Fintech 🧠 Food - 9th May 2021 - Marqeta IPO Price, Wealthsimple raise, A core banking primer & why exponentials matter in finance

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 5,776 others by clicking below, and to the regular readers, thank you 🙏

11:FS launched a new report, rebuilding financial services from the inside. We discuss why banking tech is broken, why the pace of change is a power law and why despite spending billions, incumbents do not see earnings growth.

Wanna see? 👉 Download it now. 👈

This report was a labor of love; the team worked super hard on it. Regular readers will recognize many of the core concepts. Please do reach out with your thoughts and share widely.

Weekly Rant 📣

Exponentials matter in finance

The world is changing pretty fast right now.

The weird thing about when the world changes is; it's slow then sudden.  Disruption works in exponentials.  If the past 15 months have taught us anything, it's that exponentials can kick your ass.  

An exponentially growing virus feels like something to ignore; the numbers are too small to change what we do as a society, then suddenly, everything changes.

This is exactly what happened with fintech vs traditional finance.

When Square and Stripe both launched in '09 and '10, the mainstream financial services reaction was to use the existing business model to judge these new businesses. You'd hear things like  "That dongle is cute, but customers want security" or "Customers care more about price than APIs ." 

From 2009 to 2015, incumbents punted the opportunity to do digital properly.  Post financial crisis, the focus was on using digital as a cost-reduction mechanism. Incumbents again started at their distribution model and their assumptions about their customers and built mobile experiences that looked like their web experiences on a smaller screen.

On analyst calls, you'd hear about "cost as a key battleground" and a focus on "digitizing" what they do. While every incumbent financial service company had an innovation lab, the rubber always met the road when it came to delivery. All new products had to fit the business model and leverage the existing "at scale infrastructure."

Playing economies of scale game in a market to go through an exponential shift is the wrong strategy. Banks can't turn the lights off on their existing revenue-generating business lines. Still, the mistake was (and is) to judge new business opportunities by the demands and KPIs of the current business.

The fintech companies focussed on where the exponentials would be.

So by 2015, most banks had reasonably good apps, meanwhile, quietly, Square began to serve its merchant customers, and Stripe focussed on "growing the GDP of the internet."  

By 2015, at best, the senior leadership of financial services companies would point out that fintech companies had built great experiences, but incumbents could copy those experiences. Indeed, customers would value a great digital experience from a brand they "trust" (don't get me started on that word btw).

Again incumbents missed the point; by copying the appearance of digital success rather than what made the success, incumbents saw the fintech companies as less profitable versions of themselves. 

I recently spoke to a C-suite banker who's been pushing for innovation in their organization for some time. They described the broader C-Suite reaction to fintech companies as "aww, you're so cute, look at you with you're $5bn valuations and your APIs."

As those fintech companies crossed $100bn, the reaction is more astonishment and a sense of unfairness. "How come they get such a high valuation multiple, and we don't? We're profitable! The market is a bubble!"

Those exponentials have now come to financial services.

Fintech companies are now the largest finance companies. In earnings calls, you hear CEOs being asked about their response to fintech companies. (Often this includes moans about "not having a level playing field," but there is genuine respect for the size of these companies.)

The lesson here is that your existing biases are the problem when the world changes.  

Don’t get me wrong, a bank CEO has a hard job, their biggest investors see them as a yield stock, and analysts ask them about digital. The critical metric for bankers is the return on tangible equity (ROTE), which has a weird side effect, making them often say no to growth business models and ideas.

Things that are good for most businesses are bad for banks.

It turns out the metrics you use (and are measured by) matter. If you're a NASDAQ-listed tech company (even if you do finance), the metrics that matter are CAC, LTV, and net revenue retention. If you're measured like a tech company, you can grow like a tech company and be valued like a tech company.

So how do incumbents get some of that sweet, sweet exponential growth?

I suspect the answer isn't in the existing business model.

But now the twist.  

The same exponentials that happened between Fintech and Finance are now happening again between Crypto and Fintech. This time there are “incumbents” like Robinhood, PayPal, and Square trying to add crypto to their offering, but the real innovation is in the infrastructure.

There’s an interesting divide in Fintech. Either you embrace crypto as a sister trend of fintech, or it’s somehow less legitimate. This second viewpoint, that crypto is somehow less legitimate than fintech is surprisingly common. Is there a risk that some of the big Neobanks don’t add crypto and become the next round of incumbents? What happens to the big tech companies that wanted to embed finance?

Who disrupts the disruptors?

