Fintech 🧠 Food - 30th May 2021 - Square checking accounts, Acorns SPAC and the tradeoffs in hiding compliance behind an API

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Weekly Rant 📣

If everything is Fintech, then the value is in productizing the tricky bits of finance.

Whatever you think about regulation, it is a fact of life, it exists for a good reason. Moving money is a serious responsibility, and if it goes wrong, it can literally cost lives.

As a result, being a fully regulated financial services company is hard; countless regulations, laws, and policies protect consumers and prevent fraud or crime create a cost, complexity, and overhead.

Now every company is a fintech company, they probably don't want to be a finance company. That compliance stuff is expensive. So often you see non-finance brands want to outsource as much compliance as possible.

If you’re a regulated finance company, it is mission-critical to get compliance right.

When you're not a non-finance brand, but a brand that does finance, your starting point is different.

In the now-canonical "APIs all the way down," Packy McCormick used the graphic below to show how companies are willing to outsource to 3rd parties if they need a capability to do business, but it's not core to their business.

For example, Facebook is a massive customer of Twilio. Twilio provides SMS services in 100s of countries with many different telco providers. Given that Facebook has all of the engineers, revenue, and profits, why wouldn't they build that themselves or acquire Twilio?

Because for Facebook, advertising revenue and user engagement are core to their mission, helping to manage SMS is non-core. Having a specialist who focusses all of their R&D attention on managing everything that could happen with SMS

For non-finance brands, finance is non-core.

Shopify makes more than 50% of its revenue from financial services, but it's not a financial services company. Its mission is to make commerce better for everyone. Commerce includes finance but is not finance.

Shopify provides all the tools to set up the store for a small online store and manage stock, payments, and logistics. Finance isn't the mission, but it enables the mission.

Shopify is by far Stripe's biggest customer, but it's also a happy customer because they have a specialist who takes care of everything that could happen with finance.

For B2B fintech providers - productizing compliance is core.

I've said before, one of the core innovations for Stripe was becoming the "master merchant" and taking on the responsibility that comes with being a seller online from its customers. Before Stripe, a merchant would have to demonstrate they comply with various standards (like PCI). Stripe hid all of that behind an API.

Its customers could now focus on their core mission, and leave the compliance (mostly) to Stripe.

Underneath this stack is the same regulations and laws that always existed, and somewhere, someone at a bank risk-accepting it. But what the bank compliance team evaluated is how Stripe operates, not how Stripe’s customers operated.

Stripe productized compliance.

Regulation is static but how you comply isn't.

Banks often moan that they're held to a different standard than non-banks. And they have a point; they are.  

The nature of regulation requires any company offering financial services to demonstrate how it complies. Banks do this with a "risk-based approach," which often means documenting risks and running committees to manage many different risks that appear in the business.

What they don't then do is productize the problem they just solved.

Banks re-invent the wheel for nearly every client, and in many cases, require the client to go to great lengths to prove they now comply with the bank's risk appetite.

The B2B fintech provider landscape has limited the risk of its customer breaching compliance rules by taking those rules and turning them into a product. 

Non-finance brand builders and operators do not see managing compliance as core to their business.

But; You'll never really escape regulation, even as a non-finance brand.

Shopify offering payments is one thing, offering a Balance card (that looks and feels to its customer like a checking account for SMBs) is another.

No matter how well-productized risk and compliance become, if your brand is the shop window to a finance product, you are on the hook for something.  That could be as simple as making sure you explain the financial products well to consumers or making sure you have the right partners in place to manage what happens if something goes wrong.

Who manages compliances is a game of economic trade-offs.

The folks that have productized compliance haven't done so for free.  

Let's say you're a founder of a new NeoBank, and you want to be in the market quickly. Your revenue (in the US) would likely be interchange (swipe fees). You could 

1. Work with a BaaS provider, who's put those APIs together, and has a bank partner who will absorb your fraud risk. This is the fastest time to market.

2. Integrate directly into the financial services infrastructure. This would take the longest but offer the best economics.

3. Work with a BaaS provider who's put those APIs together. This is much faster and offers a good balance of economics.

As a fintech company or non-finance brand, often interchange is your key source of revenue (unless you’re cross-subsidizing from elsewhere).

