Fintech 🧠 Food Presents: The State of Fintech 2023

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Hey Fintech Nerds 👋

I hope this finds you well.

What a year it has been.

Another week of brutal layoff news as winter hits tech and Crypto more broadly.

But this has been a good year in a lot of ways, a required year. A year we return to fundamentals, focus on building businesses that create value, and remember there's much more to do.

On a personal level, it has been a massive year. A big change in the day job, the fortune of meeting many of you, and this little newsletter hitting 25k subscribers, up from 10k in Jan 🚀.

That's huge! 

Frankly, I’m humbled any of you read this waffle. But thank you 🙏

This is my last Fintech Brainfood of the year. I'd like to hear your thoughts as we head into next year.

What did you enjoy?

What do you get most value from? 👇

Take the 2023 Brainfood reader survey.

I hope you all have the best possible holiday period, and I’ll be back next year.

So with that, what does the next year have in store for us?

Crystal ball time.

Weekly Rant 📣

The State of Fintech - 2023 and Beyond

If there's a consistent theme in all technology and Fintech, it's the low hum of fear. Layoffs, down rounds, and companies looking to sell couldn't be more different from where we were a year ago.

2021 was euphoria for anyone in Tech or Crypto. 

A sure-fire sign was in October 2021 on stage at Empire Fintech; we ran a debate called "Are we in a Fintech bubble?" With Fintech VCs and operators, even the team AGAINST the Fintech bubble had to look at a longer time horizon and talk about local maxima (Looking @ you Nik). 

Yes it was a bubble.

It couldn't last.

What will last?

Financial Services is the world’s largest TAM. Money touches everything.

But is it destined to belong to the incumbents forever or can it be disrupted?

For this Rant I looked across several key themes from the Fintech industry:

1. Macro

2. TradFi

3. Embedded Finance

4. Unit Economics in consumer and B2B Fintech

5. BNPL

6. Lending broadly

7. Fraud & Compliance

8. The UK resurgence

Macro 🌍

Fintech was hot when funding was everywhere; now what?

Tech was too hot and needed a correction, but it's important to remember 2022 has also been an outlier year where both bonds and equities underperformed

In the year where everything is down, of course, the "risky" growth stocks are down.

But Fintech companies also continue to grow and build franchises that can stand the test of time.

I noted that Wise is hiring 100s of staff, and Starling is hiring another 1000. And you have companies like NuBank, SoFi, and Bill.com, that continue to deliver "Rule of 40" growth. Fintech is still an earnings growth monster.

But there is no question that some companies yet to hit profit and to see declining growth are in a more difficult position that went public or late stage and didn't make it to IPO.

Going into 2023, Morgan Stanley and Goldman are predicting Fed rates peak in Q1 2023 before falling slowly back to 2% in mid-2024 as inflation comes close to the target of ~2 to 3%. 

Insights: 

• Earnings growth and profitability solve everything

• 2022 is the inverse of 2021, and things will revert to the mean

• We should start to thaw in Mid 2023

• Macro will trend to a slightly more inflationary 2018 baseline over time

The TradFi comeback 💪

Rising rates lift all boats or a return to the good old days?

Banking stocks had been the poor performer for the past decade but have had a return to form as investors look for value. To this date, most banks trade below their book value. Could rising interest rates signal a new golden age for banks?

As interest rates rose, the core lending business of most banks became more profitable overnight, significantly as the savings rate didn't rise as quickly. Banks profitability is driving growth, but according to Mckinsey, the vast majority trade below book value and will continue to do so. So no new golden age then.

Not all banking activities are created equal. The performance varies by geography, size, and specialization. Asia Pacific is naturally a more profitable banking market, but Europe is the opposite. Mckinsey describes a "two-speed system" in which traditional banks are left behind, and specialists begin to carve out profitability. They note the "value-creating" banks" are typically smaller, specialist, and could look at M&A (which I'm sure McConsultants would be happy to write a strategy for 😝)

It's amazing to lend while the spread between deposits and lending is so high. But when interest rates are high, there are fewer consumer and SMB buyers of debt. If companies and consumers default, banks start to take those losses. 

Fintech has also normalized no-fee, high-tech, digital-first banking experiences that not all smaller and regional banks can keep up with. Fintech has also created "deposit leakage" and turning banks into "paycheck motels" (per Ron Shevlin). The direct deposit goes in, and the cash flows out.

"Mainstream banks" have a profitability problem long term.

One way to overcome that is M&A.

