Are they aware that Hive doesn't have paper wallets and they have to pay 3 HIVE fee for each non-custodial wallet they create for Hive?

This is their current system. They have to design a custodial solution specifically for Hive and I don't think that would work with their current wallet design.

Currently you create a crypto wallet in their app to hold your crypto and then pay for cards using those crypto. So to make Hive work with this design, they have to spend 3 HIVE for every user downloading the app and somehow derive a username from the mnemonic seed phrase. Of course this is a bad design but this is the only way I can see it working.

I personally don't think this is worth it. There are other services that provide similar non-kyc services that Hive would fit their design better.