Fintech 🧠 Food - 22nd Jan 2022

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Hey Fintech Nerds 👋

Here's this week's Brainfood in summary

📣 Rant: The Fintech Hype Cycle for 2023. Fintech is transitioning from bootstrapping growth with payments to becoming a mature part of the lending ecosystem. In this Rant, I take an image of a hype cycle and opine on what's next for everything from Generative AI in Fintech to if trading apps can make a comeback. Unsurprisingly, I see a world full of opportunity, but Fintech can't be all things to all people. The market cycle is forcing companies to find the right market position and exploit it.

💸 4 Fintech Companies:

1. ReadyLife - Neobank helping renters become owners
2. Celeri - Compliance, AML & Fraud Platform for Argentina
3. TrueBiz - The KYB API
4. Privvy - Solving web3s UX vs privacy tradeoff

👀 Things to Know:

1. Goldman Sachs Fintech unit makes $1.2bn loss. 🤔 That's a big loss, but revenue is growing significantly faster than losses. This wouldn't be such a big deal if Goldman's trading business didn't have such a bad run. What they're doing with platform solutions strikes me as the right model and requires patience.
2. Genesis files for bankruptcy 🤔 The Crypto contagion continues but is becoming much more orderly. Meanwhile, other parts of the Crypto industry continue to build and do things that excite me, and TradFi CEOs like Blackrock’s are super excited about “tokenization.” My hot take? When Tokenization arrives, it will look almost identical to tokens we see in Crypto technically, with a lot more regulation baked in.

📚 Good Read: State of USDC Report by Circle. USDC facilitated $4.5trn of transfers and estimates it had a lower % of speculative use than the fiat dollar. For charities and NGOs, Circle estimates USDC is between 2% and 2.7% cheaper than traditional rails.

Weekly Rant 📣

The Fintech Hype Cycle

The new Fintech hype is compliance, alternative investments, and climate Fintech. Meanwhile, revenue-based financing, NFTs, and BNPL are in a trough of disillusionment. 

I saw this image from Dealroom's Fintech 2022 report, launching 1,000 thoughts in my head.

Before we start, this image is based on investment trends, not consumer adoption metrics, and it's a perspective placed on a two-dimensional graph. These are rarely intended to be science and represent broader themes, but unpacking why the investments are heading this way is where the insight is.

1. Why is everyone so hot on security & compliance?
2. Are alternative investments for real?
3. Is climate Fintech really that hot, or am I just not seeing it?
4. WTF is generative AI in Fintech?
5. What happens next with CFO tech?
6. Can embedded finance actually cool down, or is it perma-hot?
7. Are trading platforms dead, or will they make a comeback?
8. Do NFTs have a hope of existing in 5 years?
9. What now for "open banking" or open finance?
10. Is the only hope for challenger banks to become chartered banks?
11. Is the innovation in POS payments over? 

Health warning: Generally, I avoid jargon and add explainers to financial industry terms, but this would be a 20k-word piece if I did that. This Rant is more expert-mode than usual. Also, Google and Chat-GPT are your friends :).

Why is everyone so hot on security & compliance?

I believe scams and fraud are the most significant issues facing consumer financial services today. This chart from Alloy sums it up beautifully, 91% of Fintech companies and banks say their fraud rates increased over the last 12 months.

We're in the perfect storm for economic crimes like fraud, scams, and money laundering because: 

1. A generation of customers entered digitally. The pandemic meant the only way to open accounts was online. Digital account opening is fantastic, but it creates new attacks that are hard to detect (like scams).
2. Scammers got more sophisticated. Scam volume is increasing across the industry, with everything from romance scams (an online "lover" who pretends to need money, think Netflix Tinder Swindler) and investment scams (convincing people Crypto will explode). These are so hard to detect because real customers use real identities to authorize money movement, only to complain later they were scammed.
3. New payment types are gaining traction. Push payments, open banking, stablecoins, and RTP methods are becoming the default. From PIX and UPI to Faster Payments, SEPA, Venmo, Zelle, and FedNow, we have more rails than ever. These rails don't have mature ways to manage economic crimes like cards. 

This has become a top-level issue in all organizations because not only does economic crime create losses hurting the profitability and bottom line. The C-Suite sees their name in mainstream media headlines and being mentioned by politicians. 

The next headline is for every consumer that loses out to a scam and isn't helped out. This "reputational risk" means regulators push on the issue in exams, create new rules, and send letters to CEOs.

