Fintech 🧠 Food - 27th Feb 2022

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Hey everyone, this week, "gm" felt inappropriate because, like all of you, I can't escape the sense of horror that faces the world and especially Ukraine. My hope is that Fintech companies, experts, and the world can find ways to help the people of Ukraine.

With that said, Fintech continues to march forward as an industry and overcome massive obstacles. Perhaps one of the biggest has been SWIFT itself, which we now see as crucial to the sanctions being placed on the Russian regime. This week’s rant unpacks SWIFT and how the aging infrastructure is still crucial.

We also saw this week Chime is delaying its IPO amid rumors of high levels of fraud. Fraud and risk prevention are essential parts of the legacy financial infrastructure, but we could do a much better job as an industry. Fintech companies' dirty little secret is being killed by Fraud almost immediately after launching. Very few businesses exist that specialize in fraud prevention; if anything, it's a cost of doing business. Specialists are critical to confidently move money.

Fraud prevention people often sit in the unloved department, and it's not the focus of the business they work in, but I think this is changing. But in the next decade, those who understand Fraud, risk, and compliance will become critical helping us adopt and use better Fintech infrastructure. Finance needs an upgrade because it's so crucial to the world we live in, and that's why I love this industry, even in hard times. 

In this new world, people who get risk, fraud, and AML are the heroes we need.

Weekly Rant 📣

Sanctions; the Geopolitical Weapon

The West has limited options to contain Russia short of starting world war 3. 

Perhaps the one option left is kicking Russia out of SWIFT (which now looks likely). Kicking Russia out of SWIFT may be a kill shot but it may also embolden China and others to build their alternatives.

Let's unpack this by exploring what SWIFT is, how Russia and China have been planning to avoid it, and what the US (and its Crypto and Fintech private sector) could do if anything.

What's SWIFT?

SWIFT is the messaging system banks use to agree to move money internationally. SWIFT is not a payment system. Over 11,000 banks in 200 countries send SWIFT messages to each other to move money across borders (and across currencies).

When a business or person wants to send money to another country, a bank would primarily do that with the SWIFT messaging service. Imagine it as a set of emails (although, in reality, it's MT or ISO20022 XML messages).

1. UK Bank (HSBC) wants to send money to US Bank (Chase).
2. UK Bank (HSBC) sends US Bank (Chase) a SWIFT message "Hey, my customer wants to send your customer £100; I've already converted it to dollars."
3. US Bank (Chase) says to UK bank (HSBC), "Ok, message received, please change the balance of your customer to remove £100 from their account (debit them £100), tell me when that's done, and I'll add $120 to my customer's account"
4. UK Bank (HSBC) sends US Bank (Chase), "I have lowered the balanced (debited) my customer £100, please increase the balance of your customer by $120 (credit them)".
5. US Bank (Chase) sends one last message, "Ok, all done," and at that point, the money has been considered to be "settled" or moved, and the balances change in the customer accounts.

If this is just the messaging, how does money actually move? For that, we need Nostro (My account at your bank, so in the example above, Chase has a "Nostro" account at HSBC) and Vostro accounts (Your account at my bank, in the example above Chase, opens a Vostro account for HSBC in its systems).

When the messages are complete, the bank's credit and debit Nostro accounts before credit and debiting their customer accounts. Put another way, SWIFT doesn't move money; banks do. 

SWIFT is much more peer to peer than it appears. Opening Nostro and Vostro accounts between banks is the process of building "correspondent banking relationships." SWIFT creates the shared rule book, but ultimately banks decide who they will interact with. Typically a bank picks one correspondent in another country (e.g., HSBC picks Chase) and then lets Chase send money to other local banks in the US (and vice versa). 

The banks then "rely" on each other to be good at their job. HSBC "relies" on Chase to have KYC'd all of its Chase customers and to be confident any bank it interacts with has done the same. It also relies on its correspondent banking partner to comply with all local tax laws and regulations. 

Before a bank sends a SWIFT message or moves money, it performs countless checks to make sure customers have been KYC'd and that the payment is compliant. Payments must comply with receiving country tax laws currency controls and that the sender or receiver isn't on any naughty lists (like sanctions lists).

