Fintech 🧠 Food - 18th Sep 2022 - Fintech is dead; long live Fintech, Starbucks does NFTs and my take on the OCC sponsor bank drama

Hey everyone 👋, thanks for coming back to Brainfood, where I take the week's biggest events and try to get under the skin of what's happening in Fintech. If you're reading this and haven't signed up, join the 21,146 others by clicking below, and to the regular readers, thank you. 🙏

Hey Fintech Nerds 👋

The macro winds are blowing cold. That inflation data was not pretty, and the Fed now has to cause a recession and continue raising rates. We'll see this first in risky assets, which means your favorite Fintech stocks. 

This gets worse before it gets better. High costs are just the beginning.

I'm witnessing Fintech companies being much more thoughtful with cash and a solid return to fundamentals like revenue and burn rate.

That's a really good thing long-term.

Fintech is moving from its teenage phase to its young adult joining the workforce. Suddenly it has bills to pay, and the growth isn't as fast, but this is where lasting change happens.

So who is Fintech going to be?

The consumer champion? The vanquisher of the incumbents? 

What will 2022 have to offer?

Big players are entering; regulators are critical of Fintech, and incumbents have their M&A checkbooks out.

Walmart is launching a bank (finally), Starbucks is launching its NFTs, the OCC is kicking partner banks, and JPMC is acquiring more Fintech companies.

Fintech is dead; long live Fintech?

📌 PS, I wrote my "I wish everyone would stop asking me to explain the merge" summary on LinkedIn, and you can find it below if you need a good TL; DR.

🧷 The merge; explained simply. 👈

Weekly Rant 📣

Fintech is dead; long live Fintech.

This chart from Morgan Stanley is astonishing. The average P/E multiple for Fintech businesses in public markets is 3.4x. That sure puts the Fast.com's 166x revenue multiple into a sharp perspective!

The same Morgan Stanley report as the one pictured above also shows the P/E multiple also had a stat that of the 124 tech IPOs in 2021, only 15 are above their trading price. Then there's this from FT Partners:

Fintech deal velocity is close to mid-pandemic 2020 levels and may continue to slide. 

But just a year ago, that wasn't the case.

While Fintech companies were setting valuation records and the darling of the press, the banker argument went something like this:

• Consumer Fintech companies were just regulatory arbitrage, propped up by VC marketing dollars in a tech bubble. 

• The bankers offered the same products, after all, and had a much higher regulatory burden.

• When interest rates eventually rise, the good times will return.

Of course, that's a reductive oversimplification of what bankers were saying, but I spent enough time in board rooms with senior leaders to tell you it's in the ballpark.

You'd be forgiven for thinking the bankers were right on today's evidence. 

So here's my Rant in summary today:

• Was Fintech propped up? When growth is the metric, VC cash is the fuel. Fintech companies over-hired and over-marketed to gain market share.

• Is it regulatory arbitrage? The Durbin Amendment became a game changer. Fintech companies benefitted from regulatory arbitrage to bootstrap growth.

• Fintech companies do much more than consumer Neobanks. Not all Fintech is created equal, and the category winners are monsters that have changed the finance landscape. So the criticism that it’s “all regulatory arbitrage” isn’t fair and doesn’t apply outside the US.

• Are the products the same? It depends on what you mean by the word "Product." Fintech companies technically offer "the same financial products" as banks, but I have an issue with how bankers define "product."

• When you unlock an industry in the US, you unlock its capital globally. Fintech growth unlocked growth capital globally and across the entire financial services value chain.

• Will the good times for banks return? Banks are having their moment in the sun. Interest rates are rising, and banks are set to benefit, but I think they might waste it.

• But Fintech is just getting started. In this new reality, there are new opportunities.

When growth is the metric, VC cash is the fuel.

Digital Fintech companies were growing so fast that the question in 2021 was who would grab the most market share and become category lead. If you're seeing 10% MoM user growth as a founder, systems suddenly start breaking. The fix is to hire more people and invest in a scaleable platform. 

We saw this with the Robinhood outages of 2020 (which ended in lawsuits) as users rushed in to take advantage of the pandemic market volatility. A founder seeing record volume and record revenue would be tempted to hire as fast as possible to turn the revenue taps back on.

But sometimes, the fire at your feet distracts you from the dragon circling above. 

The real problems aren't always the most urgent thing.

And growth hides many sins.

