Fintech 🧠 Food - Aug 8th 2021 - Robinhood is a meme stock.

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11:FS has built Neobanks and challenger propositions worldwide for companies like Natwest, Standard Chartered, and Grab. As operators, we created the thing we felt the market was missing. A financial operating system.

What would a financial operating system look like? I think it would allow any brand to create experiences with finance that work with many providers in many Geos. By working with the best providers in the BaaS stack and putting them together into a consistent architecture, you have the basis of a financial operating system.

But what about differentiation? What about standing out from the crowd? Creating a financial product is one thing; it's another thing to have a wedge product with a service or hook that customers love.  

It turns out if you model the world as a state machine, it works really well for embedded finance and differentiation. Want to know more?  Come get a demo of 11:FS Foundry. 

Weekly Rant 📣

The memestock app is a memestock

There's more than a sniff of irony about what happened to Robinhood's stock this week. An app that enabled consumers to pile into stocks and create more volatile swings has its stock price piled into by consumers and swings massively.  

Robinhood shares spiked from $40 to nearly $100 on Wednesday before falling to $50 on Thursday. The rollercoaster move was led by the Redditors at Wall St Bets (r/WSB), making Robinhood their latest memestock. Only for Robinhood to announce a day later that VCs like a16z and Ribbit would be able to (and likely to) start selling their shares in the coming months.

Robinhood just can't avoid controversy.

Robinhood had just made it to IPO, putting behind it the largest fine ever imposed by FINRA. Robinhood had been found by FINRA to provide misleading information to consumers and provide financial products to them that may not have been appropriate.

The inappropriate product for some consumers was options trading. By allowing consumers to "bet" a price will go up or down, Robinhood had given a risky product to the mass market. If you know what you're doing with options, you can win big, but if you don't, you can lose big.

It's using options trading that the Redditors at r/WSB had been able to bet big on the price of memestocks like Gamestop, Hertz, or AMC Theatres. But it's also the options trading (and UI) of Robinhood that can create losses or the perception of massive losses (that had, in one case, led to suicide).

Because they unleashed a weapon.

In effect, Robinhood weaponized the consumer and sparked the revolution of Main Street investing we now see. But like the invention of any new weapon, new consequences are also created.

The gun debate is an interesting metaphor here (go with me). Depending on your political and personal world view, guns either represent freedom from the state or the state's irresponsibility. As a dangerous weapon, some view the safe use of guns as a personal responsibility. In contrast, others see it as an unnecessary danger to inflict on society because someone will always misuse them with disastrous consequences. So we end up in a world where guns are either only available to "professionals" or to the mass market but with the risk of consequences.

Most regulators define a sophisticated investor as someone who has a professional qualification or $Xm in assets or capital they can afford to lose. In effect, rich people or professionals.

Options trading is a financial weapon that was until recently only available to professionals. If someone has been well trained and takes personal responsibility seriously, they can be incredibly effective with options trading. The very best of r/WSB do their research and are on par with any "professional" investor.  

That treads a fine line between inclusion and irresponsibility.

Main Street has largely missed out on the benefit from stock market growth in the past decade. As companies stay private longer, the investors have seen their portfolios and wealth balloon as high net worth and ultra-high net worth. While in real terms, the consumer can barely keep up with inflation (and that's if you believe the published inflation figures).

On top of this, each successive generation is achieving less wealth as they age. When boomers were under 40, they had 13% of all household wealth; today, Millenials under 40 have less than 6%.

Now layer in over the top of that, that most bank CEOs are ultra-high net worth boomers and most politicians are over the age of 50. You have a younger generation that is pissed off. This generation couldn't just work, pay into a 401k and retire comfortably.  

When Robinhood gave options trading to the consumer and democratized access to financial markets, they tapped into a massive unmet demand. The demand to try and make something of life wasn't going to come from the salary or playing by the old rules. Money is culture, and that's no bad thing. This level of financial inclusion is a game-changer for the well-informed but low-income consumer. And in the mobile-first, 24/7 world we live in, being well informed is easier than ever.

But the problem isn't the well-informed consumer; it's everyone else. The old saying goes, everyone is a genius in a bull market. Robinhood has risen to popularity while tech and clean tech stocks (like Tesla) have had an incredible run.

So what will the regulators do?

Robinhood already had a kicking from FINRA, and unless they do anything egregious from here on in, as long as the bull market continues, they should be fine. I doubt regulators will do anything for now, but the issue is what happens if the market turns?

Market's don't go only up, and when they come down, there will be a reckoning. Consumers that have been winning will lose big, and the consequences could be massive. A highly leveraged consumer could quickly lose their house, go bankrupt and suffer all of the personal and family consequences that come with that.

That would lead to a public and political outcry, which would result in ~1 year later some rushed ruling or legislation. Don't forget, the SEC itself was created after Main Street got hit in the 1929 crash.

What about r/WSB?

