Fintech 🧠 Food - Sep 6th 2020

The mega trends are all on show this week 👀. Increasing specialization, the space above banks and aggregation, finally digital identity and payments coming together. All enabled by B2B fintech which is reshaping the entire market. What really intrigues me is the business model evolution behind it all.

As the increasingly specialized fintech's appear, they can go for a more SaaS pricing model, but do they want to go full Neo, or embed finance? B2B fintechs and infrastructure plays are only really getting started. The next decade is going to be a fun one.

Four Fintech's 🤑

1. Jiko - The "safest Neo Bank ever", doesn't even hold your deposits 🤯

• Far from just another neo bank, because they don't take deposits and use those to lend, instead they buy US treasuries or perform lending directly.  The customer is essentially only exposed to the credit risk of the US government. They look to have become the first neo bankto secure a charter by buying an existing bank.

• (Serious finance nerd moment 🤓), this is actually what most banks HAVE to do with wholesale sources of funding since 2008, but not consumer deposits. This brilliant diagram by Xen from Blockchain.com demonstrates nicely. Banks are capital constrained beasts, but consumer deposits could still be used as a part of their overall balance sheet management in a way wholesale deposits couldn't (stay with me here). This is not what Jiko is doing (the bit in yellow is the bit of the balance sheet banks can use to fund lending 👇)

• Jiko just lends straight out, or goes straight to T-bills. Then from T-bills right back to into the payments system when you use an ATM or debit card.

• This ultra ultra low risk treasury solution is interesting because, banks are actually struggling to be nearly as profitable as they were pre-financial crisis due to capital constraints. Jiko is being even more conservative than the Basel III rules require, against a back drop of questions about neo banks ability to drive profit.

• How will they get to profit if they're starting one step behind most banks? Jiko intends to bring in a subscription later, but I wonder if this "ultra low risk" post financial crisis play is enough to a) be profitable and b) drive consumer adoption?

• Anyone who can convince regulators to do something different has a real shot at business model innovation, can't wait to see what they do next.

2 The beans Your personal finance coach 🎳

• The Beans helps you build a financial plan, cover off all of your costs and build financial resiliency. A "layer above banking" play (similar to copilot or snoop), these apps can go beyond any one bank digital experience, because they can aggregate your whole financial life, and help you plan around that. This means they become much better placed for a marketplace offering than the neo banks.

• Love the focus on mental health 👩‍⚕️, financial health and mental health are closely related, and understanding this is why fintech is winning engagement from banks.

• Winning engagement is not the same as winning profitable business, we've seen both megabanks and neobanks really drive up engagement with financial apps, but not all have delivered profitable businesses.

• A great place to monetize that level of engagement is the space above the banks. Getting a licence is one thing, keeping it is another. The neo's will struggle to do what these PFM / personal assistant apps can do with engagement, but the Neo's can lend. So I think we'll see a barbell. Neo's getting more into lending, and PFMs more into marketplace.

• 🧪Micro thesis, you can't have a bank licence and be a marketplace. You can have a licence and be a platform. These apps are nailing the former, nobody has nailed the latter.

3. Hammock The account for landlords (I ♥ a niche).

• 🏠Being a landlord is essentially running a small business, but the finance is harder and tenants are involved creating all kinds of complex challenges.. Trying to run this out of your consumer or SMB account with a spreadsheet is a pain. I saw this and thought it's the missing half of rooftstock (which raised $50m in January). Hammock just raised 1.1m Euro seed.

• 🧪Micro thesis, finance brands will become increasingly niche. Every niche has it's financial quirks that more general apps just don't solve.  

• This makes the medium to long term economics of these businesses interesting because as we've seen with neo banks, driving out profitability from the banking play is hard. One could argue though that the more niche products justify a higher monthly fee or subscription. Hammock pricing currently uses # of properties as well as a standard SaaS pricing chart interestingly. As the meme goes most people think nothing of paying $15 a month on their favourite SaaS but wouldn't for X.