Founders and (some) investors focussed much more on user growth than user profitability.

The story of Reali is an excellent example of the consequences this can have if left unchecked for too long. Reali was a broker who offered "buy before you sell" mortgages, allowing consumers to move home faster without worrying about their mortgage completion.

Sounds consumer-centric, right? 

The little banker man living rent-free in my head is screaming, "How will that ever make money? Can you imagine the risk of that in a recession?"

Better.com didn't have that offer (to my knowledge) but was also spending heavily on marketing in the pandemic-driven relocation boom and has now had to lay off hundreds of staff. Mary-Ann at TC dug up this utterly mind-blowing quote. 

Read that again.

Let it sink in.

A return to revenue as reality and cash as sanity is no bad thing.

Did VC dollars prop up some Fintech companies? 

Yes. 

The Durbin Amendment became a game changer.

Some of the earliest consumer Fintech debit cards followed a consistent pattern in the US.

1. Find a small partner bank (sub $10bn in assets) and have them "sponsor" the debit card program.

2. The sponsor bank opens FBO (for the benefit of) accounts for your Neobank or wallet customers.

3. Connect those to an issuer processor, who can help with all of the card production and connectivity to the payment rails

4. Connect all of that to your mobile app, and then have your customers complete KYC.

5. Send them a debit card and collect revenue in the form of Interchange.

Why did all of the Fintech companies work with tiny banks? 

The Durbin Amendment limited all banks with more than $10bn of assets to charge 0.05% + $0.21c for a debit card transaction. But banks with less than $10bn of assets are "Durbin exempt" and could continue to charge upwards of 1.5%.

1.5% is more than 0.05% for those of you keeping score.

One estimate calculated that large banks in the US would collectively lose $14bn in revenues annually.

And you wonder why bankers hate it.

The early Neobanks and card programs (like the Cash App debit card that now has more than 13m MAUs) used this model. Given that the small bank held much of the regulatory risk and the issuer processor had built much of the infrastructure, it also reduced the cost and time to market for a debit card program.

Most community banks weren't built to handle 100s of millions of monthly active and billions of dollars. So it's not surprising to see regulators begin to find failings in some of these smaller banks. 

Nor is it surprising that big banks have been sounding the alarm about this whole setup for a few years. 

All while building their own banking-as-a-service offerings to serve the new "embedded finance" trend, Bain suggests will see 10% of all consumer transactions by 2027.

While the biggest Fintech companies increasingly take compliance in-house (in return for a higher share of Interchange), the sponsor bank may now have hundreds of Fintech companies on their platform. The sponsor bank will be judged by their worst-performing client, not their best.

Did regulatory arbitrage help bootstrap the Fintech industry?

Yes.

But I'd say that's a positive.

Fintech companies do much more than consumer Neobanks.

If you take every customer type and every financial product, there's a Fintech company attacking that bit of the value chain. Underbanked, mass consumers, SMBs, growth companies, international corporates, and capital markets. In every product line, in every Geo.

Despite the market correction, PayPal, Block, Checkout, Adyen, and Stripe are juggernauts. BNPL is here to stay; the corporate cards and B2B sector is still white hot with growth.

Then there's a whole wave of infrastructure companies underpinning all of that. 

The entire customer lifecycle and value chain now has an army of specialist Fintech providers. Customer onboarding, UX, compliance, fraud, AML, payments, ledgers, accounting, and reg reporting. If it happens in a Fintech company, an API-first company offers it.

It's also becoming increasingly specialist. 

KYC isn't enough anymore. Take Middesk and Detected, who do KYB and onboarding specifically for business customers of a Neobank or a non-bank. 

"AML" isn't enough anymore. Knowing who your customer is, doesn't mean you'll stop them (or others) from laundering money or committing fraud. Oh, and if you're in Crypto, it gets even more complicated. So there's a slew of specialist Crypto forensics companies with $1bn+ valuations like Chainalysis, Elliptic, and TRM.

These companies wouldn't exist if there wasn't demand for their product. 

Can a market downturn continue to support all of them? Probably not.

But I'd wager we see quite a bit of M&A activity from traditional providers and big Fintech infra buying smaller to create really unique offerings.

I'd also wager that these suppliers will change the landscape much more than they already have in the coming decade.

Finance is just better now.

• Better consumer experiences. Whether that's a Fintech company or an incumbent who's upped their game. 