We have recently seen some large banks look to M&A (perhaps none more so than JP Morgan), but regionals like Huntington Bancorp are also looking to acquire in payments and other areas. As Fintech valuations plunge, the timing is fantastic for those. There are now rumors Goldman is looking to spend on discounted Crypto and Digital Assets businesses in the wake of FTX.

Insights:

• No, this isn't a return to the good old days. The macro has benefitted banks but will return to a more normal state

• Most large banks will be lazy and continue to erode deposits and long term market share

• Some large banks are taking the opportunity for M&A

• Specialists are well-positioned for embedded finance

• Regionals will look to partner with "Fintech infrastructure" companies as a partner/provider

Everything is Embedded Finance ⚙

The game of compliance thrones?

I wrote about this at length a couple of weeks ago, and it does seem to be the hot topic in Fintech, either because of the gossip about compliance failures or the sheer scale of the market opportunity. As I said in the previous piece:

This is where "sponsor banks" have carved a niche as specialists but risk relying too much on being a sponsor bank as a primary go-to-market. If most of the assets and liabilities come via partnerships with 3rd parties, Fintech companies, and non-finance brands, if those brands collapse, so could the bank.

Fintech companies and brands try to build innovative products that don't neatly fit into a compliance spreadsheet.

That's the core tension.

How do you allow innovation without becoming unsafe?

Winning and being a sponsor bank will become about competing on control without damaging time to market and the ability to deeply understand the solution a customer is trying to build. 

Predictions:

• We haven't seen the last of sponsor bank blow-ups

• We see a bi-furcation of those who took risks and those who were prudent all along (and a flight to quality)

• Regtech and supervisory tech will be a massive theme in 2023

• Compliance consultants have a field-day

The cost problem in Fintech 💲

Better unit economics through performance, consolidation, and what else?

VC Funding is down 60% from last year.

(Look how much of an outlier 2021 was.)

This has the most impact on large consumer Fintech companies, operating at scale but not profitably. The next up-round for growth isn't a sure thing. Flat rounds are the new 3x, and many look at down-rounds or M&A exits. 

For those with the runway, the antidote is getting to sustainable unit economics and, ideally, a rule of 40 growth.

But how?

Cost control: For most companies, the highest cost is people, and that's why we see the layoffs have started. We'll also see a pullback on marketing (I doubt M2020 next year will be quite as flashy on the Fintech side, for instance). There's also a push to ensure customers are paying on time and providers give the best prices possible. The word "procurement" is finding its way into Fintech companies.

The problem with spending less on people, marketing, and partners is it can limit growth. So where does growth come from if not marketing?

Revenue growth: The first option is product extension. A consumer Fintech company might move beyond interchange revenue into credit cards, credit builders, and term loans. CashApp and Chime are classic examples of this playbook. SMB focussed Fintech companies have started to move into revenue-based finance and deposits.

We'll see more partnerships here, where feature-as-a-service businesses (like Minna for subscription management or Rightfoot for student loan management) start to appear in consumer Fintech apps with revenue shares.

The jury is out for me on whether consumer Fintech companies represent a significant threat to direct deposit, but they create revenue leakage from the TradFi players.

Vendor consolidation and optimization: Fintech infrastructure providers overlap significantly. Fintech infrastructure companies can be specialists that are a "department as an API." Several providers likely have overlapping capabilities. They all say they do everything, but some use three vendors for open finance data when you scratch beneath the surface. One to fetch the data, another to cleanse it, and possibly a third to make it usable.

There's also the issue of apples-to-oranges sales figures and numbers. Every marketing deck is a push-up bra of stats and KPIs, so it's hard to tell which provider suits you. In TradFi procurement land, the teams talk about TCO, "total cost of ownership." What is the total cost of a function in your business, and what metrics does it help deliver?

The trick is to understand what metrics actually matter for cost and revenue. Reducing fraud losses and chargebacks is an instant win.

Team consolidation: As organizations scale for growth, they don't always do so logically. Standing back and looking at org structure can yield surprising results. For example, Blockchain.com crashed together their fraud and payments teams, reducing fraud and increasing conversion and MAU*.

*(That's a case study I wrote for my employer Sardine, but I think there's a lesson there that's agnostic and you should read it)

Revenue leakage: Alex Johnson covered it last week, but there are many scams and attacks that Fintech companies suffer from, in particular. So-called "friendly fraud." is where fully verified, fully KYC'd customers use consumer protections (like chargebacks or ACH return). Fixing these leaks has to become a priority. 

Often it's expensive to fight a chargeback or ACH return, so prevention is the best cure. Every option should be explored.

