• by Mark Walsh  @markfwal, February 18, 2010

It looks like Facebook hasn't turned into a "PayPal killer" just yet. The two companies Thursday announced a partnership in which PayPal will become one of the ways to pay for items in certain games and applications on Facebook and marketers can pay for ads on the social network.

Under the deal, PayPal will be added as a payment option for Facebook Credits, the virtual currency created by Facebook allowing people to buy virtual goods in its online gift shop as well as in third-party games and apps on the site. Existing payment methods for Facebook Credits include credit cards and via mobile phone.

Developers can already include PayPal as a payment option in third-party applications on Facebook, but the new arrangement marks a more direct business relationship between the biggest online payments service and the largest social network.

Advertisers will also be able to use PayPal to purchase Facebook advertising through the company's self-serve advertising system. "We want to give the people who use Facebook, as well as advertisers and developers, a fast and trusted way to pay across our service," said Dan Levy, director of payment operations, Facebook, in a statement.

He also stated: "As our business has grown, offering local methods of payment has become increasingly important for advertisers who want to buy Facebook Ads. Teaming with PayPal, a global leader in online payments, makes this possible."

As one of the largest online payment services, eBay-owned PayPal boasts 81 million users, operates in 190 markets worldwide and receives money in 24 currencies. It handled $71 billion in transactions in 2009.

The blog Inside Facebook called the partnership an important step for both companies. "Ultimately, this should definitely lead to smoother payments for Facebook advertisers and Credits buyers, and nice incremental revenue for PayPal," noted editor Justin Smith.

There has been much speculation in the last year or so about Facebook developing its own PayPal-killing payment service to monetize not just its own platform but sites across the wider Web via Facebook Connect. The alliance with PayPal appears to dampen projections that Facebook would soon create a rival payment system, at least in the near-term.

"While this doesn't mean Facebook will never build out its own 'PayPal competitor,' this move does show that Facebook is prioritizing the growth of dollars flowing into its virtual currency and advertising platforms before building out more of the payments layer itself," wrote Smith. In a study released last year, Inside Facebook projected the virtual goods economy would hit $1.6 billion in 2010, up from $1 billion last year.

Others also applauded the deal. In a research note, JPMorgan analyst Imran Khan said the firm estimated social games generated $500 million in revenue last year, and that sales of virtual goods and premium services are a key part of the sales model -- "one which we think has been constrained by the shortage of straightforward payment options."

He also noted that because of new legislation requiring anyone under 21 to have a co-signer to get a credit card, its presence on Facebook would give PayPal a valuable way to reach the college-age set. People ages 18-25 make up the largest share of Facebook users, at almost 30%, while those 13-17 account for 11%.