This is a no-brainer which makes it a consensus bet. 

The differentiator is performance in such a competitive sector. 

*(My employer Sardine works in this segment)

Are alternative investments for real?

An "alternative" investment is historically anything you wouldn't easily buy from a broker. Examples would be real estate, art, wine, or collectibles. In the professional investor space from 2015 to 2021, assets under management (AUM) doubled from $4.08tn to $8.90tn. One estimate suggests that it will be over $17trn by 2026.

Assets like wine, in particular, historically outperform public markets, and now there is a swathe of Fintech apps targeted at consumers allowing them to invest in this sector.

I get the excitement.

But where's the opportunity? 

Is this a feature in Robinhood and every consumer Fintech app, or is it a whole business? These markets are massive, and there's a ton of complexity under the hood to manage.

Where's all the climate tech?

VC funding to climate Fintech is up 10x since 2019

There are impact investing platforms, consumer carbon trackers, and ESG reporting generalists. I have questions about all of these. 

When I went deep into ESG fintech, I concluded that something was missing and not crossing over for consumers. However, enterprise ESG is a C-Suite issue and needs infrastructure and tools to manage compliance.  

WTF is Generative AI in Fintech?

I asked the Dealroom chap, and to his credit, his view was that financial services might use the technology to build better chatbots and wealth management. 

And, yeah, maybe. 

But three things struck me.

• Tools on top of GPT-3 feel like middleware that will ultimately benefit the model providers (in this case, GPT-3), so how big is the upside for new Fintech companies here?
• Financial data isn't something GPT-3 or other models can easily be trained on at the internet scale because financial data is highly regulated and hard to get. Therefore how helpful can the models be?
• Generative AI is A* as a coding co-pilot or a research tool, but it isn't (yet) good at personalization.

The financial services industry has seen giant ML models used for underwriting, fraud prevention, and even marketing, and perhaps generative AI is a revolution waiting to happen.

If you have that idea, drop me a line. Curious to learn.

What happens next with CFO tech?

The finance team at growth companies is now inundated with solutions from Neobanks, SaaS platforms, and payments automation companies to workflow tools. Each of these sub-categories won significant valuations and was able to grow with its customer base. 

So much of this is predicated on the sheer volume of growth companies whose back office is modern or doesn't yet exist. Selling into a vacuum is much easier than displacing the back office tools at a much larger legacy company like GE, Coca Cola or Procter and Gamble.

The question over the coming years is who gets to be the operating system for the finance team. Is the natural home the Neobank and expense cards that have gone deeper into managing all payables and receivables? Or is it more of payables and workflow dashboard that adds cards later? Is revenue-based financing the BNPL of B2B (i.e., Hot right now but destined to correct)?

You could make cases for and against all of these. 

But if you zoom out, the trend is a market reaching maturity and scale. Much of what is being displaced would have been incumbent banks or solutions.

But as companies scale, there's nearly always a point at which they put in Oracle NetSuite (and maybe later something truly enterprise like SAP HANA). I wonder if anyone out there can become a true Netsuite competitor. 

Will embedded finance ever cool down?

Embedded finance has arguably been the most hype Fintech of the past two years. Starting with Banking-as-a-Service, moving into credit cards and the non-finance brand / vertical SaaS opportunity. 

But now we see some of the US partner banks face regulatory scrutiny; UK BaaS provider Railsr is apparently for sale, and reality is starting to bite. The past week also saw headlines that Goldman's platform division that supports co-brand programs and embedded finance is making massive losses. 

The promised market share and revenue potential are always in the trillions/billions, but that revenue might take a while to materialize. 

The temptation for consumer and B2B Neobanks could be to displace "expensive" BaaS providers and go further down the stack. But at the same time, the budget to hire developers to build in-house is not what it used to be. 

Winners at infrastructure are those that can help their clients consolidate vendors and stay competitive on price while delivering performance where it matters. Time to market is no longer the only reason to buy.

Do trading platforms become boring now?

Despite a little bump in Fintech stocks like Block and Paypal in recent weeks (as inflation looks to be cooling), Robinhood is trading sideways. A more cost-conscious consumer isn't going to YOLO into the next big stock pick from Reddit or their favorite Youtuber. 

The frenzy that drove Robinhood up may never return. Yet this is an $8.5bn market cap company with an estimated 13.3m MAU in August of 2022. 

