The deal will provide Masterpass mobile wallet as a payment option for merchants via PayPal’s Braintree.
PayPal is expanding its partnership with Mastercard in a move expected to help the payments service become a universally accepted checkout method at stores.
The partnership follows PayPal’s similar agreement with MasterCard's rival Visa in July this year as the company looks to extend its payments network.
PayPal will allow users to select Mastercard as their default payment method to allow for quick and easy check-out.
PayPal says it will increase its presence at stores by enabling customers to use their tokenised MasterCard in their PayPal Wallet to make in-store purchases at over five million merchants globally where contactless payments are supported.
The expanded partnership will allow consumers and small businesses to instantly cash out funds held in their PayPal account to a MasterCard account.
PayPal will also receive several financial volume incentives, as it did with Visa, and MasterCard will no longer charge PayPal the digital wallet operator fee.
PayPal has also agreed to share more data with MasterCard with respect to its transactions related to MasterCard accounts.
MasterCard’s mobile wallet, MasterPass, will also be a payment option for merchants that process payments through Braintree, a PayPal company.
PayPal, which spun off from e-commerce firm eBay last year, is focusing on aggressive growth.
The company's revenue in Q2 increased over 15% to $2.65bn from last year and the volume of payments it processes surged 28% to $86.21bn.
PayPal president and CEO Dan Schulman said: “With each partnership agreement that we sign, we further expand the ubiquity and value of the PayPal brand and improve our own economics.
“Mastercard has been a trusted partner for many years. By collaborating and innovating together we will continue to help move digital payments forward and improve payment experiences for our mutual customers.”