• To be able to move money many start with cards, but the revenue from a cards only business is largely negligible (especially in Europe). I wonder if Hammock will move up above banks (like the beans) or down towards the banking licence (like the Neo banks). Historically the trend has to move down the stack as you scale, so you can offer more lending products, but I'm starting to wonder if open banking and marketplaces make that not the only option any more.

4 Capchase - Rapidly get cash from your accounts receivable ⏩

• Free cashflow is predictable in a SaaS business, customers sign (for example) a 12 month contract for the same monthly payment. Capchase essentially allows SaaS businesses to "pull forward" this cash to use it to scale their business now, instead of seeking expensive investment by selling equity. 📥

• Historically businesses that rely on invoice finance is they end up stuck on that invoice finance, and not able to build solid free cash flow. These services are marketed as entrepreneur friendly, but they might not always work out that way.

•  However this is targeted at growth and priced against selling equity, which is an important nuance. It seems every other week someone is launching a service like this, the first that came to mind for me was Pipe.com (funded by Craft and Anthemis).

• How many of these can there be? Interestingly, I think finance businesses that do actual finance are not winner take all marketplaces (but as noted earlier, the layer above them could be).

Good reads 📚

1. Apple Pay wasn't disruptive but Apple Identity will be

(📰Dave Birch on Forbes)

• Dave explains: Apple has recently registered a number of patent claims across the general field of “verified claims of identity”... "the technology it is trying to develop to replace traditional driver’s licenses, passports and varied ID cards for government purposes or access to private property. "

• "if the “secure enclave” inside an iPhone is safe enough to store payment tokens then it is safe enough to store a variety of the virtual identities that I will need in the online future"

• Asks some big questions "Should the government know that you have logged in to my bank? Should Apple know that I am playing Fornite? Should Facebook know that you are voting online? How exactly can we design an infrastructure to deliver both privacy and security?"

• 🤔 My analysis - Apple are actually super well placed (especially after the Mobeewave acquisition) to do a lot of what Fast and Shopify Pay are trying to do. Help merchants with improved conversion, help consumers pick up loyalty and rewards from wherever they shop, and once and for all solve the password nightmare that is the internet in 2020.

• 🤔 My analysis - The prize for solving this is massive but so are the consequences of getting it wrong. On the one hand everything becomes frictionless. On the other if that digital entity is compromised, nearly everything you have is compromised.

2. Big tech is better at risk and impacting Central Bank Policy

(BIS Report 🧾)

• Historically banks have had an incomplete picture of their borrower, this can be overcome by looking for collateral (e.g. your house, or another asset). This paper does a case study of how big tech's (especially Ant Group) uses data to get a more complete picture of the borrower.

• The paper finds that the price of credit from big tech's doesn't respond to the market conditions, only to the specifics of the borrower 🤯🤯. This means big techs don't require as much or any collateral.

• 🤔 My analysis - This is super interesting, because it's essentially saying, today, central banks are able to move the entire economy (through interest rates rising or falling) only because banks have an incomplete picture of their borrower. However, if we see more, and better data used throughout the market, this interest rate pricing model may become useless to impact the wider economy as a policy tool.

• 🤔My analysis - It's also a significant moment for using data to price risk. The global central banks are sort of accepting it as a reality rather than challenging it. Having access to data alone doesn't mean a business can price risk. It's models need to be trained and need volume. However, at scale this is a recognition that it works for the individual business. I wonder if this will make traditional banks think differently about credit risk policy (often the hardest thing to change in a bank). Also if I'm an asset manager or shadow bank, buying loans originated by a big tech would be tempting. I wonder if the banks recognize that as a threat to their business yet?

