death grip on Anguilla, say no more ...) and the dramatic difficulties in importing financial cryptographers past the normal anti-immigration policies (common around the world) meant that no serious operation could take root. (Addendum: Pelle also comments in general.)

I calculated that the interest generated would have naturally led to about 100 FCers by 2000 and created a very welcome third sector for the island, but for those factors; at one stage we were seeing serious plans for half a dozen FCers every month. Only a few brave fools were stupid enough to ship in, in spite of the two big barriers, and by about 2002 they were all gone.

Posted by iang at August 28, 2005 08:36 AM | TrackBack
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