Fintech 🧠 Food - Feb 20th 2022 - Crypto's coming of age party, Affirm stock plunge & FIS buying Payrix

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.

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☀️ gm Fintech nerds.

Last week’s Superbowl was the Crypto Superbowl at a Fintech stadium, where a QR code finally worked. Binance might buy Forbes, and BNPL provider Affirm is starting to show signs of life after Peleton. There’s never a dull moment in Fintech or Crypto, and honestly, I just love this stuff 🤓.

The best thing about sitting in 11:FS is the window on the market. The sheer amount of demand for people who understand both Crypto and Fintech is utterly massive. I've never seen deals arrive, convert and work start so quickly. 

So while the public stock market and Crypto price corrections are on some radars, it's not impacting where people are spending. Not at all. Which banks will actually work with Crypto? What will the regulator do next? Where should a Fintech company even start in Crypto? The answer is it depends, on your regulator, on your strengths, and your customers. 

🔌 Folks like Mauricio joining 11:FS or our friends at Visa like Cuy Sheffield sit at the intersection of these two exciting worlds that every company in the world is now trying to understand. Maybe you should reach out to them? 

PS. I’m heading to the 11th annual FinTech Festival — hosted by MX and you can be there too. For the first time, MX is opening the doors for everyone to hear the keynotes. I’ll be doing one about data and open banking, joined byMX’s Interim CEO, Shane Evans, and author of the incredibly popular business book, The Lost Art of Connecting, Susan McPherson.

RSVP now for the event on Tuesday, March 8 at 9 am MT.  👈

Weekly Rant 📣

Crypto is coming of age.

If you zoom out, a few things are happening simultaneously. 

1. Crypto entering the mainstream consciousness, with the Superbowl Ads being a perfect example.

2. Legislators are getting much more informed on Crypto, and we could see thoughtful progress soon (e.g., the recent Senate hearing)

3. Regulatory clarity is coming for things like DeFi, which the recent BlockFi settlement with the SEC shows (for better or worse).

Why did Crypto companies Ape into Superbowl Ads?

Because they work. 

Because Crypto market share is a land grab.

And because the companies can afford to.

VCs poured ungodly sums of money into Crypto wallets and exchanges in 2021, and it's now a scaling race. CB Insights says funding is up 713% YoY, to $25.2bn, in more than 1,000 deals creating 47 unicorns. 

Each Ad was doing different things; Crypto.com had Lebron James talking to his teenage self listening to Dre, talking about electric cars before telling his younger self to "call his own shots." FTX had Larry David calling out useless inventions like the fork, democracy, and the lightbulb before dismissing FTX (a not-so-subtle dig at Crypto haters). 

And Coinbase had a floating QR code for 60 seconds. The QR code linked users to $15 in free Bitcoin and entered them into a $3m giveaway. Their website crashed, but not before seeing their app shoot from 184th to 2nd overall in the App Store.

(Petrit's newsletter Sporting Crypto broke these down in more detail if you want to go deeper)

🤔 This stuff matters because the mainstream watches the Superbowl. Crypto has gotten outside the bubble, even further than Fintech did, and it's now hyper-competitive. I’d argue Coinbase "won” on pure ROI terms because their downloads spiked so massively. But you have to believe that with the 100m audience watching at home, every major politician was watching the Superbowl too. And that is another step towards mainstream acceptance.

Incumbent Fintech companies and financial institutions must recognize that the ground has shifted or will get left behind, especially as regulatory clarity comes.

Speaking of which:

The Senate Hearing on Crypto Markets was incredibly constructive.

If you haven't watched the entire 2 hours and 23 minutes hearing, then the summary is: 

The CFTC is proposing oversight of Crypto spot markets. Today the CFTC regulates derivatives markets (e.g., Options and Futures) for Crypto after a ruling that Bitcoin and Eth look more like commodities (e.g., Oil or Gold) than they do securities (e.g., Shares). This is why the Bitcoin ETF that launched is based on futures rather than spot markets. This left buying Crypto today in a grey area. 