3. Macro fintech investing trends (🧾Ron Shevlin on Forbes)

• Another quality read from Ron, looking at trends from fintech investments, and picks out some trends from what's succeed that, well, just make sense

• 1. Better is better. Big incumbents have done digital, and consumer satisfaction has jumped. It may have taken them a while and cost them tens of billions, but their digital isn't bad.  (🤔My analysis: Don't assume engagement is a differentiator alone)

• 2. Specialization sells. "If the newer money is smarter than the older money, then fintech startups with a narrowly defined target market are where it’s at". (🤔My Analysis: This is why in 4 fintech's there's a landlord account, or last week, an account for parents)

• 3. Revenue matters. "Reality: The top of the funnel is a lot easier than the bottom of the funnel. Fintech founders that brag about the number of people on their waiting list are deluding themselves." 🤔My Analysis: This is why paths to monetization and how we view the market for marketplaces vs engagement vs lending is so key.

• 4. B2B > B2C "There’s a strong level of dissatisfaction among many financial institutions with existing vendors. And the Covid crisis has forced many incumbent institutions to accelerate their digital plans. Who are they going to turn to?"

• 🤔My Analysis: B2B is a great place to be,this phenomenal teardown of stripe for instance by PackyM show's how much value can be created competing with incumbent B2B providers. However, this B2B space is also getting crowded (as Patricia Kemp covers in "what is B2B fintech)

• 🤔My Analysis: B2B fintech has a ton of infrastructure, but it doesn't yet have it's "shopify". If specialism is the way forward, then why wouldn't we want to push for more creators, each with their own "fintech", seeing the core of what fintech brings them being engagement more so than just revenue? This is something we think about and work on a lot at 11:FS.

• 🤔My Analysis: We haven't yet seen a bank break out and create a platform play that swallows the infrastructure players (or partners with them and super charges them), but it feels like a matter of time. We also haven't seen where all of this gets re-aggregated for the creators (I also think that's a matter of time).

Things you should know 👀

1. PayPal launches 0% BNPL loans, Mastercard too! 🛒

• PayPal has launched Pay in 4, a short-term interest-free buy-now-pay-later installment offering for merchants in the US. Merchants get paid upfront while customers pay for purchases between $30 and $600 in four installments over a six-week period with no fees or interest. 📊

• Mastercard partnered with TSYS to "allow Mastercard customers to split transactions into installments before, during or after checkout. " This doesn't feel nearly as slick as proper BNPL, and as a me too offering, probably won't go anywhere. Still it's interesting to watch the incumbents recognize the opportunity

• BNPL continues it's march of incredible popularity, with Afterpay, Affirm and Klarna all growing like crazy. Gen Z see's credit cards like ciagrettes, which I guess makes BNPL like Juul pods. 🚬

• I really enjoyed this diagram from Alex Johnson, who proposes banks are not well placed to compete with BNPL providers. They're not as slick at offering APIs and their experiences don't increase conversion for merchants.

• 🤔 My analysis:BNPL and companies like Fast are showing that the consumer brand for payments and lending is shifting. Banks may offer their own alternatives here, but I genuinely don't believe it will be like the mobile app scenario, where good enough keeps them in the game. Banks face an interesting strategic choice here. Collaborate or compete? Most of the BNPL start-ups are crying out for that collaboration.

• 🤔 My analysis: The CEO of Citi Michael Corbat worries that banks will become dumb pipes if they give up too much of the brand or customer. I actually think the first bank to really nail being a platform will be very smart pipes indeed. The nature of lending, licences and economies of scale mean being the bank platform of choice is a great place to be. Imagine if big tech could bring the bank new lending or deposits at near zero marginal CAC. This means shifting the brand from being owning the branch and app experience, to a more "intel inside" model.

• 🤔My Analysis:The specialist accounts and brands that are emerging may get re-aggregated by a big tech, the new infrastructure players take a way a lot of the integration pain, but banking is still localized. A bank with licences globally, partnering with these infra players (e.g. Syanpse, Bond.tech etc). That could be something special.