• Better infrastructure and APIs. Reducing time to market and improving outcomes.

But has finance changed, or is it the same old products with different distribution?

It depends on what you mean by the word "Product."

If you define what banks sell as "regulated financial products," then yes, what the Fintech companies (or companies who embed finance) do is distribute a regulated financial product slightly differently.

But.

How someone at a consumer tech company thinks about a product is markedly different from what most banks do. In fact, banks now have a thing called "digital product managers" for people who think in customer terms instead of financial product terms.

On some level, this split makes sense. Financial services regulation and infrastructure is complicated, and having someone with deep expertise there is helpful in a large enough organization. 

But my issue is one of culture.

The regulated financial product has nothing to do with solving the customer problem (or job-to-be-done). 

And that's the real insight.

If your goal is to sell more mortgages and attract more deposits, that's very different from a company that launches with "get paid early" or real-time payments as their wedge feature. Or take the corporate spend management cards, receipts that just work. 

These experiences are grounded in solving the customer problem first and monetizing second. 

Incumbents can eventually copy+paste all of these experiences and even M&A their way back into relevance. Still, there will always be space for nimble, smaller companies to solve the pain incumbents don't see.

Yes. Incumbents and Fintech companies "sell the same product," but I can wear the same shoes as Serena Williams; it doesn't make me good at tennis. 

This is a quiet but consistent existential risk for large incumbents as consumer brands. As every company becomes a Fintech company* and they build better UX than your bank for every financial product, what do you need the bank for? 

If 10% of transactions happen via embedded finance within the next 5 years, what happens in 10 or 20?

(*I reckon Angela should get a royalty cheque every time someone says that)

When you unlock an industry in the US, you unlock its capital globally.

7 out of 10 of the largest VCs by AUM are based in the USA, and 15 of the top 20. Yet during the pandemic, these investors increasingly looked to become the default global. On zoom, everyone is the same distance, and with historically large fundraises, the funds had to cast a wider net to deploy.

The whole industry benefitted from this.

Perhaps too much.

Because now, companies that were achieving 100x revenue multiples do well to be valued based on public market multiples, and Fintech's public market revenue multiples have fallen dramatically. That's a double hit.

So with the funding taps running a little drier, who steps up?

Banks are having their moment in the sun.

But the risk is they waste it.

Equity is cheap, and debt is expensive.

And banks are the major sellers of debt. As interest rates rise, banks become more profitable just by existing (Ok, it's a bit more complicated, but there's more margin to go around).

Things are rarely that simple, though. When debt gets expensive, fewer people buy debt. Already Mortgage originations are down 23% from last year, and refinancing is down more than 83%.

Higher prices = fewer customers.

If you believe every company will become a Fintech company, banks have a massive opportunity to lean into that. 

Banks have the highest compliance burden and responsibility to governments and regulators. That's something most market actors don't want. It is a strategic advantage if they can re-work their technology, processes, and operating model to support this new world.

I'm seeing moves from some of the bigger banks to do this now, and the banks that intentionally offer banking-as-a-service space are about to get hyper-competitive.

Winning in Fintech is winning at compliance and risk.

The more time you spend in Fintech, the more you realize

• Payments are easy, but the edge cases are hard

• Lending is easy; getting paid back is hard

• Getting live is easy; staying alive and regulated is hard

Greg from Sardine said something a few days ago that stuck with me.

And it's so true. Not all Fintech companies are good at compliance, but some are really good. The tools, techniques, and processes Fintech companies use today will become industry standards.

Incumbents can learn from this, and as we enter a correction, Fintech companies will increasingly focus on fraud, compliance, and risk as a key strategic advantage.

Fintech is just getting started.

We're unlikely to have long-term low inflation and interest rates soon.

 In the short term, that means MAX PAIN for Fintech and growth companies, and more importantly, it will lead to a recession that harms consumers.

But longer term, lending is now a more viable business model, and there's more revenue to go around if every company becomes a Fintech company.

So I put it to you, reader, just like how Durbin created a wave of payment card innovation. It might be possible that the rising interest rates see Fintech companies look to begin to solve the consumer and market challenges we face with lending product innovation. 

Fintech companies start at the consumer problem.

And the consumer pain is only just beginning.

The need is real, and people will suffer. That's heartbreaking.

But when entrepreneurs have new tools to work with.

That gives me hope for the future.