If it does nothing but trade sideways, it is now a material part of the landscape. But can it cross-sell? Can its competitors, like Public, take meaningful market share away? Will the future become more boring and well-rounded, offering savings and pensions?

I'd love to see this market segment mature and become less of a casino and more consumer-first.  

Robinhood has announced launching a separate media arm to house its popular "Snacks" brand and go much wider. There is a significant appetite for consumer content on finance that doesn't feel like education but is.

But I wonder if the challenge is in the product, not the media.

Last week I covered Zerodha, a stockbroker service in India that helps users avoid losses and nudges them toward better outcomes. Many Fintech companies do this already (as micro-savings apps, broker apps, etc.)

But my broader point is there's room to be the consumer advocate for every Fintech brand. Marketing budgets aren't what they used to be, but baking advocacy into the product is the differentiator. 

Can sentiment on NFTs recover?

Yes.

But not as a speculative investment.

They won't be called NFTs; they'll be the future of digital engagement and loyalty.

Sure, most people lost money. Yes, it had plenty of wash trading. But loyalty is the no-brainer business case. Retaining an existing customer is far cheaper than acquiring a new one. NFTs that live on a Blockchain exists as a global CRM of which wallet interacted with which brand.

Imagine if you could see everyone who bought Nike shoes in the past year? In web3 with digital shoes, you can. And if you're a brand that loves Nike customers or a retailer, you might have options to engage or retain those customers.

Brands are relieved the NFT mania has gone away because now we can focus on experiences and engagement.

What now for Open Banking?

Open Banking can make a fair claim of responsibility for the boom in Fintech. In the US, Plaid became a consumer default way to sign up for new consumer finance apps faster. In Europe and the UK, the PSD2 regulation inspired countless founders and investors to pay attention to the sector.

Today lenders use consumer spending data to find new ways to lend, and markets across North America, LATAM, EMEA, and APAC have varying degrees of open banking services available.

The question is, what next? 

I can see a few spaces.

1. Data Enrichment becomes a default. Spade, Henron, nTropy, Pave, and their global equivalents all exist to make data useful. This is still an open battleground with no clear winners. The enrichment space creates new use cases, and that's exciting. What don't I know if this, as a category, is a set of companies that goes public? It could be an area for future M&A.
2. Widening into Open Finance. Insurance, investments, pensions, and anything financial are the obvious next step (and approaching various maturity in different geographies). 
3. Moving into payments. Open Banking could be most disruptive as a payments rail. But my thesis is payments rails don't die; they're additive. Cards haven't removed cash (although it displaced plenty), and Open Banking won't kill cards. As a rail in the UK, Open Banking is now quietly a way to fund other Fintech apps, and you can even pay your tax bill with it. But volumes are low across the board, and there is plenty of competition for being a good RTP rail. The differentiator for Open Banking is the sheer amount of data and how that could build loyalty feedback loops.
4. Become an identity layer for finance. The consumer bank account that has been KYC'd is a great anchor for digital identity in markets that don't have a national ID system. Giving users a gateway to control and manage how their data is stored and manage their various accounts is an obvious step but incredibly hard in practice. The banks will fight any utility that tries to take away one of their core values without them sharing meaningful upside, and the space is competitive. In the US, Apple is taking a much more patient approach to owning identity, and in Europe, Open Banking regs limit the space for innovation (because they're so narrow). It's more likely that Open Banking is a part of the identity patchwork, and figuring out where to play is the ultimate puzzle.

Each of these thoughts warrants a rant to fully unpack (and I may do in the future).

From challenger to charter?

The current interest rate environment means there are four possible outcomes for consumer Neobanks

1. Get a license and start lending.
2. Exit via M&A
3. Carve out a profitable niche
4. Die

Getting a license is hard in any market but especially in the US. This is a path that only a handful may successfully make. If we look at SoFi and Varo, there's also a rough adjustment to becoming a bank. We saw a similar thing happen with Monzo in the UK. But on Monzo, they're projecting to hit profit next year, and Starling projects it will 4x its 2022 profit number. If a brand hasn't sufficiently annoyed the regulators in their life as a Neobank, they have a better shot. The odds are poorer for companies that offered consumers lending in return for "tips" or other models that regulators are less pleased with.

M&A could be attractive for non-finance brands (as we saw Walmart acquire Even and One to make a play for their customer base). If they have a ready-made way to monetize and a large customer base, they solve some of the cold start problems and profitability challenges more general-purpose Neobanks face.

