The firm iZettle was founded in Sweden, providing credit card readers to small businesses.
The company has a presence in 11 countries and offers other services for small businesses such as lending.
IZettle has almost half a million merchants on its platform and expects to generate gross revenues of $165m (£122m) in 2018, processing total payments of around $6bn (£4.4bn).
PayPal chief executive Dan Schulman said, "Small businesses are the engine of the global economy and we are continuing to expand our platform to help them compete and win online, in-store and via mobile".
Amanda Miller, a representative of Paypal confirmed company's biggest takeover since its birth.
The deal will enable PayPal to expand its presence in in-store payments globally, and will mark the largest-ever acquisition by the United States fintech giant, Reuters reports. It would be the largest ever deal for PayPal, Bloomberg reported. While it may raise some questions around the ambitions of European technology startups, given that iZettle had recently revealed its intentions to go public, it also revealed how eager PayPal is to boost its brick-and-mortar aspirations in Europe. The deal will give PayPal a bigger footprint in hundreds of thousands of stores, and bring it in even more direct competition with Square. The company expects to generate gross revenues of around $165m this year, with approximately $6bn of total payment volume expected to be processed on its platform. Since Paypal now does not have a strong offline presence in these markets, it will look to leverage on iZettle to penetrate into these markets.
PayPal bought out mobile payments startup Paydiant for $280 million in 2015, and it continues to operate as a PayPal unit under its own brand today.