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  • Fintech 🧠 Food - Jan 10th - $40k Bitcoin, Sofi SPAC, Divvy & Mambu raise and the father of fintech

Fintech 🧠 Food - Jan 10th - $40k Bitcoin, Sofi SPAC, Divvy & Mambu raise and the father of fintech

Hey everyone 👋, thanks so much for coming back for more brain food, covering four Fintech's that caught my eye this week, an in-depth look behind some of the biggest stories and best content of the week. It's the "I know kung-fu" version of what happened in Fintech. Apparently. :)

You're going to want to check out the tweets this week, some absolute gold in there.

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Weekly Rant 📣

We'll regulate crypto into legitimacy, but we need to be careful in the process. Crypto is a messy teenager with unlimited potential that's creating an alternative financial system. Where fintech is a 1.5 technology that created a layer above the legacy infrastructure, crypto is finance infrastructure 2.0. In 2021, we'll see these lines continue to blur.

Why? 

Crypto is overcoming its detractors. 🎢

Traditional bankers tend to get quite riled up about crypto and Bitcoin in particular. That's why it stuck out this week when JP Morgan put out an analysis with a $146k Bitcoin price target. This from the bank whose CEO once called Bitcoin "poison."

You'll hear the same arguments against Bitcoin from a certain type of banker: "It has no intrinsic value," "it's too volatile," "it's only used for crime". These arguments have been around since 2013, and yet Bitcoin isn't dead. So quickly:

  1. Bitcoin doesn't need intrinsic value. Bitcoin isn't a currency with a central bank, so it doesn't need intrinsic value. The CFTC named Bitcoin a commodity in 2015. As a commodity, its price is driven by supply and demand. Bitcoin has a fixed supply that halves roughly every four years. The parabolic price movements follow these halving events almost perfectly. It's surprisingly predictable.

  2. Volatility is a feature, not a bug.  Bitcoin may have set out to be a "currency" in its original whitepaper, but it behaves much more like a commodity. The fixed supply is a design choice; it's intentionally different from fiat currencies, which can have an unlimited supply.  

  3. Bitcoin has remarkably little crime when compared to the global financial system. In fact, except for a brief scams spike in 2019, Bitcoin is average 0.5% according to data research from Chainalysis. These numbers are less than you might expect in the global financial system, ranging from 1 to 2% fraud or suspected criminal activity. If you want to get caught doing a crime, use a system that permanently records every transaction in public.

So if Bitcoin isn't too volatile and just for criminals, we have to look deeper to see what's going on. 👀

  1. Investors are going risk-on: Post financial crisis, post-pandemic, the sheer amount of money printing has forced investors to go "risk-on," searching for riskier assets that drive a higher yield. As a result, investors move out of cash and US Dollars, decreasing in value and towards tech stocks or even Bitcoin.

  2. Driving institutional demand: I covered a couple of weeks ago Mass Mutual and Square treasury now holding Bitcoin. This is just the beginning; in 2021, we will see many Fortune 500 names follow suit.  

  3. Enabled by mature infrastructure: There are now banks and new entrants who offer crypto custody (safekeeping), insurance, and GAAP accounting. When you put the jargon aside, that means big institutions feel confident they could buy Bitcoin like any other asset.  

  4. And a surprisingly robust regulatory framework: It is a complete myth that Bitcoin is "unregulated". When someone makes a Bitcoin transaction, it must comply with AML / CFT rules in all jurisdictions. Every developed economy has a framework for understanding what type of asset it is and what rules apply.

Regulated into legitimacy 👩‍⚖️

This week the OCC gave some groundbreaking guidance for banks and the future of payments.  

It allows banks to 

  1. Access public chains (Eth, BTC)

  2. Hold coins from these rails directly or on behalf of clients

  3. Run a node for a public chain

It's hard to overstate how significant that guidance is. 

Despite the CFTC and FinCEN guidance, banks were incredibly risk-averse to crypto. In the US, outside of a handful of smaller banks (e.g., Silvergate), it has been near impossible for crypto businesses to access the banking system. The mainstream banking system now has clear guidance that it can work with crypto and public chains.

Given the demand for crypto from institutions, large banks can now become prime brokers and custodians for crypto assets. We may even see crypto start to show up beyond Fintech. Perhaps in your favorite Neobank? Traditional brokers?

Although new AML rules are concerning 💔

In the same week, FinCEN is seeking feedback for new guidance on regulation for "unhosted wallets" (or non-custodial wallets).  

My shortcut mental model here is a hosted wallet (e.g., Coinbase) is where someone else holds your bitcoin on your behalf and you login. An unhosted wallet is like the leather wallet in your pocket; you manage it.

FinCEN proposes that all unhosted wallets be subject to AML / CTF limits, meaning the maximum someone could send or receive from an unhosted wallet would be $3,000. Anything about that amount would require a legal identity. That's the same as the maximum someone could bring to a bank branch before requiring a KYC process.

