Fintech 🧠 Food - 20th June 2021, JPMC buys a Robo, Goldman does Eth futures & Finance Products vs Fintech Products

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Weekly Rant 📣

Finance products vs. Fintech products

Finance products are a commodity. So get big, sell lots, make money. 

The way to win at financial products is to get really big, like JP Morgan or Citi big, and build a balance sheet. That way, you collect enough deposits that even when interest rates are at all-time lows, you can make money from your lending business.

Semi tangent: (stick with me here) The movie Waterworld is a mediocre tale about a distant future starring Kevin Costner, where global warming has melted all the ice on earth. Nearly all land on earth is submerged underwater, and inhabitants fight over floating cities. In the end, our lead actor finds safety on a mountain top and natural high ground not yet submerged. This is the game banks have to play. They're either treading water (staying still), or they're getting larger to keep their head above water. 

Because banks view what they sell to the mass market as static, they tend to view digital as another way to package what they sold all along. Thus, when looking at fintech companies through a banker's lens, they often see only the financial product.

It's about where you start.  The very culture of the big banks is designed to interpret the world in this order:

1. Start at the banking business model

2. That can be distributed in many ways (including mobile)

3. That may help solve a customer problem

The reality of selling a commodity is you never get to charge a premium. Don't get me wrong, some businesses can do very well at being the scale provider of commodity products, but they know that's what they're there to do. For example, Costco isn't trying to convince you it's really digital with its mobile app.

Banks are. They're trying to compete with fintech companies, big tech, and now embedded finance on service often (with a few exceptions), it's not working.

But you can't have it both ways. You can't be operating in a commodity, scale game and trying to compete on service. (This is why community banks historically did well in the USA, but the definition of service is changing).

Fintech products are a service. Solve a problem, charge a premium, grow.

The way to win at fintech is to solve problems even they may not have realized they had, elegantly. That's why you see Chime do get paid early; Square build beautiful real-time payments, or Stripe solve payments for merchants online with 9 lines of code.  

It's about where they start

1. Start at the customer problem

2. That can be solved in many ways (including mobile)

3. That may be monetizable in the future

The companies just mentioned offering financial products that the bank would (checking, make payments, merchant acquiring). But businesses can charge a premium that banks cannot because they create much more value for their customers. Those customers are often willing to pay a premium because of how valuable the service is. For example, Stripe can charge up to 10x what a bank might for an ACH or Wire (at book price).

These premium, problem-solving products (hello alliteration) see massive growth and aren't reliant on the scale to drive a profit (although now they are also hitting an enormous scale).

Easy to use or problem-solving?

Bankers often define fintech companies as "easy to use," but it's more than that. It takes effort to identify a customer problem and why a particular feature might solve it.

Entrepreneurs naturally spend a lot of time in the problem space of customers. When they hit a potential solution, they'll launch a feature that solves that problem even if they don't yet know how to monetize it.

There is no credible way to launch a feature in most banks unless 1) Another bank is already doing it or 2) you can clearly show how the feature will make money (using the existing business model, of course).

The "easy to use" trap

When you confuse what fintech companies are doing with great UX, the temptation is to copy what you think they're doing. This is why banks spend billions on mobile apps and digital front ends but haven't really changed what and how they sell.

The classic example is Finn by Chase. Launched in July 2018, it was designed to appeal to "millennials" by being digital-only, and, get this, allowing users to tag transactions with emoji. Unfortunately, by June 2019, Chase shut down Finn, citing a lack of demand.

Finn by chase didn't work. Because it was a finance product with emojis. 

Customers aren't adopting digital banking apps because they're digital; they're adopting them because they solve a problem.

History repeating?

In January of this year, JP Morgan announced that they intend to launch the Sapphire brand in the UK "this fall." But I wonder if the lesson will be learned. Will it be a financial product that competes on price or a fintech product that competes on service?

The JP Morgan acquisition of Nutmeg caught my eye this week because it felt like the bank was buying a proven brand rather than building it themselves. Is that because the internal bank build is not resonating with beta users? Is it because there's something wrong with their core? Or is it because they are starting with the wrong business model?

We'll find out "this fall." 

ST.

4 Fintech Companies 💸

nSure AI - Fraud prevention for digital goods

• nSure AI helps identify and prevent fraud when selling digital goods like gift cards, software, and games. These digital goods typically suffer from high levels of fraud, and the industry way to solve this is to reject a high percentage of transactions.  nSure can approve 98% of transactions, vs. 80% as the industry average, while preventing more fraud.  The company is so confident in its software it will accept 100% liability for any fraud losses for users of its platform.