Digital community or affinity brands are another beast. They could attract a scaled niche and hyper-serve this community. I've not yet seen data to show that brand affinity will make them top-of-wallet and attract deposits and spending behavior, but it seems reasonable that it could. I wonder if the obvious next step here is credit cards specifically. 

Death is to be avoided, but there could always be a Fast.com of Neobanks out there lurking. 

I need to give more thought to the B2B Neobank license journey. Starling makes much of its profit in the UK thanks to this segment. It will be hard for companies that offer revenue-based finance to get a license again because of the regulator's suspicion of anything new and related to lending. But this could be an interesting step for the more vanilla spend card programs.

POS payment innovation is dying

It has certainly matured, but new battlegrounds will emerge, and a new generation of companies could win.

The one inarguable winner in Fintech over the past decade has been payments-acceptance driven partly by the boom in e-commerce. Stripe, Adyen, and Checkout all command massive valuations and are a significant part of the payments landscape.

These companies are now massive and reaching maturity in their markets. 

As e-commerce becomes mobile and embedded into content, new gatekeepers like Apple have more power. As new payment rails emerge, new payment flows follow. 

Those new payment flows can be a wedge for a smaller company to grow from. 

There's also an opportunity to move down the stack. As you peel back the payment acceptance onion, many of the industry names that were there 20 years ago are still involved. Can more payment companies become acquirers and be developer-first? Like Sequence in Europe or Moov is now doing in the US.

I'm hyped for the future of Fintech.

I could spend days going deeper into each of these topics (and may do in future Rants). But I wanted to show how one image can trigger so many conversations. 

This landscape is constantly evolving and full of opportunity.

Fintech isn't dead, far from it. 

10 years ago, Fintech wasn't even a word.

Now its an industry

In 10 years, we can put a dent in the industry beyond payments.

Competition for the incumbents is a good thing; building a better ecosystem that involves incumbents is a better thing.

Let's do this.

ST.

4 Fintech Companies 💸

1. ReadyLife - Neobank helping renters become owners

ReadyLife helps renters get a mortgage approved if they pay 9 months of rent via the ReadyLife debit card. The service has a fully-featured Neobank app, including get paid early and peer-to-peer payments. The service is currently accepting applications for a waitlist.

🤔 Who's underwriting the mortgages? I love this innovation, and it's a great way to solve the biggest problems facing Neobanks. Often Neobanks don't get direct deposits and struggle for revenue. The rental payment is a high-dollar monthly payment, meaning the interchange revenue (swipe fee income) is higher. Also, after 9 months, there's a good amount of data to show if a user consistently makes rent on time. My compliance brain is screaming this is risky and could go wrong, and I wonder how many renters will look to take a mortgage with interest rates so high at the moment. But this innovation needs to exist, and I hope ReadyLife succeeds.

2. Celeri - Compliance, AML & Fraud Platform for Argentina

Celeri combines customer onboarding (KYC), transaction monitoring case management, and regulatory reporting into a single platform focused on Argentina. The Celeri dashboard centralizes information for compliance teams. It can submit the data to regulators like FACTA (the IRS cross-border division), the Central Bank of Argentina, and the Financial Information Unit (for AML).

🤔 The compliance dashboard and regulatory reporting stand out here. There are general onboarding and transaction monitoring tools, but they create manual work for teams to comply with local regulations. That localization makes Celeri unique; I wonder if they can expand that across LATAM too. The single dashboard approach is also smart; it reduces time to market for smaller companies and prevents a ton of manual work. Compliance and fraud are so hot rn; this is well-timed. 

3. TrueBiz - The KYB API

TrueBiz provides an API to identify risks associated with a business by searching "100s of data sources" and serving a response. This enables streamlined onboarding and less manual review regardless of the use case.

🤔 KYB has been a specialist with very few providers in the market, but now with TrueBiz, any onboarding provider can add KYB. No? Today's KYB solutions are services that onboard the customer (e.g., capturing KYC information for account opening, etc.,) but being API-first creates a wider spectrum of use cases. They're aggregating a bigger supplier like Refinativ or LSEG under the hood, but making this developer-first is neat. And as I said earlier, compliance tech is so hot rn.

4. Privvy - Solving web3s UX vs privacy tradeoff

Privvy aims to solve the web3 UX problem by connecting on-chain data with privacy-assured off-chain data. Today in web3, developers avoid storing user data on-chain, which creates painful reauthentication experiences, or they store it themselves, limiting user privacy. Privvy allows developers to create a consistent user experience regardless of which wallet they use or which underlying Blockchain. 