ST.

4 Fintech Companies 💸

1. Thematic - ETF Index building as a Service

• The Thematic platform allows the asset manager to construct an ETF, manage it, and handle compliance, distribution, and community. Thematic aims to help disruptive new asset managers and investors to build index funds to compete with the handful of funds that control 80% of the ETF market today. 

• 🤔 Asset management has been one of the hardest parts of financial services to disrupt because it is so specialist. But at the simplest level, an asset manager's core business is manufacturing funds. Blackrock, Vanguard, and State Street all do other things, too (as any large complex business does). But disruptive innovation always comes from solving the core problem in a simple and more accessible way. There is an army of smaller asset managers and fund managers who couldn't compete on cost and scale that might now be able to, and that's good for consumers and consumer Fintech apps. 

2. Fyn - Turbotax for Crypto

• Fyn allows investors and web3 projects to pull together their Crypto transactions and calculate their tax liabilities. Fyn supports output to existing accounting tools (including Turbotax) and allows wallets and exchanges to embed the tax management functionality in their offering. 

• 🤔 This is well done. There are a few "tax management for Crypto" services, but Fyn is the first I've seen focus on the DAO (and to some extent NFT) space which is becoming a tax minefield. Imagine you're the NBA or Nike; how do you report NFT secondary revenues? Or how does an NFT investment DAO write its tax position with all its partners? And in which jurisdiction does the tax apply? Just erugh. Needs solving. Nice.

3. VATkey - Crossborder Sales Tax Refund Calculator

• SMBs can connect their accounting and expenses software to VATKey, and VATKey will automatically calculate their cross-border sales tax refunds. All European businesses can re-claim any sales tax they paid suppliers from any other EU nation and tax authority, but an estimated €10bn refunds go unclaimed annually.  

• 🤔 I'm a big fan of "found money" for SMBs and growth companies. But VATKey feels like a product, not a business. VATKey charges €99 + 25% of any money they "find" for the SMBs. They connect to many accounting and expense apps, but why wouldn't those apps build or acquire this? It feels like a feature, not a product, a great feature, but maybe that's all it needs to be given their revenue model (although for them, distribution and/or marketing will then be key). 

4. Ellis - Student Immigration as a Service

• Ellis is a platform for Students immigrating to the United States to create bank accounts and get a mobile phone contract and debit card. Ellis will also be a rent co-signer and will help with government forms and tax paperwork.

• 🤔 The future of consumer experience in Fintech is wrapping around a high pain problem set completely, and Ellis is doing exactly that for international students. There are countless Fintech services now aimed at helping migrants get their first bank account, but I really like the completeness of the Ellis vision. Recognizing that filling tax or filling in government forms in a second language is part of the same problem set as getting a bank account is shaped by experience. 

Things to know 👀

1. Starbucks partners with Polygon for NFT Loyalty

Starbucks will partner with Polygon, the Eth compatible L1 (and soon L2), to buidl its web3 experience dubbed Odessy. Starbucks will give "digital loyalty stamps" as NFTs that will unlock artists' collaborations, unique events, and immersive digital experiences. Starbucks has also built a game called Odessy, in which players can complete journeys to earn further NFTs

• 🤔 This is way more thoughtful than people give it credit for. People are hating on this announcement from Starbucks because its big brand does NFTs. The involvement of artists, Starbucks history, one-off experiences, and collaboration with artists is fascinating. 

• 🤔 Starbucks has mastered loyalty. Starbucks has 24.2m active rewards users; why not build in a little game and unique experiences with artists? 

• 🤔 "Starbucks is a bank." The reality is the Starbucks app acts as a digital charge card, where each purchase rewards a user with double stars. Starbucks has roughly $1.2bn sitting on these cards today, all because they gave out extra magic stars. And you're telling me people won't play a game if there isn't some benefit in it for them? 

• 🤔 But Starbucks has been trying Crypto for years with little success. I've lost track of the number of times Starbucks launched Bitcoin payments. Starbucks also invested in a partnership with the NY Stock Exchange, Bakkt, back in 2018. But if anything, I think their persistence will pay off. 

• 🤔 NFTs are inevitable; they might just need a rebrand. Unfortunately, 99% of NFTs have been corporate cash grabs, terrible projects, and in some cases, outright scams. Brands LARPing as cool is not a good look.

