Fintech 🧠 Food - 6th Feb 2022 - Apple in Merchant Acceptance, Walmart acquisitions and CBDCs vs Stablecoins the battle for the future of payments?

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 11,089 others by clicking below, and to the regular readers, thank you. 🙏

☀️ gm. Another week where everything happened. I had to cover Apple and Walmart because they're massive. But India taxing Crypto also caught my eye because it's part of a trend where nations try to ban Crypto only to realize they're better off taxing it. Meanwhile, FTX raised at a $32bn valuation, and the Fed has been on fire, releasing all the whitepapers. If you look past the price movement, there are good reasons to be quietly optimistic about the future of Crypto as an industry and Fintech as the ultimate on (and more importantly) off ramp.

This is a long one; click here to read the full thing if your email client clips the content.

PS. Congrats to Giglamesh Ventures. Miguel has been an absolute Fintech content hero for many years now, and it's great to see his passion for LATAM Fintech being followed up with his own fund. One to watch for sure.

Weekly Rant 📣

CBDCs, Stablecoins and the future of payments

It has been a big week for digital assets and payments. The Fed released its CBDC whitepaper and Stablecoin report in the past two weeks, and Meta sold its Diem stablecoin project to a bank (Silvergate). From this vantage point, I think we can start to see how payments and crypto are going to play out. Is CBDC the future? Are Stablecoins dead? Not so fast.

When the Federal Reserve releases a whitepaper, nobody cares 99% of the time. When it's about the potential for a Central Bank Digital Currency (CBDC) or Stablecoins, it has the potential to shake the ground.

Stablecoins had been seen by some regulators and institutions as a risky form of "internet money" that needs to be completed with or a threat to national money control. But I think that’s changing.

For me, the future for consumers has much more to do with Stablecoins and the future for institutions has more with CBDC. I think these papers give us clues as to what happens next.

To understand why let's zoom out to first principles for a sec. 

(I'm going to go on a bit about types of money here but it's important, stay with me)

The payment is the core economic primitive of finance.

Payments touch everything; every purchase, paycheck, or mortgage downpayment is a payment. Everything you see around you needs to be paid for. Payments are the elemental economic primitive of finance.

But not all payments are the same.

Today there are countless ways to pay, each with its own drawbacks. Cash is instant but doesn't work on the internet; cards are digital but expensive, ACH is digital but slow, etc. 

Today's payments system(s) often excludes the lowest income segments of society and wasn't built for a cross-border world. There are efforts to upgrade these systems (like FedNow), but they wouldn't impact consumers' day-to-day lives like true digital cash would.

The Fed paper discusses the potential for a retail CBDC that would play the same role as cash. Most digital payment systems we use today are operated by banks or 3rd parties. Cash is the only true way a consumer can directly hold "central bank money." 

To understand this stuff, we have to unpack the types of money.

What the heck is central bank money?

Any balance held by the federal reserve is "central bank money." Some folks claim this is the only "risk-free" form of money because a central bank never goes insolvent (it can always print more money). The two ways to get central bank money are cash and an account at a reserve bank. Today, only highly regulated financial institutions have accounts at the federal bank, so it's cash or nothing for consumers.

Commercial bank money (i.e., the cash sitting in your Wells or Chase checking account) isn't technically risk-free. There's a risk that your bank will become insolvent and cannot complete payment. This risk is covered by insurance from the government (FDIC in the US, FSCS in the UK). But big banks and financial institutions always account that commercial bank money has some risk attached. 

This is why central bankers always say, "everyone will want central bank money because it's risk-free." (Which sounds arrogant when you say it out loud, but in their context, they're not wrong).

But if you buy the premise that there would be generally available digital central bank money, available through a simple API or service for any consumer or business, then perhaps the idea that "everyone would want it" isn't so crazy?

A brand new form of money like CBDC, built on modern technology, could also be massively convenient. Imagine auto deducting sales tax, auto-filling tax, real-time welfare payments. The reduction in friction and inclusion has real potential. Money and a payment system provided by the central bank are government compatible. 