There's a big difference, however.

An unhosted wallet is like your leather wallet, not a bank branch. Unhosted wallets perform several innovative functions in the world of crypto. By enforcing antiquated AML rules, we may damage innovation in ways regulators perhaps haven't realized. 

Let's set up a trade where three parties are betting the oil price will go up, and two parties are betting the price of oil will go down. Because it's a bet on oil's future price, none of these parties want to buy the oil outright. Instead, they're willing to stake a small percentage (margin). In the traditional finance world, the simplest way to manage this complex trade would be with a middleman. The middleman takes margin from all five parties, and on days when the price goes down, pays the people who bet that it would go down some of that margin (and vice-versa).  

It turns out that with decentralized software, we don't need the middleman anymore.

An unhosted wallet can be quickly created by software and store value (the margin) from multiple counterparties while a complex trade occurs. The software is just doing what its code tells it to do. Read the oil price and make a payment to whoever wins the bet on that particular day.

All of this happens without an intermediary. The creator of the software has no control over what happens next.

It's like if we all put our money in a leather wallet, but that leather wallet was intelligent enough to manage trades and payouts by itself with its own consciousness.  

If the software is running as designed but has no single legal owner, how do you enforce KYC? Who do you KYC?  

So while I understand the motives that FinCEN has to try and prevent criminals from moving value around the world in unlimited quantities with no regulatory oversight, I worry we're throwing the baby out with the bathwater.

KYC was built for an analog and paper-based world. We now have global, digital technology that provides us with new options and opportunities.

The transparent nature of crypto networks, combined with policing the exchanges and hosted wallets, provides significantly more powerful tools than we have in the legacy financial system. Initiatives such as InterVASP.org and Global Digital Finance aim to create standards for the crypto industry to manage risk in a much more effective way. Let's use what the tech can do, be thoughtful about privacy, and produce better outcomes.

Crypto does still have some significant challenges.

Bitcoin and the crypto community can be fantastic, but it can also be bombastic, loud, and frankly odious. People who don't know what they're doing can easily find themselves in financial trouble with complex products, emerging coins, and scams.  

Most crypto networks also show every transaction ever in public, with the wallet address viewable to everyone. There are ways to manage privacy in this world, but far from being a privacy utopia, crypto could bring the opposite if we're not careful.

What has any of this got to do with Fintech?

Fintech 1.5 sits above the legacy financial infrastructure and abstracts the pain with better design, better APIs, and hopefully, better outcomes.

Crypto as 2.0 is providing an alternative financial infrastructure. What happens finance infrastructure is a global public good owned by no one single entity? The most exciting part of that question is I don't think anyone knows.

Meanwhile, companies like Square and PayPal are making crypto backwardly compatible with the existing system, while Defi is re-imagining how financial infrastructure could run if we had no intermediaries.

In 2021 we'll see these subjects blur more as crypto continues to soar, and mainstream media attention increases.

Of course, when crypto does inevitably crash, people will exclaim "tulip mania" and "it was always a scam!" But slowly, quietly, we're building an internet native economy. And that's exciting.

4 Fintechs 🤑

1. Perch - Build credit by paying bills on time

  • Credit builders keep popping up. Companies wouldn't be doing this unless there was user demand, and it makes sense. Credit agencies weigh scores heavily on people who already have credit. Younger people tend to have many subscriptions they're paying on time but don't have many credit products. Perch is an app for now, but with investors like Sequoia, Citi, and Softbank - I wonder if they end up as another B2B API or Plaid acquisition.

2. Oxygen - The bank for people with multiple incomes

  • 35% of the US workforce is freelancing, and if you include side hustles and the gig economy, it's nearly 50%. Personal or business accounts don't cover the needs of people whose finances are interwoven with their company. Oxygen has built a platform for personal and business finances. It lets users set up a business (like Stripe Atlas) as part of the account opening flow. They just raised $17m and joined folks like Catch in an emerging wave of SMB and freelancer accounts popping up in the US. If it follows the UK trend, this sector could be much more profitable than consumer Neobanking.

3. Tint - No-code & API based insurance as a service

  • Tint has a platform for non-finance companies to add insurance to their offering. Early use cases include ride-hailing and delivery apps, adding insurance for their drivers. Tint allows the user to design the insurance product and provider's underwriting. A market place of insurance companies then provides the insurance itself. Let's see if this takes off like banking as a service has.

4. Juno - Neobank with 2.15% APY checking 

  • Juno is another Neobank, digital-only, and competing on rates. No minimum balance, no hidden fees. The product also features a neat 5% cashback on top brands like amazon (up to a limit of $500 per month). All of this reads like a great acquisition strategy. Still, even running on top of banking as a service and Evolve Bank & Trust, I wonder how OnJuno ever hits profitability. Yes, they can make money on interchange, but can they cross-sell? It's becoming very crowded. That said, the USA has over 5,000 banks, and there's money to be made in being a better bank that can cross-sell. But how many more Neobanks can the market sustain?