2. JPMC acquiring payments Fintech Renovite

According to CNBC, JP Morgan Chase will acquire a payments startup called Renovite to "fight off threats" from Stripe and Block. Chase has been one of the largest merchant acquiring providers, but its revenue growth has stalled due to the competition. The newer competitors use payments as a wedge to build ecosystems of products around a merchant.

• 🤔 Chase has been massive in merchant payments for decades, a disadvantage when new competitors emerge. Chase Paymentech has a long history of being acquired, IPO'd merged and acquiring competitor portfolios. In short, it's a hodge-podge. When you're at scale and part of a large organization, it's just hard to keep up without breaking something.

• 🤔 Acquisitions are a smart move. It's pragmatic for incumbents to admit they can't consistently execute at the cutting edge, and Fintech is cheap rn. 

.

• 🤔 This is about the modern tech stack, but is Renovite the right acquisition? Renovite is not a business bringing customers to Chase, so this is clearly about the modern tech stack but is it me, or does the Reonvite website not scream cutting edge to you? Where are the developer docs, and why do all the products look like Microsoft CD boxes from 2008? And this is to compete with Stripe?! 

• 🤔 Fighting Stripe and Block is more complicated than it sounds. Even if JPMC had the most beautiful APIs and developer docs for payments tomorrow, they'd also have to make payments "just work." The closer you get to payments, the more you realize payments are easy, but the edge cases are tough to manage. Managing those elegantly, in a way customers barely notice, is where the value is.

• 🤔 My guess is yes, Chase wants to compete with Stripe, but this is more about retaining market share. Chase needs to retain its customers, especially in the enterprise segment. Don't forget Adyen, PayPal, Checkout, etc. This is a crowded market now with well-funded, modern competitors. 

Good Reads 📚

1. OCC and Blue Ridge Agreement shows BaaS Issues

Absolutely killer piece by Jason of Fintech Business Weekly last week. TL;DR below so I can add some commentary, but the whole piece is click-worthy.

Blue Ridge is a "partner bank" that helps Fintech companies launch Financial products to consumers directly and via BaaS platform Unit. With this strategy, it has grown assets from ~$500m in 2020 to ~$2.5bn today, but its compliance processes and infrastructure haven't kept up. The OCC calls out five key areas.

• Oversight of 3rd parties

• Audit and Bank Secrecy act compliance

• Customer due diligence and beneficial owners for business customers Transaction monitoring and Suspicious activity reporting

• IT control (understanding risks, where Data is stored etc.)

The OCC must now sign off on any new partner, service, or activity an existing partner does. Jason points out this will impact all partner banks and Fintech companies that work with partner banks. Everyone will have to upgrade their processes (even state-chartered banks). Jason also notes out BaaS platforms can help their partner banks get the compliance house in order, and compliance consulting firms will have a field day.

• 🤔 Banks are ultimately responsible to the regulators, but they will be measured by their worst Fintech company client. It would be like if your school was measured by the worst kid in class. Regulation is about minimum acceptable thresholds. Partner banks now have to be great at managing 3rd parties.

• 🤔 This is the first real shot by regulators at Fintech companies and partner banks, but it won't be the last. There's a wave of action coming on the back of SBA loans, PPP loans, and fair lending, and Crypto is slap bang in the middle of regulators' firing line too.

• 🤔 Fintech companies tend to serve the higher-risk populations (SMBs, sub-prime, freelancers, Crypto), so they need the best controls. Very few entrepreneurs get into Fintech to solve for compliance, but solving compliance is how you solve everything in Fintech. The companies that make it are the ones that grok this.

• 🤔 Data and visibility are everything, and it feels like we need standards and best practices here. We need to get better at sharing data as an industry and standardizing what good looks like. BaaS and compliance infrastructure companies should agree on the minimum data sharing between partner banks, Fintech, and any 3rd parties. They can compete on features, coverage, and performance, but not minimum standards.

• 🤔 The sheer volume of compliance could be a nightmare to manage, but there are ready-made solutions. But I want to shout out to solutions like Themis, a compliance collaboration tool designed to solve this problem. A module per compliance requirement forms to fill in for banks, intermediaries, and the Fintech company. (I have no investment or relationship with Themis, I just think it's cool, and Neepa is a good human).

Tweets of the week 🕊

That's all, folks. 👋

Remember, if you're enjoying this content, please do tell all your fintech friends to check it out and hit the subscribe button :)