The role of the dollar as a reserve currency.

The dollar is the world's global reserve currency, any change to how it works impacts the global economy. Since 1944, the dollar has underpinned global energy, goods, and services trade. If you're in Nigeria and want to buy from Vietnam, chances are your Nigerian Naira gets converted to the US Dollar before then being paid in Vietnamese Dong. 

Being so massive, the demand for the offshore dollar increased after 1944 as part of the Marshall Plan to rebuild the world after World War 2. Foreign countries and banks (mainly in Europe) held US Dollars, later dubbed "Eurodollars" to denote real US dollars held by a bank outside the US. 

In the 1970s, as the international payment infrastructure became digital with SWIFT, the dollar was by far the dominant global currency. This meant that any bank touching dollars had to follow the rules set by the US government (for example, not making payments to anyone on the OFAC list). The US can use its status as a reserve currency as a political tool to freeze assets for politicians or companies that break the global order. 

International payments are slow, expensive, and exclusionary. A new globally accessible dollar could have massive demand if the US allowed it. It would (if adopted) also give the US visibility and access to global consumer and business trade flows that are currently not as visible.

The introduction of a CBDC could have massive overseas demand but is more likely a reaction to China. 

But the dollar's dominance is not guaranteed. China, in particular, is using overseas investment and trade to win allies and support through its belt and road initiative. Like the Marshall Plan, China invests in overseas infrastructures like shipping, airports, and roads across Africa and Asia. More than anyone, China rubs up against the global dollar system and having its own reserve currency would create significant economic benefits. 

And China has already launched a domestic CBDC. China's Digital Currency Electronic Payment (DCEP) initiative has 240m app users and 10m merchants supported. Since its launch, DCEP has seen more than $8.3bn in transactions.

Put simply, the Fed had to react since its largest global competitor is now actively building a CBDC. The European Central Bank has announced an initiative, and smaller states like Singapore and Sweden are deep into pilots and trials of their CBDCs. 

What about Stablecoins?

The need for a Fed response also gained political importance when it looked like Meta (then Facebook) would release its own private currency to its 2 billion users. Meta's effort ended sadly with a $200m sale of their Diem project to Silvergate (which for Silvergate is a bit of a coup, as the bank that’s handling most of the Fiat on/off ramps for the Crypto industry to now have a tech platform that’s been robustly built by Meta and dragged through fire by regulators. I sense it may help them scale in time).  

While the urgency may have dropped out of countering any initiative by Meta, Meta also moved the stablecoin conversation forward and did a lot of hard yards for the industry. 

There are three main types of Stablecoin.

1. USD Dollar backed (1 dollar held, for every 1 stablecoin issued). Examples would be USDC, USDT, and USDP.

2. Crypto backed (ETH or other assets held as reserve against dollar). For example, MakerDAO. 

3. Algorithmic (Crypto-backed and little to no human intervention). For example, FEI.

For the purposes of this Rant, when I say stablecoin, think US dollar-backed stablecoin :).

Unlike CBDCs, most (dollar-backed) stablecoins are not central bank money, but they're a claim on some other entity and set of assets. For example, Paxos is a regulated Trust Company that holds 96% of the USDP it issues as "cash and cash equivalents" and 4% as treasury bills. Put another way, you can be massively confident that one USDP will be redeemable for $1.

In the Stablecoin paper, the Fed notes that Stablecoins to date has lived up to the promise and been stable. The Fed also looks into whether Stablecoins should be backed with accounts at the Fed and states that most Stablecoins can play a role if they're appropriately regulated. 

Louder for the folks at the back: This research is suggesting issuing Stablecoins is A-OK, so long as you're audited and store the deposits at a commercial bank. 

So why bother doing retail CBDC if Stablecoins are allowed to be a thing?

Will Retail CBDC be a success?

It's no slam dunk for me, far from it, but it has a role to play. 

The Fed itself calls out several risks.

• If everyone can hold digital money at the central bank, would that compete with commercial banks? Possibly yes.