There are rules about investment advice and financial promotions that r/WSB gets around neatly with its FAQ, moderation, and users' behavior. Users share research and their own activity, but not financial advice.  

However, it is clear that when r/WSB apes into a particular stock, the less informed consumer may see this in their Robinhood app and follow. When a bubble happens, each investor is betting that someone will follow them, and the price will increase before they sell (the greater fool theory).  

The question is, are Redditors manipulating markets? By intentionally rallying behind one stock, especially betting against hedge funds, the Redditors produce spikes in price. Those spikes in price get followed by less-informed investors. Those spikes don't always last, and the less informed investor is left holding the bag.

Inclusion vs. responsibility is hard, and honestly, I'm torn.

I'm a millennial who started work at 16 (not college-educated), then, paid 10x for my house as my boomer neighbor (in real terms). I have done far better from crypto and tech stocks over the past 20 years than any traditional consumer financial product (e.g., pension or savings). My approach has never been to "ape in" to a memestock or use leverage. But that could be right for others.

It has to be ok for a sufficiently informed consumer to have access to growth, especially in a market where opportunity is harder to come by. The issue is how we define "sufficiently informed."  

What if consumers could demonstrate over time their sophistication, and as their portfolio begins to grow, they earn leverage. Rather than giving everyone a weapon, we watch them use regular tools responsibly first.

This feels like a product decision Robinhood (and others) could make and something regulators and industry could rally around. How does the consumer demonstrate and certify their own sophistication?

Let's balance inclusion and responsibility. The market needs it. And if we don't do it proactively, then when the market turns, it will get forced upon a hastily written amendment to a significant funding bill (like, say, the infrastructure bill 👀). 

ST.

4 Fintech Companies 💸

1.Embedded - Clearing, and Custody-a- a-Service

• Embedded is an ApexClearing competitor built by the former Square Cashapp investment LLC leader.  Fintech companies that want to offer share dealing to their customers need three things. A registered broker-dealer, clearing, and custody. Companies like Drivewealth provide broker-dealer APIs to Fintech's like Sofi and Stash, and ApexClearing has been the default clearing and custody provider for a long time.

• Embedded offers a competitor to Apex in a market clamoring for better infrastructure.  If you have heard the name ApexClearing before, it's because they're used by almost everyone except Robinhood for custody and settlement. Robinhood took clearing and settlement in-house to reduce their costs but had many outages along the way.  

2.Wapi Pay - Asia / Africa Payments Gateway

• Wapi Pay provides P2P (person to person), enterprise (business to business), and merchant solutions for trade between Kenya and Asian markets like China, India, and Indonesia.   It's still costly to send and receive money between Africa and Asia, with some payments costing as much as 20%. Wapi Pay charges roughly 3% for payments.

• The level of trade between Africa and Asia is increasing; in Q1 21 alone, it jumped by 27% to $52bn. African merchants have a global market to serve, but the level of cost has been prohibitive. Services like Wapi Pay will open the floodgates for more trade.

3.Onramp Invest - Crypto Integration for Financial Advisors

• Onramp provides onboarding, portfolio modeling, custody, and education in a turnkey platform for financial advisors to use with their clients.  Without this platform, independent advisors and firms would have to build their own UI and integrations.  

• Cerulli estimated the RIA market in 2020 was worth between $17trn and $20trn in market cap. RIA's also make up 50% of new assets to businesses like Schwab. As crypto becomes mainstream, these advisors need tools to help their clients and services like Onramp play in a massive market.

4. Yaydoo - Modern Treasury for Latam

• Yaydoo provides an easy-to-use platform for small business owners to make and receive payments.  Yaydoo has built workflows to automate both making and receiving payments from invoices. Yaydoo also offers a business expenses card and supply chain financing (factoring). Yaydoo has also created a marketplace for buyers and sellers that manages the quote, invoice, and payment process end to end.

• If this were in the US, it would be Modern Treasury + Ramp + Tradeshift.  With more than 50k customers and a growing market like Latam, this is an exciting prospect. 

Things to know 👀

1.Square to buy BNPL Afterpay in a $29bn all-stock deal.

• Afterpay is the Australia-based BNPL provider founded in 2014 that in June 2021 reported 98k merchants doing $21.1bn in GMV through the platform.  

• This has had every fintech commentator worth their salt do a write-up in the past week, but check out Marc Ruby's write-up if you want the history of Afterpay and a breakdown of their prospects. Alan Tsan gives a more Australian perspective but was also the first I saw point out the link BNPL provides between consumers and merchants.  Square has a consumer ecosystem and merchant ecosystem, but BNPL bridges them beautifully.  

• 🤔 My Analysis: Square is betting 25% of its market cap on Afterpay, so Alan Tsan pointed out this is a "bet the farm" move. But, Square stock has doubled in the past 12 months. In effect, the growth in stock has "paid" for Afterpay.