Things to know 👀

  •  Fintech startup SoFi says it will merge with a special purpose acquisition company, or SPAC, backed by venture capital investor Chamath Palihapitiya. The merger with Palihapitiya's SPAC values SoFi at $8.65 billion. Palihapitiya has taken multiple companies public through SPACs, including Virgin Galactic.

  • 🤔 My Analysis:SoFi is claiming to be the "AWS" of banking, a "winner take most" game. I don't think it's that simple.  Sofi was a cheap student loan re-financer, and Galileo is a strong banking-as-a-service player. There's a long, long way to go before that's a platform in the way AWS is.  Sofi looks more like Marcus by Goldman, a specialist lender with outstanding APIs (albeit a lot further ahead on the APIs).

  • 🤔 My Analysis: Sofi has proven it can cross-sell but will need to add features and depth.  Being a lender, do they end up with a LendingClub / Ondeck multiple, or do they become a proper "as a service" player with a balance sheet and license? Right now, the strategy appears to be to do both.

  • 🤔 My Analysis: They're aiming for a bank charter, so I can see how over ten years, if they can keep the growth up, expand their product offering and platform offering, they could become an embedded finance business that also has a consumer brand.  Maybe it's because of how fresh the Galileo acquisition is, but the strategy still feels messy. 

  • 🤔 My Analysis:The wildcard here is inflation.  If we see inflation through '22 / '23 and interest rates rise, Sofi might be best placed to have an embedded payment and lending business.

  • Divvy provides card and expense management software for small businesses. This is an incredibly hot sector, with Ramp having raised recently and Brex doing its thing. Divvy intends to bake much more vendor management, financial processes, and credit all into its service.

  • 🤔 My Analysis:Many startups are now playing for the "growth business" end of the market, which is a great place to be.  Stripe and Shopify have both consistently done well targetting the small and growing merchants of the world.  I wonder if there's an "Adyen play" to be made here. Going after the larger corporates, or being the product someone graduates to after Divvy?  If it's out there and I haven't seen it, drop me a note, [email protected] :)

  • Mambu sells software to banks, both big and small, to help them develop their own digital banking platforms. The company said its valuation rose to 1.7 billion euros ($2.1 billion) in a 110 million euro funding round. The news comes at a time when digital banking adoption has been accelerated by the coronavirus pandemic.

  • 🤔 My Analysis: If there is a front runner to be "the next nCino" its Mambu. Mambu has been at it since 2011, and slowly grinding their way to growth with real customer implementations like Oaknorth and N26.

  • 🤔 My Analysis: Incumbent vendors in core banking sell long contracts where the cost of change is considered very high. Mambu started with smaller micro-finance organisations across Africa and Europe before graduating up through the European Neobanks.  

  • 🤔 My Analysis: No doubt this investment is about coming to the USA and expansion. In Europe, it's now common for Mambu to be in the conversation when a bank is looking at a core transformation, but less so in the US.

  • 🤔 My Analysis: Thought Machine and 10x are the two most well known competitors in this space, although there's a smaller emerging pack and we could start to see the banking software stack get a lot more interesting in 2021...

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PS. This week BBVA is to close Simple, a pioneering Neobank.  The outpouring of affection for the brand, former employees, and the impact Simple had on the whole industry has been something to behold. Simple may not have the user numbers Chime, Varo or Current achieved, but they changed the game.

Also, this thread from Shamir is gold.

Good Reads

  • Visa was founded by Dee Hock, a man who deserves credit as the Father of Fintech. Hock was the man who realized that BankAmericard was creating a "tit for tat" war of fees and a bad customer experience, preventing adoption. Hock realized Visa wasn't in the credit card business, but the moving value business.

  • Moving value required three things 1) Identify the buyer to the seller 2) Guarantee that the transaction would be faithfully recorded 3) Transfer the value. Visa's market cap per employee than many canonical big tech businesses. 

  • 🤔 My Analysis:  This is such a strong piece because it speaks to the value of first principles thinking.  The value of "trust" in a logo that a transaction will work, and the outcome will be expected on network effects are incredible.  Hock's insight is a lesson for anyone building in crypto or payments today. There are many debates about speed or cost, but it comes down to Hock's three principles.

  • 🤔 My Analysis: Marc alludes to Hock's issues with BankAmericard applying to Bitcoin (and crypto) today. I agree.  While PayPal and Square will help with consumer adoption, crypto payments rails need a level of trust.  That trust could come from a logo, but the logo must deliver identity, faithful rule-following, and faithful transfer of value. It may even be the card schemes themselves that play this role. However, I'd be super interested in seeing something more decentralized we can do to create a similar outcome.

Tweets of the week 🕊

That’s all folks 👋