• If commercial banks get fewer deposits, would there be less lending in the economy? Certainly yes

• Would this be bad for the economy? Absolutely!

This is called "narrow banking," where the commercial banks are cut out of the system. Having less lending in the economy is generally considered bad for economic stability, and the core function of the central bank is economic stability!

But all of this assumes the CBDC would be a success. We also have to consider:

• Will the Fed ever actually build this? Large public infrastructure takes a long time to build, so even if they do it could be too late.

• Will anybody use it if they do? The Fed and the US government are not renowned for developer-friendly APIs and cutting-edge UX.

The IMF published research several months ago, basically stating that central banks have to choose between competing with big tech companies on experience and technology or regulating them. China looks like it has taken the competitive route, but despite the massive scale of issuance, day-to-day usage and adoption remain relatively low and user feedback has been poor. China could always force adoption (and maybe they will if their goal is to reign in big tech and see all the data?) 

Reading between the lines of the two papers, I think the Fed gets this. Their desire to see a two-tiered system for Stablecoins, where USD deposits at commercial banks can back USD Stablecoins, is pragmatic. 

The role of CBDC internationally is also tough to predict. 

• Would every citizen with a non-stable home currency want to access as the global reserve currency? Yes.

• Would that be disintermediating credit provision in those countries? Yes

• Would that be damaging to those economies? Absolutely!

• Will I stop using this question format now? Ok sure.

Will Stablecoins be a success?

The Fed Stablecoin paper saw two core risks, the lack of audits and good governance (which Tether originally appeared to be guilty of but may have cleaned up its act) and "narrow banking."

If the only way to issue a Stablecoin were with an account at the Fed, then why would anyone want deposits at a commercial bank when they could have Stablecoins backed by the Fed? This again would mess with lending and credit supply. So we see the Fed constantly returning to this issue and therefore suggest Stablecoins should be backed by deposits at commercial banks.

Stablecoins are already a success in the world of Crypto and DeFi. Traders use them to ride out volatility and as a base asset.

Stablecoins are potentially becoming a domestic consumer success, as companies like Juno, Linus, Donut, and Eco start to offer high yield returns for Stablecoin deposits.

Stablecoins could become the Eurodollar for everyone else. The US government never implicitly allowed foreign banks to hold US Dollars, but they also didn't ban it. It became useful. I suspect we'll see similar with USD Stablecoins, as consumers and businesses in the global south look to hold digital USD for stability. 

Businesses could also accept Stablecoins as a payment type and open themselves to a global marketplace of potential new customers.

Stablecoins are a payment rail and an asset. When using Stablecoins, you have many ways to buy and transact them. You can buy at a centralized exchange like Coinbase or hold them in a Web 3 wallet like Metamask. Stablecoins can also be sent on Ethereum, Solana, or other networks. This makes them uniquely adaptable to the needs of a global economy.

Embracing Stablecoins could be the best geopolitical move the USA could ever make. Unlike China's DCEP, which has strict controls and limits, Stablecoins simply need to follow a regulatory framework when they're issued and transacted. The free market is then open to innovate on how and where that happens.

What happens now?

I don't think we'll ever see the Fed issue a retail CBDC. The Fed won't require Stablecoins to be backed at the Fed but will expect them to be backed at a commercial bank. Policy is coming, but it's not a scary thing.

Solana Labs recently announced they're working with Circle, Checkout, and Shopify to launch "Solana Pay," a single standard to allow merchants to accept USDC. This could come from an FTX wallet and a Phantom wallet. The use case makes sense, but there are a couple of lessons from history here.

Solana is one protocol, and a closed group of partners supports it. This initially made me think of AOL, but then payments pre Visa or Mastercard. The consortia payment types are a natural step in the progression, but proper payments networks require more than a protocol and technology.