If you're an early-stage company that doesn't have an operations team, option 3 is compelling—having a BaaS provider with a partner that can absorb risk allows you to get moving quickly. In return, though, you'd likely give up most if not all of your interchange revenue.

If you’re a later-stage fintech company, you're going to look at that value chain and think about what part of the economics you want to own. Companies like Square now collect much more interchange but in return have had to build their own risk, fraud, and operations teams.

If you’re a scale non-finance brand, the trade-off to think about is time to market vs economics. The sooner you understand risk, compliance, and trade-offs, the better.

For non finance brands often their core revenue isn't interchange, therefore compliance is a non-core activity and a price worth paying.

For fintech companies, who value interchange revenue, that's less obvious, and I’d expect over time they’d increasingly vertically integrate.

The opportunity for packaging and re-packaging risk and compliance elegantly varies by audience.

Damn, we live in exciting fintech times don't we? :)

Risk and compliance knowledge in Fintech is a superpower.

ST.

4 Fintech companies 💸

1.Axle - Freight financing & Vertical SaaS 

• Axle provides invoicing, carrier payments, and financing for brokers in supply chain finance.  Shipping goods and services internationally is still very manual and paper-based, so businesses often rely on brokers to remove that headache.  

• Brokers that dominated historically had used scale to offer the best pricing. Axle turns that on its head by being the vertical SaaS that gives the broker a middle and back-office platform and access to finance to compete with larger brokers.  In effect, they've turned invoice factoring into much more of a sales and marketing competition than one of scale.

2.Algbra - Ethical Neobank / Super app (UK)

• Algbra aims to connect purpose to finance by taking the principles of Islamic finance and making them available to everyone. This influences everything from how Algbra holds and stores your cash to be clear on community fees and involvement.

• Algbra is building its tech infrastructure from the ground up vs. buying SaaS solutions for its core technology. We've seen two broad approaches dominate in Europe, where banks like N26 and Oaknorth use a platform like Mambu, and other players like Revolut, Monzo, and Starling build their stack.  

3. Adhara - The Operating system for CBDC

• Adhara provides a suite of tools for a future CBDC world (or one where stablecoins are used regularly by corporates and banks).  Services for central banks, commercial banks, and corporates include real-time FX, treasury management, and a payments hub.

• If CBDCs become a thing (which it looks like every central bank globally is pushing for), banks and corporates will need the new tools to manage moving money in this new way.  In the more interesting (and more likely) scenario that stablecoins and CBDCs co-exist, institutions will need regulated on/off ramps. Software for those institutions will become like shovels in a gold rush.

4.Pintu - Coinbase for Indonesia

• Pintu is a retail-focused crypto wallet that offers buy / sell / hold capability for the top cryptoassets in Indonesia. Pintu has focussed on education and leans heavily into the first-time crypto buyer market.

• Pintu's homepage features a comparison of returns on Bitcoin vs. a deposit account. I do worry with that sort of marketing that it is misleading; those returns are not guaranteed. That said, I can see the value in "localized Coinbase" products. Something in local language / local currency for a massive market like Indonesia should do well.  Indonesia has a thriving fintech ecosystem; why not crypto too.

Things to know 👀

1. Acorns will SPAC at $2bn.

• Acorns, the savings and investment App with almost 4 million users and $4.7bn assets under management, is going public via a SPAC. Acorns charges its users between $1 and $5 a month to make small contributions either to their savings or retirement account.

• 🤔 My Analysis: Acorns has been a pioneer in mobile-first savings and investment experience. They popularised the "found money" feature and made features like "rounding up to the nearest dollar" a mainstream feature for fintech companies.

• 🤔 My Analysis: Acorns is also sort of the "anti-Robinhood" given their focus on passive investing over the long term vs. short-term trading.

• 🤔 My Analysis: $4.7bn isn't a massive asset book, but the subscription means they're generating at least $48m revenues per year (and possibly more). What's unclear to me is, what's the long-term goal for Acorns? They have already started to diversify into banking services. Are they going to be yet another service like Moneylion and everyone else heading for the Super app space?