🤔 This is really fucking smart. Like if data lockers (think Skyflow or VeryGoodSecurity) had a baby with WalletConnect. The first thing a user has to do in web3 is "connect their wallet," but that's where the pain starts. The market is attacking this with different KYC tools, white-label wallets, and even Soulbound Tokens (yes, really). But doing this as developer infrastructure is *chefs kiss*. 

Things to know 👀

1. Goldman Sachs Fintech unit makes $1.2bn loss

Goldman's platform solutions unit, which contains credit cards, Fintech, and transaction banking, made a pre-tax loss of $1.2bn in the first 9 months of 2022. Overall the bank's revenue at this division is growing significantly (135% YoY), but so are its losses (up from $1bn in 2021). 

🤔 This segment needs patience. Marcus and platform solutions were intended to drive predictable revenue for times (like now) when the investment banking division saw more difficult trading conditions. They're not there yet, but the trend is positive, with revenue growth significantly ahead of losses. They could be very well positioned if they can get through this awkward growth phase without cutting the business lines too dramatically.

🤔 They've built a lot that has the potential to contribute more revenue more efficiently in the future. The transaction banking (TxB) division counted $70bn of deposits in the results, which is truly massive. This banking segment has traditionally been steady and profitable, and Goldman has a modern platform ready to go. Curious to see if those deposits can turn into payments revenue and more. 

🤔 Goldman is a partner bank with a modern platform that takes credit risk. When Apple card has lending losses, it's actually Goldman who has to cover those (making Apple Card seem like a sweet deal for Apple). Perhaps it is a very generous deal, but it gave Goldman a foothold in that segment. 

🤔 The idea that consumer Neobanks are not the only ones chasing profitability is fun to think about. But the reality is that Goldman has intentionally gone wide into deposits, lending, BaaS, and transaction banking with build and M&A in a very short time. It would be tough for any VC-backed company to replicate this.

Major h/t to this fantastic results breakdown thread from Jason Mikula here and more context from him on the BaaS implications here. 

2. Genesis files for bankruptcy

Crypto Lender Genesis has filed for bankruptcy and owes creditors an estimated $3.5bn. Genesis provided loans to hedge funds, institutions, and consumer lenders but has suffered in the fallout from Luna, Three Arrows, and FTX. 

🤔 The contagion isn't over, but this does feel closer to the end than the beginning. Crypto prices are increasing, and the builders and companies never over-leveraged have moved on. Of course, Crypto prices are very sensitive to Macro and could be up because inflation is down, but my take is that Crypto has flushed out a high percentage of its leverage and bad actors. No bailouts here. 

🤔 The optics of Crypto are still terrible, but TradFi is very excited about "tokenization." This week the Blackrock CEO and Jamie Dimon both talked about turning securities and payments into something resembling a Crypto token. This would be the biggest transformation of finance and payments since the 1970s. 

🤔 Tokenization, in reality, is remarkably similar to Crypto tokens. In most cases, "tokenization" is now happening on Ethereum or is heavily influenced by the world of Crypto.

Good Reads 📚

1. State of USDC Report by Circle

In 2022, USDC facilitated $4.5trn of transaction volume, with 60% of those relating to smart contracts, although its circulation remains tiny at $45bn compared to the $2.3trn of US Dollar in fiat. Circle says 15% are wallet-to-wallet transactions, and they suggest this shows increasing real-world usage. The average transaction fee on Ethereum is $0.50 vs. $0.01 on networks like Polygon or Solana, which saves between 2 and 2.7% of fees for institutions in charitable giving.

🤔 Lower fees can be meaningful. If there's going to be a business case for Stablecoins being consistently cheaper than fiat rails is essential; otherwise, what's the point? It will be important to ensure this is done with as good, if not better, risk management than existing rails for it to gain credibility. 

🤔 Instant liquidity is a critical selling point. Aside from countries that have directly connected their real-time payments rails (of which there aren't many), the vast majority of international payments are slow. There are local rail aggregators who can reduce fees, but they're as slow as the slowest system. Stablecoins arrive immediately, meaning businesses get paid instantly. 

Tweets of the week 🕊

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That's all, folks. 👋

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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 * (3) Any companies mentioned in Rants are top of mind and used for illustrative purposes only.