• Digital goods sales are growing 2x faster than physical goods, as everything from V-Bucks to digital content to the humble gift card becomes digital.  Digital goods are also a hotbed of fraud, costing up to 8% of revenues for merchants, who may dedicate up to 20% of the operational cost to resolving the issue. This is a massive market and a problem worth solving.

Now - The flat fee for invoice factoring

• Now lets merchants get paid instantly after they have invoiced their clients. Now then receives the payment from the merchant's customer in 30+ days from invoice and manages the collection of funds.  Now charges a single flat fee (3% of the invoice) and funds their lending through selling the debt as bonds.

• For many small businesses, just getting paid is one of the biggest operational overheads, with payments often lagging 70, 80 or even 90 days behind a sale. A growth business may end up not being able to afford to make more sales because of this payment delay.  Traditional banks and credit union's traditional models aren't built for growth businesses. Now aims to change that with a flat fee structure. I do wonder if that flat fee can scale. I like the simplicity but imagine the margins must be razor-thin.

Ophelos - Supportive debt collection (UK)

• Ophelos provides customers who have fallen into debt a suite of options for repaying (e.g., pay now, pay in small bits over time).  Ophelos sends no threatening letters through the post and lets everything be handled digitally, avoiding the anxiety of speaking to a person.

• Debt can have a massive impact on mental health.  Half of all adults with a debt problem also suffer from poor mental health, and people with problem debt are 2x more likely to develop severe depression than those without.  Traditional debt collection tactics of red warning letters and collection agents at the door are not only a hangover from a bygone era, but they're also less effective.  TrueAccord (the US equivalent) collects far more than traditional agencies by taking the kind approach. Doing the right thing is good for business.

Pagos AI - Analytics for payments

• Pagos provides a suite of tools to help merchants better understand their payment activity. For example, Pagos can read the BIN (Bank Identification Number) of an incoming payment and help merchants identify fraud, message customers during checkout, or managing costs by understanding what cards to reject.

• This is pretty niche, but I like Pagos because it sits on top of any payments processor and adds these deep insight capabilities. There are tools to prevent fraud or provide customer insight, but they're often either domain-specific (e.g., all about fraud) or baked into something more generic (e.g., a Stripe Dashboard).  As financial services are unbundled, so are the various pieces that had been aggregated into platforms.

Things to know 👀

1. JP Morgan to acquire UK Robo Advisor Nutmeg

• JP Morgan is set to pay £700m ($966m) for UK Robo Nutmeg, which has £3.5bn ($4.8bn) assets under management. Nutmeg has 140,000 customers in the UK. 

• 🤔 My Analysis: JP Morgan aims to launch Chase in the UK to compete with Marcus from Goldman.  US Banks have a history of trying to enter the UK market only to back out; through the 90s internet banking boom, JP Morgan acquired sold several credit card franchises from 99 to 2006, only to sell Barclays in 2008.  US Banks often assume the US model can copy+paste to the UK, but it just doesn't work; the money culture here is very different.

• 🤔 My Analysis: The UK is a hard market for Robo, several high-profile attempts like Investec and Moo.la have closed in recent years after failing to gain momentum. What has worked well in the UK is commission-free trading (free trade) and PFM / savings apps that become investment apps (e.g., Plum, Tickr).  The future of Robo is everyday savings.

• 🤔 My Analysis: Isn't it interesting that they chose acquisition for the Robo advisor while building their own Neobank experience? If you missed it, Chase is apparently building its own digital bank that will take direct deposits in the UK under its Sapphire brand. Due to launch "this fall," things have gone pretty quiet.  I wonder if the Nutmeg acquisition is to get some UK traction because the digital bank build is taking too long. 🤔 😇

• 🤔 My Analysis: The sum was "undisclosed" but became clear as crowdfunding investors who had bought nutmeg shares for £12 were advised they would be paid between £30 and £32 per share (I’m done with converting to USD, GBP is cool now, like the Beatles for money).

2. Goldman launches Eth Futures & Options

• Goldman will offer Eth options and futures trading in the coming months. This follows the bank having embraced Bitcoin earlier in the year.  Futures and options contracts allow users to "bet" the price will go up or down in the future and are popular with institutional investors.

• 🤔 My Analysis: Wherever Bitcoin goes, Eth follows. Eth is the #2 cryptoasset, and by now, very well known to regulators and banks alike.  But Eth itself is quite different from Bitcoin. Bitcoin has one function, being a store of value, "digital gold," Eth was designed to have many uses. Where Bitcoin is a blunt instrument like a sledgehammer, Eth is a swiss army knife. Both have their place in the digital future.