Insights: 

• More partnerships for revenue extension

• More vendor consolidation 

BNPL's reckoning: People either love or hate BNPL but is it here to stay?

Between Klarna's big down rounds and the public stocks being down anywhere up to 90%, BNPL has taken a beating in the past 6 months. The market values BNPL closer to a lending business than a shopping and payments super app. There are also regulatory headwinds coming toward BNPL.

As we face a Macro environment where the consumer is running out of savings and starting to go delinquent, do the BNPL products still work?

The killer question is who hits profitability and by when? 

The power of BNPL at its best is partnering with merchants to drive more net-new sales, higher order value, and repeat sales. If this is true, and the shopping apps enable that, BNPL is not only here to stay but will be a force.

Prediction: BNPL is here to stay and is more than an "also ran" in the long term. It might not reach the heights of growth it had over the last decade, but with a high user base and strong brand, they're all well placed to diversify.

Everything is lending 💸

But is everything getting paid back?

Lending is so hot rn.

Whether it's a credit card aimed at Gen Z increasing its valuation in this market, "embedded lending." catching fire, or revenue-based finance. With the high-interest rate environment (and, frankly, demand), the pivot to lending products is rapid and palpable.

But credit is so much harder than debit.

There are a few hacks. 

Credit cards that hit different: One has been the rise of the "credit card" that pulls cash from your checking account, so you're always at a near zero balance and never pay interest. These companies benefit from higher interchange revenue than their debit card Neobank counterparts and may offer more reward points or loyalty.

Open data underwriting: Using checking accounts or payroll data to "secure" a lending product has also created another exciting form of underwriting. If I can see your financial position right now and have first preference on your paycheck, I will get paid back. 

Revenue-based finance (RBF): Connecting real-time sales, accounting, and bank account data to lend to a business that pays back as sales come in. 

The question remains how well do all these products perform as the real economy starts to suffer. Consumer savings are down, and consumer delinquencies have started and will worsen in H1. The tech sector is on its knees, so will revenue-based finance still grow if its customers are going out of business? Will cashflow underwriting prove itself?

I'll be honest RBF gives me some heartburn. It competes with invoice financing, which I heard a banker once call "a drug that small businesses can't get off." Once you take financing now for sales that just happened, you never pay that back. 

The difference with revenue-based finance is that the business only pays back if it generates revenue. That sounds great, but it could also extend the period businesses pay back over months or years. So we see many companies now putting a cap on term or the amount over principal that a company will pay back. I have an inkling that regulators will eventually look closely at this sector as they did BNPL. If I were in that sector, I'd be working proactively on compliance and small business advocacy.

Predictions:

• A regulator somewhere kicks up a fuss about alternative underwriting.

• The real economy tests a new generation of lending businesses in H1, and we find out if there's anything novel in underwriting long term.

• Companies will invest more in thoughtful collections and customer care.

The fraud and compliance problem 😬

The dirty little secret of mobile-first finance

An Aite-Novarica study from 2020 suggests consumer Neobanks debit cards have nearly 3x as much fraud as traditional banks (0.30% vs. 0.10%). Many Fintech companies have worked to fix this, but it's a massive issue across the industry. 

Much of it comes from digital-only onboarding. A customer "passing" KYC with a real identity is not protection. The identity could be stolen, or worse, the customer could be a known bad actor using their real identity but attacking Fintech companies with "friendly fraud." Friendly fraud can be as simple as "whoops, the ATM ate my card and didn't give me the $300" and as complicated as layering ACH returns across multiple banks and Fintech companies.

In the day job, I often hear prospects say, "we don't have a fraud problem," because the assumption is all transactions are legitimate.

They're not. Yet, when you look at the history of that mobile phone or SSN, you find, oops, this was a bad actor somewhere else too. I expect much more focus on this space in 2023 to plug revenue leaks.

On the compliance side, I wrote a couple of weeks ago about how the regulators are coming for embedded finance and BaaS too. 

As Jim at Blockchain.com said 

Insights: 

• There is no downside to being great at fraud and compliance.

• That doesn't mean hiring many bodies; it means hiring right, partnering right, and understanding what drives results.

Fintech in the UK 👑

Don't call it a comeback.

Fintech companies in London received more funding than any other city (including New York or SF). London came in with $9.5bn, $7.8bn in NY, and $7.4bn in SF.

As a Brit, this is both great news and no big surprise. Companies like Zopa and Wise are growing rapidly, hiring, and now the operator alum effect has kicked in. Where operators at a unicorn Fintech leave, found their own company, and get angel funding from their ecosystem friends.