Push payments are hard; new networks will fix this. The problem with any type of Crypto payment (or wire, for that matter) is once I push send, the money has gone, and I have no way of getting it back. If I buy something and the merchant doesn't deliver, then tough luck. There could be countless solutions like escrow, and we can learn a lot from how card networks evolved a set of standard rules about "what happens when stuff goes wrong." Managing the unhappy path of payments is 99% of the battle.

Global payments are hard; new networks will fix this. There are countless networks, centralized wallets, web 3 wallets, and TradFi payment types in different Geo's. The industry will coalesce around a standard or set of standards, but this will take time. (Especially since cross-chain bridges aren't problem-free at the moment). Pragmatism, APIs, and DeFi mullets will be key here. As Web 3 primitives emerge, we'll also find consistent bridges to Web 2 and TradFi for various Geo's.

TradFi and DeFi exist somewhat separately today, but risk and fraud tooling will fix this. We have good on-ramps, but the off-ramps are limited because they're so risky. Anything could happen in the DeFi world, but the Tradfi world is ultimately the one with regulatory responsibility. The winners who straddle both worlds will be the ones best able to understand and balance the fraud, compliance, and reputational risk from both sides.

The US is tiptoeing towards being the most progressive state globally for Stablecoins. And if it pulls it off, it just might win the future.

ST.

4 Fintech Companies 💸

1. Earlybird - Family funded kids Crypto investments 

• Earlybird is a Fintech app that allows parents, friends, and families to invest in ETFs and funds for children. It allows family members to gift an investment directly rather than via check and land it directly in the account. Earlybird has now added Crypto investments as part of its broader portfolio. 

• 🤔 Crypto is famously volatile, but Earlybird points out that over the 5 to 10-year horizon, assets like BTC and ETH already have a strong track record. I feel they wouldn't offer this product unless there was demand. This is another example of Crypto as CAC Hack, and if you're not doing it increasingly, the question is, why not? Some people still recoil in horror at the idea, but that is slowly changing. I wonder how big the market is for family first Robo long term (consider how often Robo gets acquired vs. going public). This app absolutely solves a consumer need, but I sense Earlybird is showing us how kids' accounts and investments should work in the future, everywhere. 

2. Compound - The wealth manager for the tech world

• Compound helps founders and high net worth Gen Y and Z high growth company employees deal with the complexities of finance and make better financial decisions. Today, this audience has to choose between self-managing or stuffy private banks built for another generation and decade. Compound helps users track assets (startup equity, Crypto, ETFs, stocks) and optimize their taxes.

• 🤔 I've been waiting for the "private bank for the 21st century," and while a few have tried, none quite seemed to have the feel of Compound. Compound has advisors who can also help with the challenges of its customers. This is an example of the platform at the front, advisor at the back, vs. traditional private banks that are advisor first, platform second. I can guarantee every existing wealth bank has a project to target this audience and will struggle to execute. 

3. Wedge - Spend any asset anywhere

• Wedge allows users to spend from any asset in their wallet, including stocks, bonds, ETFs, and Crypto. Users can choose which asset to spend before or after every transaction. Users can also buy / sell / hold any of those assets directly from Wedge. Wedge has partnered with Lithic, Alpaca, Sila, and Gemini to make all of that possible.

• 🤔 This is a super interesting proposition. On the one hand, I feel like spending long-term investment assets is something you probably should do. On the other, this kind of flexibility and control will work for some folks. It reminds me of Curve in the UK, which let you spend on a Mastercard, but get the points on your Amex by "switching" after the payment. It's fantastic, but it's niche. The other big takeaway here is this is a new generation of suppliers, Lithic and Alpaca, in particular, stand out. Lithic is a payments processor that allows amazing things to happen in and around a payment because of how it's built. 

4. Fiat Republic - BaaS for Crypto for Europe

• Fiat Republic provides a single API to link multiple Crypto friendly banks. It also offers domestic and European payments rails to help businesses reconcile deposits and automate withdrawals. Founded by payment industry veterans, Fiat Republic is also baking in AML compliance to its offering.