Companies that sell Crypto must comply with KYC / AML, and some are voluntarily buying licensed exchange businesses to operate futures markets. But the spot market (i.e., buying Crypto right now without a complex contract) doesn't have one accountable agency. It's an open secret that the spot market is full of wash trading and has a high risk of scams, but without a Sheriff, it's left to the industry to try to clean up the act. 

To be fair to the US-based exchanges and wallets, they work hard at this, but Crypto is, by its nature, global, and so US-based companies are battling against international competitors who might not hold the same standard. The committee was super open to this suggestion, and I wouldn't be surprised to see proposed legislation to give the CFTC oversight of Crypto spot markets in the future.

🤔 The US is recognizing its Geopolitical opportunity with Crypto. The politicians asked questions about the dollar's role as a global reserve currency. While the CFTC deferred to the Fed on the dollar's role, they did point out that nation-states may exploit Crypto and that bringing transparency through a regulatory structure that makes Crypto legitimate in the US is the best answer to that. 

Outside the hearing, Bankless (the Crypto podcast) recently hosted an interview with Congressman Tom Emmer (R-Minnesota). In November of last year, the Congressman pointed to the Infrastructure Bill that attempted to tax Crypto mining and had a broad reach. This resulted in every representative and senator getting bombarded with 10s of thousands of calls per day. It became clear that this was an issue the public cared about, and the politicians learned to do it, and the Crypto lobby appeared to educate them on this process.

Lobbying gets a bad name, but the Congressman said it's impossible for one politician to deeply understand every subject they may be asked to vote on. When done well, education from all sides helps them form a balanced perspective.

The industry representatives made points like Crypto is traceable but has regulatory gaps. Democrats focussed on the potential need to "move towards" more clean energy, while Republicans focused on removing intermediaries and individual freedoms. There's something in Web 3 and Crypto for everyone. But my overall takeaway is that the lobbyists have done some hard yards since November. 

🤔 The lobbyists are educating politicians and it’s working. Several big messages are landing in the Senate hearing (and more broadly). It hadn't escaped the politician's attention that when China banned Bitcoin, nearly 100% of the Bitcoin mining shifted to Texas (and ~40% is renewable, which is higher than when China operated mining). To have them bring this up, shows they’re being briefed, and they know Crypto matters at the ballot box.

The BlockFi settlement gives clarity to DeFi.

But maybe not in a good way.

BlockFi settled for $100m with the SEC, potentially setting a precedent on how the US (and global) regulators will view DeFi. If we're unlucky, this is the slow march of DeFi ending up just like traditional finance, but if things go well, then the US, in particular, becomes the defacto global home of Crypto. 

If you're not familiar, BlockFi is a centralized wallet used by 1m+ consumers and 350 institutions to earn a yield on USD dollar stablecoins. So as a consumer, you could make 9.25% APY on the Gemini stablecoin GUSD. The SEC considers these products to be securities "because the users lend these assets to the BlockFi." The SEC also says BlockFi was illegally operating as an investment firm.

From now on, if a company wants to sell yield generating (or interest-bearing) products, they have to file an S1 (equivalent to IPO'ing in disclosure). All of this is possible for BlockFi, a $3bn business; it will just take a long time. The SEC likes to claim it has a 60-day process, but the reality is these things can often take 

🤔 Is DeFi a Security?

They are when offered a centralized entity like BlockFi. DeFi yield generating products look awfully like investment contracts. Investors lend their money to a company like BlockFi, which invests in DeFi protocols to deliver a return. If you bought an S&P 500 index fund from a Fintech company that provides a ~7% yield average, that would be a security (it would also have a not dissimilar risk profile). 

But my beef here isn't with the definition; is with how the SEC has proven its point and the consequences for a nascent industry. 

This is regulation by enforcement. Instead of passing new, thoughtful rules that apply to the modern context, the regulator enforces an old, vague and generic rule. The meaning of the old rule remains unclear, and if you go near it, you may get hit with a lawsuit. Over time, the cases add up, and what is not allowed emerges from the constant legal battles.

