Does anyone know about the $5 pay pal chain letter?

It's very much a scam, and NOT legal.

Here's what Paypal's website says about gifting schemes:

Multi-level Marketing, Pyramid and Matrix Programs

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You may not use PayPal to send or receive payments for any form of multi-level marketing programs (including online payment randomizers), as well as matrix, pyramid and Ponzi schemes, "get rich quick" schemes, â€œAutosurfâ€ programs, High Yield Investment Programs (HYIP), or other similar ventures.

Multi-Level Marketing
Multi-level marketing plans, also known as "network" or "matrix" marketing, include any business in which a person receives proceeds from his or her own sales of goods or services, of recruited members, or any combination thereof. Similarly, PayPal prohibits as a Multi-Level Marketing plan any business in which payouts occur at two or more levels (both by the individual who actually sold the product as well as by the person(s) "upline" that recruited the selling individual). PayPal prohibits Multi-level Marketing plans whether or not they are legal under the laws of one or more states.

Pyramid and Ponzi Schemes
Pyramid schemes, including Gifting Clubs, involve the exchange of money in relation to the process of enrolling other people into the scheme. PayPal includes in its definition of "pyramid schemes" any system in which a hierarchy is created by people joining under others who joined previously, and in which those who join make payments to those above them in the hierarchy ("upline"). Pyramid schemes are prohibited as a form of investment fraud by federal laws and by the laws of each of the fifty individual states. PayPal considers online payment randomizers to be a type of pyramid scheme because the majority of commissions are paid for recruitment of new members, and typically operate by random placement within the program.

Ponzi schemes involve a system in which existing members of a program receive payouts that are largely funded by new payments into the program. The source of these new payments into the program can either be from new members paying to join the program or from existing members contributing more money to the program.

Matrix Programs
PayPal prohibits as a "matrix program" any business model that involves the exchange of money primarily for the purpose of being added to a waiting list for a product. In these instances, the individual at the top of the list receives the product only after a set number of people have joined below him or her.

"Get Rich Quick" And Other Related Businesses
Get Rich Quick schemes include any type of self-employment, start-up businesses, or investment opportunity where the claims of profit or returns on investment are unrealistic or unsupported. By law, if a business opportunity costs $500.00 USD or more, the promoter is required to support any claims regarding earnings or profits with written documentation.

In determining whether a website or account violates our Multi-level Marketing, Pyramid and Matrix Programs Policy, PayPal will consider some or all of the following factors:

Offering commissions to recruit new members
Requiring new distributors to purchase costly inventory or "start-up kits"
Members' profits are derived from recruiting new members or from the sales of newly-recruited members ("downline"), rather than their own sales
Payouts are funded through money paid into the system by new or existing members
Money paid into the system is significantly greater than money paid out
Unrealistic or unsupported promises regarding profits/return on investment
Percentage of the companyâ€™s goods sold by non-distributor
Businesses warned against by the Better Business Bureau, state Attorney General, Federal Trade Commission (FTC), or any state or federal agency
Flow of money derived from new members predominantly moves "upline"
Preservation of the business rests on the exponential growth of new members or customers
Speculative real estate or non-development property