One service, eBay’s PayPal, dominates the arena of online payment systems, a place littered with vanquished or teetering foes, from Yahoo’s PayDirect to Microsoft’s Passport. So when technology bloggers and other Internet watchers learned last week that Google’s long-awaited payment-processing system, Google Checkout, didn’t even include a person-to-person payment capability, as PayPal does, they quickly dismissed it as a minor threat to PayPal.

“Many popular news sources are hyping the future of Google Checkout as the definitive PayPal killer,” wrote Anders Bylund, a columnist for the PC news site Ars Technica. “[But] the official word all along has been that there will be no person-to-person or micropayment solution, and that Google was not intending to compete directly with PayPal. The company has delivered on its promises…eBay can put down that nuclear warhead it had planned to deploy in its defense.”

However, it may be too soon to conclude that eBay is safe from attack. Indeed, while PayPal has many functions that Google has not attempted to replicate, eBay itself is treating Google Checkout with caution. In a policy change first noticed by bloggers on July 6, the online-auction giant has gone so far as to ban sellers and affiliated merchants who let their customers use Google Checkout.

In fact, the unveiling of Google Checkout on June 29 could be a disturbing development for rival payment service providers – just as Google’s focus on Web-based productivity tools such as the Writely word processor and Google Spreadsheets has become a threat to for Microsoft. It’s possible that Google could steal much of the existing and potential market for “electronic wallet” services from PayPal, and entice millions of users to share their credit card information and shopping habits with Google and its sophisticated targeted-advertising algorithms.

In a further hit to PayPal, an influential analyst with Citigroup, Mark Mahaney, issued a report on July 6 arguing that Google Checkout is faster and easier for consumers to use than PayPal. “As we see it, this speaks volumes about Google product development skills and PayPal’s lack of innovation,” wrote Mahaney, who lowered his target stock price for eBay from $51 to $40. (Analysts and investors also reacted negatively to news on July 6 that Jeff Jordan, until recently president of eBay’s PayPal division, is leaving the company.)

For consumers, Google Checkout amounts to a place to store credit and address information online so they don’t have to re-enter it every time they buy something from a Web retailer. With a single click on the Google Checkout button located on the payment pages of participating merchants (which so far include Levi’s, Starbucks, Buy.com, Timberland, and more than 80 others), customers can authorize a credit card payment and confirm a shipping address. It’s essentially a pan-Web version of Amazon’s 1-Click ordering system – except that Google can, if customers prefer, keep personal information such as e-mail addresses and credit card numbers secret from retailers. Users can also view a history of their Google Checkout purchases and track the status of each order.

For merchants, Google Checkout is a way to attract customers – or at least that’s how Google is marketing it. Similar to the Visa, MasterCard, and American Express stickers on the doors of bricks-and-mortar retailers and restaurants, a special shopping-cart logo appears with the advertisements of companies that use Google Checkout and advertise through Google’s AdWords program. The company charges merchants a lower processing fee than many other payment service providers: $0.20 per transaction plus 2 percent of the total payment, in contrast to $0.30 plus 2.9 percent for PayPal and much higher fees at most credit card companies. And Google is sweetening the proposition by giving Google Checkout participants who also use AdWords a healthy rebate on their 2 percent processing fee; for example, $10 spent on an AdWords campaign earns a $100 rebate on Google Checkout fees.*

*Correction, 7/10/06: A previous version of this story stated that Google will give Google Checkout participants a rebate on their AdWords spending equal to ten times their Google Checkout fees. In fact, it’s the other way around: the rebate is based on Adwords spending and is applied to the merchant’s Google Checkout processing fees. Technology Review regrets the error.

That’s enough savings to cover the full cost of an AdWords campaign for some smaller merchants – which means consumers are likely to see the Google Checkout logo appear on many new websites this year. And Google’s reputation as a largely benign and trustworthy company may prompt many consumers to sign up for the service, even if it means typing in their address and credit card information one more time as part of the Google Checkout signup process.

In fact, Google Checkout comes with a virtually built-in user base. Many Google users have already entrusted personal information to one or more of the company’s numerous online services: Gmail, Google Toolbar, Google Spreadsheets, Google Notebook, Blogger (which is owned by Google), the free photo-storing service Picasa (also owned by Google), Google Calendar, and Google Desktop (for indexing the contents of a hard drive). So it would be a relatively small step to give Google a credit card number and let the company track online purchases, especially when the promised reward is simpler transactions in the future, along with tools like the purchase history and transaction tracker.

PayPal, of course, offers similar purchasing services, and also conceals buyers’ credit card information from merchants. Today, some 105 million people have PayPal accounts. It’s one of the most common methods for individuals to exchange funds person-to-person over the Internet: PayPal members can send money to anyone with an e-mail address, and the company recently introduced a system that lets cellular subscribers make PayPal payments from their phones. And, unlike Google Checkout, where the money flows only from buyers to merchants, PayPal can be used to request money and to receive charitable donations.

But PayPal has had nearly a decade in which to emerge as a payment system used everywhere on the Web – and it hasn’t. Founded in 1998, the company didn’t gain momentum until 2000, when sellers and buyers at eBay began to adopt it as a quick and largely fraud-proof alternative to credit cards, personal checks, and eBay’s own internal payment system, called Billpoint.

Today, 70 percent of all PayPal transactions are payments for items purchased on eBay. That has limited its visibility outside eBay. While numerous small Web retailers let customers pay through PayPal, few major online shopping destinations use the system.

EBay may not feel yet that PayPal is in a vulnerable position, but it’s certainly keeping tabs on Google Checkout. This week, it added Google Checkout to its list of payment services not permitted for use by eBay buyers and sellers. The company’s Accepted Payments Policy states that the company determines whether a payment service is “appropriate for the eBay marketplace” based partly on whether it provides privacy and anti-fraud protection and whether it has “a substantial historical track record of providing safe and reliable financial and/or banking related services.”

EBay spokesperson Catherine England says Google Checkout falls short on this second criterion. “As you know, Google Checkout is a week old, so there isn’t a lot of clarity as to how people will use it,” says England. “We really look for a good history and track record, so we’re holding them to the same standard that we would hold any other service. Once they’ve had some time, we’ll probably reevaluate – but there’s no way to speculate until we have more information.”