This sucks. Yes, it provides regulatory clarity (especially where no court case gave clarity or law has been passed to grant new powers), but there must be a better way.

The consequence of this move by the SEC is to take an in-demand product away from prominent players like BlockFi and Coinbase and give anyone smaller who was thinking about offering DeFi yield a reason not to. When inflation is 7%, and average saving rates are 0.05%, having another option for consumers to generate a return isn't strictly a bad thing.

It's easy to be a cynic about all things DeFi for consumers. The arguments write themselves, "crypto is risky," "you could lose your money," etc. And yes, there are risks, but these can be addressed thoughtfully. The biggest threats to consumers like scams, rug pulls, and smart contract hacks are often managed by centralized actors like BlockFi on behalf of the consumer. By taking large centralized actors out of the DeFi market, the SEC arguably made DeFi more harmful to consumers, not less. DeFi is still there offered by competitors or directly via non-custodial wallets, it’s now just a bit harder to use.

I’d love to see the conversation focus on where the risk is and paths to registration (where required by law) and not damage the prospects of an industry with regulation via enforcement.

First, do no harm.

In the mid-90s, the USA took a different approach to the internet. The principle of "first do no harm" was adopted through what became Section 230. This allowed innovation to flourish and effectively made the USA the obvious home of the internet (at the time, the USA was also the only credible world superpower).

If the US leans into Crypto, had has an opportunity to win the future just as it did in the 90s.

By contrast, the reaction to Crypto is nearly always a mix of fear and disdain from the establishment. Technology is neither good nor bad, but it can be useful. The temptation to slow things down is massive because it buys thinking time for policy and regulation, forcing Crypto offshore and underground.

The value in Crypto has been the product innovation and speed to market. Finance infrastructure is being deconstructed into open source building blocks, which consumers are not harmed by for the most part. Those open-source building blocks are sometimes repackaged by centralized companies that can help manage and prevent risk or harm to consumers. 

BlockFi will be absolutely fine in time. But what about entrepreneurs with an idea for how DeFi yield could work better for consumers? How do they compete now?

Still, I'm optimistic for Crypto's future in the US.

Politicians are now more informed, and for DeFi, there is at least the beginnings of a legal roadmap or path to legitimacy. And consistently, the US private sector has found its way with the rules and regulations through sheer persistence. 

Crypto as an industry has attracted incredible investment, and it would be unwise to bet against an industry with that much firepower. If this industry can afford to dominate the Superbowl with Ads and be the loudest lobby in Washington, it can afford some SEC licenses.

I suspect what happens next will be the emergence of SEC-compliant infrastructure for Crypto and DeFi. We saw in stock trading companies like Apex Clearing, Drivewealth, and now Alpaca and Embed make offering these products much simpler. Companies like Zerohash, Conduit, and the other major infrastructure players like Paxos, Fireblocks, and Anchorage (et al.) could all make DeFi available as an API.

Once again, Fintech skills look so rare for Crypto's mainstreaming.

Crypto is coming of age.

ST.

4 Fintech Companies 💸

1. Moneyhash - Payments Orchestration for the Middle East and Africa

• Moneyhash helps e-commerce and marketplace businesses consolidate their payment providers into a single platform and provides a unified checkout and workflow service. Moneyhash also handles invoicing, payment routing, and currency localization. 

• 🤔 Payments ops are so hot right now because they're displacing what their customers would have had to build anyway. For clients, if it's worth doing but not worth their time doing it, then hiring a payments orchestration provider makes complete sense. Handling integrations to payment providers in the Middle East and Africa is no joke, where the infrastructure is often hard to access, poorly documented, and in many cases slow. 

2. Sprout - VC fund investing for mortals (UK)

• Sprout allows UK consumers to invest in "top-performing" VC funds for as little as £5,000 ($6,770). The platform curates several VC funds, and users can select a fund, invest, and then view the performance of that fund over time. 