The consistently brilliant PackyM wrote a piece a couple of weeks ago about who will disrupt the existing big tech hierarchy. The core idea is that Web 2.0 has dominated the last decade with cloud, social and mobile on centralized infrastructure. Web 3.0 will be decentralized (to be fair, this idea has been around for about five years, but Packy articulates it brilliantly).

The volume of talent moving into Web 3.0 and crypto from fintech is massive in the past six months. Yet there is an "old guard" of fintech companies (and tech folks) who are convinced crypto will fail, that inevitably the market will crash and life will return to normal.

I had a front-row seat to Fintech vs. Incumbents, and from where I'm sitting, crypto is more exponential than fintech has been in the past decade.  

Yes, crypto prices could crash, but the innovation is staggering if you're one of those on the fence. Consider, are you looking at crypto with your existing biases?  

The most significant metric for crypto projects isn't CAC or LTV; it's the size of their community, total value locked (TVL), and how strong a project's meme is. If that seems weird or cute, again, are those your biases?

I was also head of Blockchain R&D for a bank and an early Eth community member, with another front-row seat, things look familiar.

Crypto will re-make fintech, by changing the underlying infrastructure. For me the biggest questions are how, and when, not if.

ST.

4 Fintech Companies 💸

1.Gr4vy - Payment Orchestration Platform

• Gr4vy isn't SaaS; it fits inside the retailer's infrastructure and helps them "route" payments with a no-code platform and toolset.  Every retailer or company that accepts payments ends up having to build software to route different payments. The more payment types they receive, the more complex this software becomes.  

• I'm a fan of how Gr4vy creates a client-managed instance of what they do rather than offering SaaS.  SaaS will always trade control for time to market.  I expect we'll see a similar trend in the BaaS platforms, where short-term, time to market wins, long-term control, and flexibility wins. The platforms that offer both will be the most compelling.

2.Alt bank - Brazilian Neobank for the Unbanked

• Alt bank is designed for the illiterate; instead of words, users can follow color-coded prompts to complete a transaction.  Alt bank already offers debit, prepaid, savings, and even Dr's visits (via a partnership), with 1m downloads so far. 

• If the benefit of fintech is driving a real social mission, there is so much to learn from Alt Bank.  I love that they're partnering with medical services and offering discounts on drug stores. If you're building in emerging markets, this is one to watch.

3.Qredo - Lastpass for Crypto (Institutions)

• Qredo is a decentralized custody platform. Meaning, it helps ensure assets are stored, transferred, and managed securely, without ever holding the assets on your behalf.  Today institutions (e.g., brokers or investors) trying to buy or sell crypto have to choose between retail wallets, cold storage, or centralized exchanges).

• With Multi-Party Computation (MPC), users don't have to manage keys or be concerned about managing exchange passwords.  Many centralized custodians also offer MPC (e.g., Fireblocks), but Qredo aims to win over the true believers in decentralization by decentralizing this.  I always worry that "decentralize all the things" is impractical in the short term, but right as a long-term trend. Crypto market structure has a long way to go, but Qredo is worth looking at if you follow the space.

4. Yup.io - A Social Network for Curators

• Yup allows users to curate and share content from across the web and get rewarded for doing so.  Yup tracks likes and other reactions, content is shared on a user's profile, and then if other users "curate" the same content, a user is rewarded with tokens.

• Most internet users don't create content they curate (consider Brainfood, for instance). But this curation activity isn't as rewarded as creation.  By creating a token, Yup is essentially turning influence into a market.  Yup uses social consensus to calculate how influential any user is.

Things to know 👀

1. Marqeta rumored to IPO in June

• According to business insider Marqeta is due to IPO in June and will file paperwork on May 14th.  The expected valuation at IPO is between $10bn and $15bn, which would near triple their last round in May 2020.  Marqeta is the payments processor for companies like Doordash, Instacart, and Square.

• 🤔 My Analysis: Marqeta (alongside Galileo) can rightly take credit for leading a lot of the fintech debit card innovation we have seen in the past decade in the USA. Before Marqeta worked with a payments processor was a confusing menu of choices, prices, and things to consider. Marqeta "productized" the debit card offerings and reduced cost and time to market by taking options away. Once again, often, it's not what you add but what you take away that matters.

2.  Wealthsimple raises C$750m

• Wealthsimple began as an online investing platform but has expanded into crypto and P2P transfers in the past year. Wealthsimple has more than $5bn assets under management and roughly 1.5m customers.  Wealthsimple is also available in the UK and USA.