• 🤔 My Analysis: I've seen the meme "BNPL is a feature, not a product" a few times this week (I think the original credit is to Ron Shevlin). But for me, BNPL is a wedge product, not a feature. It's a product because it creates incredible value for the merchant and consumer when executed correctly.  

• 🤔 My Analysis: It's a wedge for consumers and merchants, with data in the middle to bridge the two. The consumer wedge: You already want the thing, the lending is frictionless, and you get the thing in installments making your life easier. The merchant wedge: increased sales for adding a button at checkout. 

• 🤔 My Analysis: Afterpay sees what consumers are buying and what merchants are selling (and how both are performing). This makes BNPL the perfect place to cross-sell from.  Consumers are already making repeat purchases, but the field is open for cross-selling other financial products. The merchant data also allows insight into how the business is performing to lend directly to them (indeed, Afterpay already sells cash flow lending to Merchants in Australia.)  

2. Rapyd raises $300m at $8.75bn

• Rapyd provides a range of payment services (payments, mobile wallets, cross-border payments, card issuing, and more) via APIs. Customers include Ikea, Uber, and Rappi.  Think of them like Stripe but with more payments types / global coverage and less focus on things like Atlas (supporting 900 payment types, in 65 currencies).

• This raise comes 7 months after their last $300m round that valued Rapyd at $2.5bn.  In that time, revenues have grown 3.5x (so is the new valuation, go figure).

• 🤔 My Analysis: Rapyd looks to me a bit like if Rocket Internet did a Stripe clone focussing on markets where Stripe wasn't strong (although Stripe is an investor).

• 🤔 My Analysis: Anything payments is on fire right now, and Rapyd is positioned between payments, banking as a service, and cross-border payments in a somewhat unique way.

Good Reads 📚

1. Expert level review on how Defi and Compound Finance work 🤓

• Dirt roads is a relatively new substack publication from an author (Luca Prosperi), a former banker and private equity investor. In this post, he elegantly compares Defi (specifically Compound.finance) to traditional finance.  The mental clarity in this post is staggering. (But we warned, it's quite a dense read)

• Most Defi "lending" protocols aren't actually doing lending.  When you look at Compound, it is made of two components (Algorithmic rate setting, automated liquidation engine). Understanding these and how they're different from banking is crucial. 

• "Depositors" add their funds to a liquidity pool, and "borrowers" can borrow from that pool. Algorithmic rate-setting calculates what "borrowers" pay and "depositors" receive. The liquidation engine incentivizes depositors (massively) to liquidate positions that have become risky.  Compound is effectively the math and algorithms that brings together the borrowers and depositors and publish the rate. Compound never custodies (holds on to) the funds or performs any lending activity.

• 🤔 My Analysis: Because banking makes more sense as a collection of activities than any business line, aligning incentives between departments is critical (which some banks do better than others). Compound has no departments to align; it simply built two primitives that align the incentives of market participants and stood back.

• 🤔 My Analysis: In effect, what we're seeing with Defi is the building of financial primitives as lego blocks.  Mastery of Defi is the ability to recombine these primitives into trading strategies.

2 The value layer of the internet

• Exchanging value on the internet is incredibly complex. Ben Milne proposes two internet primitives to abstract that complexity called _ValueType and _TransferType.  If I understood correctly _ValueType is an asset (e.g. _ValueType(USD) or _ValueType(BTC)). _TransferType is a mechanism to move or exchange value (e.g. _TransferType SWIFT, ACH etc).

• Ben suggests "exchanges are implied because _ValueTypes have to be converted between each other," and "Geographies are implied because laws exist".  In other words, from the two primitives, we can imply the rest. Currencies have jurisdictions, as do payments rails etc.  Geographies are a people thing, and protocols are an internet thing.

• 🤔 My Analysis: I love the idea of implying rules from asset type (and/or transfer type). My worry is the infrastructure is so complex and the rules even more so.  We could assume that the infrastructure is defacto, compliant with its jurisdiction and the value exchanges it operates. Still, I instinctively want to straw man countless examples to see if the model breaks.  I feel like this concept needs a small summit with a group of compliance nerds.

• 🤔 My Analysis: If you buy the principle that the lower-level primitives of finance are now being built and exposed (by companies like Moov), it's reasonable that you could then abstract them into a higher-level primitive. But what is the connective tissue between these primitives? This feels like it needs a summit of nerds to noodle on and then the heavy hitters to adopt a v0.1.

Honorable mentions 📡

• Punks, squiggles, and the future of generative media. This is a deep dive into "generative art" and why it's such a compelling category when linked to crypto. 

• What do the SPACs and IPOs say about Fintech darlings? Lex looks at the rush to the public markets for Fintech companies and asks if the earnings multiples add up over time. For payments companies, it's a no-brainer, but lending companies may struggle, and Lex provides views on everything in between.

Tweets of the week 🕊

That's all, folks. 👋

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