• 🤔 Investing in some of the larger VC funds (becoming an LP) is usually reserved for the wealthy or ultra-rich. While there is an in-crowd of operators who invest in up-and-coming early-stage funds (like Nik Milanovic's new fund, for instance), the massive names like Sequoia, Tiger, and a16z are far beyond most mortals. Sprout fits as a sort of crowdfunding for VC. I'm curious how much demand there is for this on both the investor and VC sides? Some publicly-listed VC funds exist, but does making VC an asset class make it easier to digest for the mass market? 

3. Duplo - Payment Ops for African FMCGs

• Duplo allows brands to collect payments, automate payouts and move money between branches and suppliers. Distributors can reduce their theft risk by replacing cash with digital wallets, and marketplaces can enable B2B payments between corporations, distributors, and agents. 

• 🤔 Suppliers of consumer goods (e.g., food, clothing, toiletries) deliver their items to the last mile, including a network of agents and small shops in Africa. So much of this relies on cash and a paper audit trail that risks theft, fraud, or forgery. Duplo is providing digital tools for the economy that's already happening.

4. Diagonal Finance - Non-custodial subscriptions (Web 3)

• Diagonal allows anyone to create a subscription service on Ethereum "in as little as 5 clicks." Diagonal is "non-custodial," meaning it never sits in the flow of funds. The software creates a set of rules to pull money from one wallet and send it to another on a set schedule with no intermediary. 

• 🤔 Subscriptions have been the lifeblood of Web 2 SaaS business. Everything from Superhuman to Netflix runs on payments and subscriptions infrastructure from companies like Stripe and Adyen (and many others!) Diagonal essentially allows anyone to create a subscription in seconds. With all these emerging Web 3 primitives, who will use them and how they evolve remains to be seen, but it's all just so interesting.

Things to know 👀

1. Affirm shares plunge after results leak

• BNPL provider Affirm posted results that saw their operating costs double, and its net losses increased significantly above market expectations. Against this, Affirm says it has 20x more merchant partners and doubled its consumer user base. Revenue jumped to $361m, with operating costs of $577m. One-third of Affirm revenue came from Peleton, which is now struggling with its own sales. Affirm says Peleton will make up less than 10% of revenue in the coming year. 

• 🤔 BNPL isn't dead, far from it. The whole Tech sector is getting clobbered, and Affirm is seen as having too much customer concentration (1/3rd of sales are from Peleton, which is also down). But the revenue growth is still coming, and of everyone in Fintech, BNPL providers are still best placed on building the flywheel between merchants, consumers, and shopping data. 

• 🤔 Appealing directly to consumers is the critical battleground for BNPL and all financial services. BNPL providers are becoming shopping apps that do financing rather than financing apps that do shopping. The shopping app is key to getting the data that re-activates consumers, which delivers the ROI for merchants. As they move into physical stores, I'm curious if the flywheel and conversion rates hold up.

• 🤔 Affirm is showing the downside of customer concentration. Marqeta grew with Cash App, Galileo with Chime, Affirm grew with Peleton. This power law in the growing customer segment is fantastic if you're a supplier and your customer is growing but has the opposite effect if they don't. That said, lending and payments are very different businesses. I doubt Cash App volume would fall as Peleton has.

• 🤔 Afterpay timed their exit well. That's it, that's the whole thought. (Also, so mentioned before, Block is now super well placed in the "data flywheel" of a merchant, shopping app, and consumer).

• 🤔 The BNPL regulatory headwinds are no joke, and the Fintech industry doesn't yet lobby in any meaningful or effective way. In the UK, the regulator is already insisting BNPL providers update their terms and conditions, and that's before any proposed rulemaking. And we know the CFPB has an active inquiry into BNPL providers, which will undoubtedly lead to rulemaking. All of this could take 5 years or more to appear, but there's a high probability BNPL providers are pushed to do more. The US Fintech industry has two lobbying organizations (both well run, with great teams) but minimal participation from the industry. The bank lobby, by contrast, is exceptionally well funded and effective. Fintech companies need to up their game on this, and 1033.