• 🤔 My Analysis: In the past year, anything that looks even vaguely like Robinhood has done well; it is no surprise to see Wealthsimple pick up momentum as users flock to investments and crypto

• 🤔 My Analysis: Feature breadth is a key battleground in fintech, and everyone is trying to become the fintech super app.  

• 🤔 My Analysis: Isn't it interesting how underdeveloped the Canadian fintech market is relative to other markets?  A concentrated banking market, with glacial regulatory change.  I predict this will change in a big way in 2022.

Good Reads 📚

1. The Goldman of crypto

• Bank analysts are increasingly asking bank CEO's "What will you be doing to meet the demand for crypto" which is a massive shift in focus in the C-Suite vs. just a year ago. Due to regulation, other than being an on-ramp for consumers, there aren't many easy "institutional-grade" products banks feel comfortable offering in crypto.  While some banks are dabbling with futures and custody, none have yet gotten into offering trading and lending, the core investment banking products.

• Galaxy Digital, launched in 2018, is an old-fashioned merchant bank, where principal trading, client execution, and advisory are all done under one roof. With the significant increase in institutional demand, Galaxy Digital has been hiring substantially in six months.  Within five years (or less!), the largest institutions will inevitably want to trade all of their assets via one set of desks they trust (e.g., their big banks), but Galaxy Digital is well placed until then.

• 🤔 My Analysis: Banks are risk-averse by nature, but they're also businesses.  Crypto demand is now real in banks' institutional client base, and the investment banks are best placed to serve that.  (See: Just this week Citi saying precisely that)

• 🤔 My Analysis: If Galaxy is Goldman, who's the JPMC of crypto? JPMC plays a massive role in payments, clearing, and settlement. In other words, the money is moving after all of the trading. In Defi, in theory, the network manages this, but to do it securely and at scale, there's a role for the "payments monster" of crypto without operational overhead.

• 🤔 My Analysis: The on / off-ramp between large financial institutions existing infrastructure and crypto will be key in the next five years.  Getting banks $trillions and $quadrillions into Defi is a once-a-generation opportunity, but banks have very complex systems and regulations to manage. Companies that can go deep in banks and pull that liquidity into Defi are selling shovels in a gold rush.

2. A core banking primer

• This primer describes the core business model of banks before giving an overview of legacy banking systems.  They use the Gartner definition of a "core" banking system that processes daily transactions, stores deposits, savings and creates loans. The core also interfaces with the bank's general ledger (the accounting system used by the bank).

• Software is added on top for other functions (e.g., Payments, CRM, risk management, and other add ons). Historically all of these services were offered by a single vendor. The US core banking market is highly concentrated, with Finastra, FIS, Fiserv, and Jack Henry holding 95% of the core banking market share as recently as 2017.

• The primer makes a case for "new core software" as a competitive advantage.  Modern cores are cloud-native, modular, and don't have to duplicate customer data; they are also better placed to enable embedded finance. The primer then discusses the role Defi could play in moving from cloud-based infrastructure to decentralized. 

• 🤔 My Analysis: This primer is correct in its analysis of historic cores and the benefits of some cloud-based cores.  But my issue with nearly everything involving "core banking" is the definition of what core banking is (which isn't the author's fault). Most "modern cores" have started with the Gartner definition and built a much better version of that.  When you stand bank and look at what banking is, having a "core" doesn't make sense.  

• 🤔 My Analysis: My advice with banking software is to consider what a bank is, what it needs to do, and what design pattern is most effective to achieve that. Various cloud-native "cores" answer for some of that, but they are only ever a part of the answer.  If you're building a bank (with a license), a core, even one with lots of great partners (like, say, Mambu) still leaves your engineers with a lot to do.

• 🤔 My Analysis: Instead of re-designing "core banking," the trick is to rethink banking from first principles.

• 🤔 My Analysis: There's also a trick played by the legacy core vendors on all banks that is bullshit. They claim their platform "is regulated". It isn't. It has just been used by a regulated bank before.

• 🤔 My Analysis: If you're in a bank thinking about a core replacement, my advice is: 1) Define what the future of your business needs to be able to do. 2) Think longer-term; how will every vendor, platform, and tool be replaceable if you have a new system of record? Including the "new core"!

Bonus links

• This podcast with Alex Rampell on the history of Visa as "the first financial protocol" is well worth a listen. Excellent explanation of the model.

• Reverse engineering Revolut's strategy. Revolut appears to be Blitzscaling in every market with every finance product, but why? Aika gives some thoughts and context here.

Tweets of the week 🕊

That's all, folks. 👋