We now have three fully-fledged digital-only banks, Starling, Monzo, and Kroo, and payments monsters like Checkout.com, which have become the default first choice for "international expansion." Starling is profitable and hiring 1,000 extra staff; Monzo expects to hit profit in 2023.

Profitable, growing, and hiring is a great recipe, but the superpower of the UK was always policy innovation. It lost that spot to Singapore in the past decade, but that is changing.

Since Brexit, the UK has become less focussed on Fintech competing with banks and more focussed on the risk presented by Fintech companies. That may swing the other way as the government looks to update the Financial Services Bill with the "largest change in 30 years."

The UK innovated the "new way to get a banking license" for smaller companies. The first major jurisdiction to do regulated open banking and the first to do a regulator-led "Fintech sandbox."

Things I didn't write about because I ran out of time 😅.

Faster payment systems. Instant push payment is the new normal, and it's gaining volume and traction from P2P to e-commerce. It creates a consumer protection vacuum, and "authorized push payment fraud" is the hot issue. That will get worse in the US when more RTP types arrive. In the UK, it's truly massive and arguably "the issue" in Fintech and Tradfi.

Open Finance Section 1033, the CFPB "hope" to finalize the rules by 2024. The rules might not be what you hope they are as a catalyst for account data access. Today, it breaks so often that builders are looking to avoid using open finance tools and go directly to core banking providers or banks. Regulation tends to disappoint. 

That said, Open Finance could prove itself as a lifeline to lend to good customers and give them a lifeline as the economy continues to struggle in H1.

In Europe, open finance continues to drift sideways and generally be lethargic; that will be true in 2023. But we will start to see large financial institutions look at open banking based underwriting and BNPL adopt it for cashflow underwriting more broadly.

Crypto is having a deep and bitter winter. The FTX news has made the mainstream financial and consumer press view Crypto as Toxic, yet Crypto won't die. 

It won't go away. 

It will get regulated.

As regulation does appear, Crypto will slowly legitimize and move from purely speculative to much more utility-focused. DeFi will gradually be seen as the new infrastructure for financial services.

The cleansing was needed.

Here's to 2023 🎆

If everything is awesome was the theme for 2021, everything is awful is the theme for 2022. The reality is somewhere in the middle.

The layoffs will eventually finish, and that talent will build the next amazing thing. 

I like problems and constraints because they bring the best out of humanity. We probably didn't need another generic consumer Neobank or food delivery app. But we need to figure out energy security and how to grow in a world with a declining population. 

We need to figure out ways to fund founders from diverse backgrounds.

And for all the big things we need to do in the world, if we change how we finance something, we change that thing immeasurably.

We’re attacking the world's largest profit pool.

And you think a bad year can stop us?

So here's to 2023. 🥂

Thank you for reading.

See you next year.

ST.

4 Fintech Companies 💸

Retirable - Digital first retirement planning

• Retirable combines video and chat-based financial advice with retirement planning, income planning, and a spending debit card. Users benefit from tax planning and a plan that includes possible healthcare and home care costs. 

• 🤔 Retirement is a historically profitable segment that has yet to be disrupted meaningfully. But now the Gen X'ers are hitting their mid-50s, either planning retirement or considering retiring early. This generation has lived and breathed digital professionally for 30 years, so video and chat interfaces make sense. Retirable is attractively designed and well put together. 

2. Equals - If Spreadsheets and SQL had a baby

• Equals combine the power of database connectivity with a spreadsheet format to allow complex business analytics and decisions. Everything from product to hr to board decks can be constructed, created as a template, and shared.

• 🤔 Google Sheets are often at the heart of no or low-code solutions used internally by BizOps teams at growth companies. One of the largest challenges of operating any business is combining all these data sources, calculating them, and taking action. Equals is a shot at making that the default motion. If Excel runs the world of financial services, Sheets runs startups. What will Equals run?

3. Paintbrush - The Angel Financer

• Paintbrush provides loans of up to $50k for companies, freelancers, and individuals with a side hustle. The underwriting is done by Continental Bank, which uses one applicant as a personal guarantor of the loan. Repayments can be done on a 15% APR basis for monthly repayment or based on revenue and income (up to a maximum of 1.5x principal loan). 

• 🤔 This is an interesting take/alternative to "revenue-based finance" or "non-dilutive finance. For companies that increase their income, this can mean repaying loans faster but limits the total cost of the loan over the long term. Paintbrush's primary competitors are traditional small business lenders or angel investors. This is ideal for founders who don't have that network yet. 