• 🤔 Finding banking partners is the single hardest thing for many Crypto businesses. The same names come up often (Silvergate and Cross River in the US, LHV, and Clearbank in Europe), but they're small and often overwhelmed by demand. The bigger banks "can't get the risk appetite" to onboard Crypto clients and, in the process, are missing a massive commercial opportunity. No large bank wants to be the first in the firing line for the regulator if they can avoid it. I find this quite lazy because the risks can be managed; it just takes work. Having a BaaS player pre-integrated to the overwhelmed by demand smaller banks is a great move.

Things to know 👀

1. Apple will let iPhones accept cards

• A business can accept payments directly from their iPhone with a new service. The service uses the same NFC chips on the device that make Apple Pay payments possible and follows the 2020 acquisition of Canadian company Mobeewave. Commentators have observed that Apple could either reduce costs for services like Square for Merchants or bring Apple into competition with Square.

• 🤔 Historically, small merchants were hard to underwrite because businesses were easy to create and had a high risk of fraud. If a merchant only did 10 transactions per year, the revenue wasn't worth the risk for big banks. Square, Toast, and others innovated on the risk model and UX for these smaller organizations.

• 🤔 This was all enabled by innovation from the card networks called Payment Acceptance Cloud, which removed the need for a hardware device to take payments. This means any device (not just iPhones) could accept payments without an extra bit of hardware. Think, Android devices, cars, and the whole IoT universe.

• 🤔 Will Apple compete with Square for merchant acceptance? Initially, no, companies like Square might use this feature, but long term Apple always competes in the end. I remember talk in 2009 about when Apple would release "NFC payments," based on Visa and Mastercard standards that enabled it, and it wasn't until 2014 it actually happened. It might be a while yet.

• 🤔 Is Square doomed? Not just yet, while their shares traded down, the value Square offers merchants has gone deeper into managing inventory, taxes, payroll, etc. I sense that Apple will use its position to charge a fee as it does in the App Store and Apple Pay. The real question will be, does that end in a battle like we're seeing on the app store? Banks ultimately rolled over on Apple pay and split the interchange revenue.

2. Walmart acquires two Fintech companies

• The Fintech company that Walmart has created and backed with support from Ribbit capital has acquired two companies in a bid to become an all-in-one money management platform. Even an earned wage access Fintech company allows employees to get paid early (and Walmart itself is a customer). One Finance is a Neobank that offers "auto savings" and money management for consumers. The new company will be called simply "ONE."

• 🤔 Walmart has effectively got all of the functionality it needs for its Neobank effort with these two acquisitions. It's striking to me that the CEO of ONE is ex-Marcus by Goldman, itself a brand that rolled up countless Fintech and financial services companies.

• 🤔 It makes me wonder where the Ribbit money and effort went when it was called Hazel? Did they build anything? The only thing on the internet was filling the Hazel trademark and an intent to "serve both affluent and low-income consumers." 

Good Reads 📚

1. Fintech Blueprint breakdown of fireblocks funding

• Lex talks through the $550m funding round for Fireblocks, achieving an $8bn valuation. He points out that Fireblocks has always differentiated on its key management and security solution. Fireblocks has clients like BNY, eToro, and BlockFi and saw more than $2 trillion on volume on $45bn assets under custody. Lex's core argument is that there is room for a handful of very large players here and their growth is just getting started as institutions enter digital assets.

• 🤔 Fireblocks has quietly been selling shovels in the institutional Crypto gold rush. Their market position is well deserved, and they've figured out how to require institutions to change very little to be able to work together. This low lift, we support how you already work key management puts them in an excellent spot to continue to grow with institutional interest.

• 🤔 The deep infrastructure of Crypto is in a good place with companies like Anchorage, Paxos, Fireblocks (and everyone who I forgot to name here too). The hardest thing in Crypto is bridging the two worlds and managing risk across both at the client side. We will see folks begin to arbitrage TradFi vs. DeFi and exploit that gap. Companies that can handle the risks in between and make it compliant have an enormous opportunity. 

Tweets of the week 🕊

That's all, folks. 👋

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