PayPal are criminals and it's only because of stuff like this they are so powerful.
You only make it big in the corporate world if you know how to be an a-hole.
Ignore their flimsy email full of baseless threats and keep the damn domain.
They can't demand that you simply let the domain expire, don't be scared of them.
Ignore them.
Best thing to do.
Please don't do either of these, you are opening yourself up to liability.