• 🤔 My Analysis: Eth is the oil of the crypto-economy.  It is the fuel for countless other networks and apps that run on top of Eth (e.g., NFTs, Defi, Stablecoins). By getting access to Eth, you, in effect, have a right to play in the new world of Defi. This is quite a conservative move from Goldman.  The hedge funds that were trading Bitcoin 3 years ago have now long since moved into Defi.

• 🤔 My Analysis: What we're seeing over time is more institutions heading into crypto. Their timing is mainly dependent on their risk appetite, which is why ultra-conservative banks like Wells Fargo will probably be last in.(Side note, isn't it funny how even the most "risk-averse" banks can get into hot water with regulators, It turns out avoiding innovation isn't the same as doing the right thing for customers, who knew?!)

• 🤔 My Analysis: The banks really make their money from prime brokerage; offering Bitcoin and Eth futures is still very much "dipping a toe in the water" by comparison.  By offering prime brokerage, the banks would allow their biggest institutional clients into crypto properly. There is a massive demand for this, but the supply hasn't been nailed because the banks would need an exchange they can use. The crypto exchanges that exist don't cut it, and Bakkt hasn't executed.

Good Reads 📚

1. Stripe: Thinking like a civilization

• Mario has written the case study on Stripe.  From the Collison brothers' beginnings, product offense as defense, their culture, their M&A, the competitive landscape, and an outlook for the next 10 years.

• When they set about fixing payments, it became clear that is the tip of the iceberg; payments are extremely broken but so are all of the activities around payments (like fraud, tax, billing, invoices, etc.)  Stripe launched two products in its first five years and nine in the last five. By fixing the underlying infrastructure, they've gone slow to go fast.

• Stripe has some more esoteric qualities like "taste," where every website refresh is cooed over by designers. Or soft power, like Stripe Press or climate, initiatives that manage to be beautiful and finger-on-the-pulse always-stick-the-landing and... je ne sais quoi.

• 🤔 My Analysis: We've already seen companies "age out" of Stripe and take capability in-house (e.g., Airbnb, as Mario notes). I actually think this is a broader trend as having great APIs is becoming standard in fintech. Companies like Finix allow SaaS businesses to become payment facilitators (i.e., the equivalent of Stripe).  As every company becomes a fintech company, the value of taking payments in-house increases.

• 🤔 My Analysis: Stripe's biggest strength may be its only weakness.  By simplifying the complex so incredibly well, some configurability gets lost. The next wave of fintech companies is unbundling the finance value chain even more. Honestly, though, I don't think Stripe minds. Another company that has a very opinionated view on the product is Apple, and they did ok.

• 🤔 My Analysis: Stripe has started to do M&A successfully, which is rare, so often M&A is a finance transaction (more acquisition than merger). John Collison is obsessed with companies that have grown through acquisition, and as they look at enterprise and geographic expansion, that's an excellent muscle to have.  The GDP of the internet is still early, so Stripe has a long way to go (and looks cheap on a P/E basis!)

2. Composable identity

• On Web 2.0 platforms (e.g., Google, Facebook, Twitter), your digital worth is measured by the advertising $ you can generate. Your digital identity and reputation are fragmented across many platforms, but what if you could own all of those pieces of digital identity permanently? What if you were in complete control over what you revealed, to whom, and when?

• Identity is a messy concept. There are many types of identity (physical, digital, social, etc.), then many types of interaction (consume, contribute, transact). But nearly all data is exportable and could therefore be represented with tokens (the blog even has neat ideas of handling trapped social data).  If we can map the data with tokens, we can also map the interactions between data points as a graph. If you then add on the permissions/connectivity between crypto wallets and tokens, you're getting very close to the ability to control / own data.

• Services are already being built to create credit scores or certificates based on on-chain activity.  With Web 3.0, we tend to start with the primitives, and from there emerges the marketplace. It's unclear what form this marketplace will take, but it begins with building these primitives.

• 🤔 My Analysis: I absolutely love this thinking. The read itself is very dense and technical. Still, the core concept is that individuals will own their own data, and managing it via marketplaces feels logical to the point of certainty.  The question in my mind is when not if.

• 🤔 My Analysis: There is a thread of mainstream politics (both left and right) that anonymity is "evil" and that big tech must weaken privacy for the benefit of law enforcement. But much like how on-chain analytics are far better at detecting financial crime than the existing financial system, on-chain identity has massive advantages over the current system.  If we get privacy right, an identity market will use data to identify, score, and price risk. It can also be used to detect, identify and even take action against harmful behavior.

Tweets of the week 🕊

That's all, folks. 👋

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