some random thoughts on all this -
visa and mastercard have had some weird issues working with adult. a few u.s. banks allow it, but not many, and there are always new and sometimes incomprehensible rules being made regarding processing for erotic sites and material. but it's not impossible that banks are one of paypal's concerns, not just orchestrating morality. mind, i have NO idea if it's true - i'm just saying it's possible.
paypal also has to please large numbers of large clients, many of whom are far from erotic-friendly. they may be concerned that very edgy fiction about acts that are illegal may cause some of their clients to not only stop using paypal, but to raise a lot of noise. i notice those who favor censorship do seem to be quite good at making lots of public complaints very loudly.
while smashwords could indeed find other processing, merchant accounts take time to get, can cost quite a bit to set up, won't pay your authors and a bank may have just as much objection to edgy content as paypal has. it can take far longer to get paid by your bank - long enough to put some small businesses under. and many people are very comfortable using paypal. it's fast, it's easy, it seems more secure. a lot of the people who license ebooks at smashwords are used to using it.
there are some third party billers and a few smaller companies with paypal like payment systems. but they're not as large as paypal, and the larger ones won't process for adult.
i like buying books at smashwords, and i can't imagine what a huge job it would be to move processing for every book to another system. nightmarish wouldn't even begin to cover it. then all the time spent on an alternate payment method to authors. seems like smashwords would need to pay new staff to do all this work, and that costs money.
i absolutely do not believe that anyone should decide what another other adult should say or read, but i would be surprised if smashwords has the resources to deal, easily or maybe at all, with all that would be involved in moving to a new processor, plus there's be the loss of sales from people who use paypal.
by not buying from smashwords as a result of this, we have the power to harm smashwords as a business plus all the independent authors who sell their work there. i doubt that it will hurt paypal much, however.
btw, there was a woman a couple years ago who i read about in the news. she wrote a what i've been told (i didn't read it) a bdsm story involving a baby, and pled guilty of obscenity.
http://www.post-gazette.com/pg/08220/902556-100.stm
the written word is not always safe from legal prosecution. while people use the word "obscene" to mean sexually explicit material, obscenity is actually a crime - often quite a big one. it has a very iffy definition "patently offensive by contemporary community standards" and it's not just a crime in the u.s., btw.
wow, my rant went on for longer than i expected - even though i shortened it!