2. Fast launched 🚀 - Is it the future of buying stuff and identity?

• There wasn't a single "on click" check out to rule them all until now👑. No really, Amazon Pay is amazon, Apple Pay, Apple, Google Pay, Shopify Pay. They're all limited by device, browser or something. Fast aims to fix that, and then a whole lot more. But also now there are too many one click payment solutions.

• Ultra slick checkouts will be important for merchants and consumers. For merchants they dramatically increase conversion (per this blog from Shopify). For consumers, anything that removes friction is good, and the internet doesn't have a good wallet.

•  Fast is essentially competing with Apple to be "that thing that means I don't have to log in everywhere" AKA your digital identity 🆔. Apple has a real advantage in physical retail over fast and a 5 year head start, but fast are amazing at marketing.

• The launch didn't go so well if you're a European. Super interested to see how this works in Europe where account to account payment companies like Banked and Vyne are doing very similar things, with lower fees. Fast's focus on the consumer brand and identity I think gives them an edge. They're also amazing marketers, and like Shopify are not selling lower cost payments. They're selling increased conversion for merchants.

3. 100 years happened in a week of Defi

• First, Uniswap passes coinbase in 24 hour volume (is coinbase now a 🐱‍🐉?). Uniswap is of course the decentralized exchange that raised an $11m series a from a16z and others. It allows anyone with an Eth wallet to trade tokens in near real time, directly, peer to peer.

• Then 🍣Sushi unravels as it's creator exits (scam or not, you decide). Let's unpack sushi for a second. Sushi was setup as an an "evolution" of decentralized exchange protocol Uniswap. Within three days after its launch, the platform accumulated $700M in asset deposits. Many speculate this was because it was a "fair launch" (in other words, there was no founder owership, no pre-mine and no venture capital. Much of the fervor around Sushi was that it hadn't taken VC money or done a pre-mine. This was true decentralisation (this phenomenal thread really gives an insight into the psychology). Right up until the creator converted a portion of the developer fund and then decided to step back.

• Why does Defi even matter?The product is decentralisation, it works without a middle man. That's what the enthusiast is buying into. There's a market who makes money of trading the tokens that fund the development and running of those tools. Yes, there's also ludicrous APY's as yeild from these tokens which is no doubt drawing people in too. But why some tokens make it massive, still comes down to narrative.

• Right now defi is so small it's like a rodent among dinosaurs, and the bet is if there's something cataclysmic in the real world of finance, like monetary policy that's absolutely 🍌's for decades on end, and there's a reckoning, defi would just keep chugging

Tweet of the week 🕊

CB Insights publish the top 250 fintech companies in a beautiful logo vomit slide, that will no doubt turn up in every bank strategy deck for the next year :)

Takeaways of the week 🍝

1. Building a profitable licenced finance business still comes down to fundamentals lending

2. But for engagement specialization is everything

3. This means the Neo's that are emerging are getting ever more specialized

4. Yet the space above the banks is ripe for disruption and aggregation around different contexts (e.g. real estate, parenthood, merchants)

5. True aggregated marketplaces will require the infrastructure to get better because moving money and creating an account like experience is still a bit too hard without going the neo bank card route (this is slowly changing)

6. Data has changed lending already, and now central banks have to react

7. How new and old banks manage their balance sheets will need to change if big techs embed finance successfully

8. Owning internet identity is finally becoming a reality, with Apple and Fast both making moves here, this further accelerates the embedded finance trend

9. The banks themselves still have a platform opportunity but worry about brand, and as Ron pointed out, did good enough at digital 

10. Therefore we will see a barbell, Neo's moving more into lending. The space above the banks increasingly aggregation and marketplaces. Driven by a competition in infrastructure APIs. The open question is where the banks are in this story

11. PS, Defi is awesome 🍿

That's all this week

Thank you for reading this far 👋

Did a really fun podcast with Marqeta, Railsbank and Synapse here if you want a good listen on the future of Bank as a Service 🎙

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