4. Kredito - SMB Banking & Working Capital for Chile

• Kredito provides a deposit account, debit card, and working capital loans to SMEs in Chile. The team has 105,000 companies onboarded and 26k monthly active users. The core account base is growing at 30 to 40% monthly. 

• 🤔 So many markets still have poor banking solutions for SMEs, large populations, and a growing middle class. LATAM continues to be a powerful growth opportunity for Fintech companies. I wonder if the fraud and underwriting risk levels will become an issue over time as companies move to digital. 

Things to know 👀

Going super short this week

1. Plaid lays off 20% of its workforce

Plaid will lay off 260 people, or 20% of staff, with the engineering team thought to be hardest hit. A spokesperson said they're aligning "headcount to goals," so areas like recruitment could be the hardest hit. During COVID, Plaid experienced significant growth but hired (and took on cost) faster than revenue grew (according to the CEO's letter). 

• 🤔 Plaid is the default, but that grip is slipping. "Plaid for X" is a category of company. The logo has consumer mind share, and the developer focussed execution is Stripe good or better. But since many banks have started to fight "screen scraping," using account linking for verification is becoming an unreliable experience (regardless of provider). Plaid is taking strides to sign API deals with financial institutions but needs to get this right to maintain its market lead in the US.

• 🤔 Plaid's may still need to grow into a massive valuation. Plaid's last round at $13.4bn is likely to be hard to justify on revenue from account linking. The strategy is clearly to move into ID+V and payments. The bull case is Plaid becomes a layer that helps own identity and is another payments rail. The bear case is these products aren't built out yet and distract from defending the core business.

• 🤔 As is always true, many folks being laid off did nothing wrong. And Plaid's aftercare is very solid. 6 months of medical and mental health support + 16 weeks of pay. The silver lining of these layoffs has been watching companies try to do them the right way.

Good Reads 📚

1. Why finance is so hard to decentralize

Byrne makes the case that finance is already decentralized because there are so many actors. Every transaction involves a web of banks, providers, consumers, and businesses operating their own software. Automated Market Makers (AMMs) work in good times but become dangerous in times of volatility.

DeFi has structural weaknesses as designed, like requiring Oracles to provide pricing (that can be manipulated and re-introduce intermediaries). The system also has no circuit breakers during volatility, so a run on an asset (like Luna) can gain momentum with no brakes. Traditional finance started with humans and paper and is evolving towards automation. DeFi starts at full automation and might evolve towards just enough human intervention where required?

• 🤔 A stock will be halted in public markets if it declines by 20% in a single day. This "circuit breaker" allows humans to step in and figure out if something more sensible can happen than complete collapse. DeFi has no equivalent and might benefit from an in-case-of-emergency-break-glass mode. Although the DeFi true believers would hate that.

• 🤔 The tension between TradFi and DeFi is useful for the overall development of infrastructure. Every 4 years, we oscillate between "Blockchain, not Bitcoin" and "It is always Crypto." Traditional Finance has a ton of experience in what might go wrong and how to build practical interventions. DeFi is experimental and will try things TradFi wouldn't dream of. Both of these worlds existing are good for everyone if we can limit the blast radius of DeFi.

• 🤔 AMMs will be the future of automated cross-border financial markets. Eventually. I nodded at it last week, and I'll point to it again, The Bank of International Settlements project Mariana is exploring Automated Market Making. I guess they'll find structural issues with AMMs and LPs as a concept but also explore solutions. 

• 🤔 "Stablecoins" will be the payment rail of the future. Eventually. And they'll be called deposit tokens. A few weeks ago, Project Guardian with DBS, JPM, and MAS backed "stablecoins" with deposits held at a bank. They identified several technology gaps before the concept was enterprise-ready. Still, they saw a massive potential business case for global, 24//7 liquidity where transaction logic can be baked into the payment.

• 🤔 I don't believe the world will ever go fully bankless, but I don't think TradFi will build its own technology rails, either. The open-source, permissionless, 24/7 financial infrastructure that today is called "Crypto" will be a huge part of the future of financial market infrastructure. It will have to be made "enterprise-grade" for existing TradFi to use at scale. But it's happening. Slowly, then suddenly.

Tweets of the week 🕊

That's all, folks. 👋

Remember, if you're enjoying this content, please do tell all your fintech friends to check it out and hit the subscribe button :)

Disclosures: (1) All content and views expressed here are the authors' personal opinions and do not reflect the views of any of their employers or employees. (2) All companies or assets mentioned by the author in which the author has a personal and/or financial interest are denoted with a *