2. Square will launch a checking and savings account.

• In a recent update to Square's app, the code indicates a business checking and savings account for businesses, according to an iOS developer called Steve Moser.  The account would make funds from sales via Square immediately available and offer a 0.5% savings rate.  

• The new accounts would integrate with the existing Square debit card for business, and the account would be no-fee and avoid minimum balance requirements.

• 🤔 My Analysis: Square has the perfect wedge product as the operating system for its merchant customers. Square will remove all of the standard fees large banks require and monetize elsewhere as they always do.  

• 🤔 My Analysis: The SMB bank account space is 🔥 with companies like Brex tackling it head-on, Ramp via expenses, Modern Treasury and Melio via payments, and of course Square from the merchant experience.  If the banks don't adapt rapidly, there will be a change of the guard in SMB banking.

• 🤔 My Analysis: If you're a mid-sized community bank that makes most of your revenue from SMB banking, you should look very closely at how Square does business.

• 🤔 My Analysis: Square's loan charter is Utah-based, Utah is low-key a fintech hub that regulatory nerds should be paying close attention to.

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Good reads 📚

1. Digital Currency from Fear to inflection

• This report from the economist has some interesting data about both Central Bank Digital Currencies (CBDCs) and cryptoassets. The main barrier to the adoption of Bitcoin and crypto is a lack of knowledge (51% of survey respondents said). 78% of institutions and corporates surveyed said CBDCs are required to "supplement the role of cryptocurrencies."

• 33% of institutional and corporate respondents said the primary role of cryptoassets was "asset diversification." The three most pressing needs to make crypto more usable for institutions were 1) Trust and Understanding in the market, 2) More market structure, 3) Regulatory clarity.

• 🤔 My Analysis: It's not CBDC or crypto. It's CBDC, and stablecoins and crypto, and more.

• 🤔 My Analysis: While much of the crypto industry calls for regulatory clarity, what stood out to me is the need for "understanding" and "market structure." Market structure means things like exchanges or clearinghouses, the regulated "middle-person" in financial markets.

• 🤔 My Analysis: While both the CME and CBOE offer crypto derivatives, the big institutions still can't come into crypto spot markets or offer prime brokerage without a market structure that works at their scale and with their level of regulatory requirement.  If you want to bring huge money into crypto, you must build an institutional-grade market structure.

• 🤔 My Analysis: A few folks are trying; while historically retail focussed crypto-natives like Coinbase do sell to institutions, but frankly, they make so much more money from retail, it's not a priority. There's also Bakkt built by the New York Stock Exchange owner ICE, but that seems to have spent tons of cash and achieved nothing since its inception.

• 🤔 My Analysis: The most exciting project is SDX, which is working on Wholesale CBDC and is owned by the Swiss Stock Exchange and payments platform in Switzerland (SIX).  I think someone needs to build an SDX but in the USA and unite the CBDC and Stablecoin conversations in the process.

2. Banks "go to war" against Fintech's

• This headline is an excerpt from CapGemini's recent world payments report (imagine the Almanac of banking). Findings include: 68% of consumers say they would try a digital-only offering operated by their primary bank. Of the banking executives surveyed, 63% said a digital-only subsidiary enables ubiquitous banking (🤔 ?!).   However, legacy mindsets and business models hinder the digital-only bank journey - including a lack of long-term parent support (47%).   65% of consumers globally want banks to reduce their carbon footprint

• 🤔 My Analysis: Of the banks that have built new digital challenger brands and already had a retail bank service, there are vanishingly few examples of success. Customers Bank spun out BankMobile, Standard Chartered is gaining ground with 100k sign-ups in Hong Kong for Mox, and Mettle is still going strong in the UK. (Two out of those three worked with 11:FS).

• 🤔 My Analysis: All three successes have in common: they committed to multi-year investment, gave authority to a new team to execute, and spent energy protecting the new digital bank from the parent.

• 🤔 My Analysis: We haven't heard from Chase, looking to launch Sapphire in the UK "sometime this year" in a while. Generally, I like the strategy there, though, to execute a new technology stack in a new Geo to give enough distance from the parent to avoid interference.

Tweets of the week 🕊

That’s all folks. 👋