2. FIS has Acquired Payrix

• OG Fintech provider FIS has acquired Payrix, the payment acceptance provider for vertical SaaS platforms. FIS also announced 4th Quarter and full-year results, showing revenues up 10% for the full year to $13.9bn, with $6.1bn of EBITDA (or a margin of 44.1%). Despite this, FIS shares traded down more than 10% after announced results. 

• 🤔Payrix gives FIS access to a market they had little right to compete in. The "vertical SaaS business that embeds finance" has seen an explosion of growth. The PayFac-as-a-Service space (including Finix and Infincept) drives revenue for those vertical SaaS businesses. To deliver for this customer base, providers need clean, developer-focused APIs and a natural appeal to that customer base. Traditional merchant acquiring companies (even like the mighty Worldpay) struggle to play here credibly.

• 🤔 FIS has done a great job growing via M&A. Acquisitions like Clear2Pay, WorldPay, and now Payrix has helped them expand footprint and revenues. They operate core banking platforms, merchant acquiring, and card issuing platforms. This is a model others can follow, as we inevitably see these conglomerates emerge. Interestingly, their customer base seems to age with them, only for a new supplier to sweep up the next generation of growth customers. Incumbents don't die; they erode.

• 🤔 Payments (and core banking) is a great business. At a market cap of $62bn, FIS is trading at 4.5x revenue or 10x EBITDA. Over the past 5 years, their share price has been essentially flat; this is the very definition of a yield stock where investors look for high profit and high dividends. But it also shows the growth potential of the new market entrants like Marqeta, Galileo, and Lithic to diversify their offering and revenue pools over time. 

Good Reads 📚

1. Braintrust - Fighting Capitalism with Capitalism

As with everything Packy writes, my summary won't do it justice, and you should read it. Still, the future of consulting is directly relevant to the future of finance, and especially incumbents.

• Braintrust is a perfect case study for Web 3 and the change in ownership means for internet business models. Packy introduces Braintrust, a "user-owned talent network" that, since launch, has produced $37m in GSV (Gross Service Value, what its client pays the talent in its network). While its web page looks like a way for NASA, Nike, or Deloitte to hire freelancers, Braintrust is different because it all runs on a BTRST token. 

• Web 3 disrupts traditional internet economics. The token re-inforces the low take rate, which allows something like Braintrust to compete with traditional talent marketplaces like Upwork. Clients use Braintrust to hire high-quality talent for a low industry fee (10% markup) and find talent in days, not weeks. Talent uses Braintrust to find high-paying work at top brands and work their own schedule. Talent also earns BTRST tokens, which allows them to vote on the future of Braintrust itself. These tokens are also rewarded for doing things traditional marketplaces hire for, like vetting new talent. 

• 🤔 If you want to see the future of consulting, look at Braintrust. Having a single brand large clients can interact with has tremendous value, but the consulting model runs on a pyramid. The incumbents put out "thought leadership" and have genuinely smart people but make most of their profit from selling lots of junior talent at a high margin. Braintrust focuses on high-quality talent and keeps its costs as low as possible by making the talent part owners of the service.

• 🤔 IP is another key battleground in consulting, where anything the smart people come up with is owned by their employer. So often, a framework is developed and then used with all clients at scale (e.g., the Gartner Hype cycle or Mckinsey's 3 horizons). Twali is an exciting twist on this take. Think of Twali as Braintrust, but the outputs are stored as NFTs owned by their creators and referenceable for other clients with automatic royalty payments.

• 🤔 One of the most broken things in financial services is its supplier ecosystem. Large consulting businesses always have an incentive to sell more bodies whether there is a value add or not. In many cases, incumbents have become desensitized to $100m projects that take 5 years to deliver because that "feels credible." These organizations' talent often work hard to help regulated, slow incumbents do more, but the incentives are still broken. When new tech meets a new business model, industry disruption often follows.

Tweets of the week 🕊

That's all, folks. 👋

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