This gets more complicated when you add more than one country to the mix. Let's say we need to send money to Angola from the UK, and HSBC doesn't have a direct relationship in Angola, but Chase does. HSBC would send dollars to Chase, who would send dollars to the bank in Angola, then credit their customer. 

This is a "two-hop" transaction, and just scratching the surface, SWIFT payments can take 3, 4, 5, and sometimes many more "hops" to get to their destination. This means each bank is reliant on the following bank to move money. SWIFT is doing some interesting work in APIs to try and make this more visible, but this complexity is why SWIFT payments are often considered slow and expensive. Because they're a lot of work for the banks.

SWIFT is expensive and slow. It can cost anywhere between $40 to $120 to make a SWIFT payment and depending on the hops (and complexity of the transaction), a settlement can take 3 days to 3 weeks to complete. 

The US Dollar is the dominant currency in SWIFT, which gives the US a dominant influence in the global economy. According to SWIFT, more than 50% of transactions are in US Dollar, 30% in Euros, and 5% in British Pounds; SWIFT estimates around 50 million transactions occur per day. This means any rules set about how the dollar must be traded impact the entire global supply chain. Any bank that wants to interact with the US dollar, at all must also follow those sanctions.

Every payment system eventually sits on top of banks (and SWIFT). Whether you're using Western Union, PayPal, or Wise, each payment service holds relationships with underlying bank partners. The payment services hide the pain of international payments by limiting the type and complexity of payments made and passing on the cost efficiency to their customers. Banks have to support any payment type to any correspondent and are ultimately responsible to their government (and the US government in particular) to enforce laws, regulations, and sanctions.

Banks are the police of money. And everything ultimately falls back to them.

What are Sanctions?

If you've seen the news this week, the words "Sanctions" and "Harsh sanctions" have been everywhere. To oversimplify, sanctions lists (like OFAC) are a giant naughty list of individuals and entities (companies, charities, etc.) 

If a person, government, or entity is on a sanctions list, banks must refuse a transaction to that entity. When a government adds an individual or entity to the sanctions list, each of the 11,000 SWIFT member banks that transact in that country's currency (Dollars, Euros, or Sterling) must then make sure it blocks those transactions.

Applying sanctions is hard and relies on the banks.

The bank applies sanctions by knowing who its customer is, which with consumers is trivial. Usually, a customer is onboarded with their own identity documents. With businesses, this is much harder; sophisticated state actors (like Russian Oligarchs close to Putin) may have hundreds of companies. A trust company in Russia might own a holding company in the Cayman Islands that owns a trust company in Panama that has accounts at banks in London and France. 

Finding who ultimately owns these companies is very complex (identifying ultimate beneficial owners or UBOs). For instance, opening a business in the UK costs about £100 and requires minimal documentation. The banks can prove "that is a real business," and they found some owners. But if there's a complex hierarchy of companies that own companies, the paper trail becomes almost impossible to untangle. (Check out this thread for a good read on complex hierarchies)

This complexity is why payments via SWIFT are sometimes so slow and expensive. Banks are doing deep investigative work before payment can even happen. This takes a lot of human and manual effort. Ultimately payments companies like Wise and Western Union avoid a lot of this complexity by keeping their transaction complexity (and size) low. Banks have a higher burden.

The cost of getting it wrong can be massive for banks. In 2015 BNP Paribas was fined $8.9bn for failings related to Iranian, Sundanese, and Cuban transactions. 

New sanctions will be an operational nightmare for banks.

Russia is a major trader of oil (the commodity), and it’s often traded over long-term contracts rather than one-off transactions. What happens if a bank had clients buying oil futures on long-dated contracts? How does a bank even figure out what payments to stop?

What about banks with Russian subsidiaries? Russia is much more connected to the global financial system than say, Iran. While these sanctions could eventually make life incredibly difficult for Russia, they’re going to take a while to bite. (Hat tip to Yann Ranchere of Anthemis for the point on being an operational nightmare)

Russia has been preparing for sanctions for years.

Russia has been subject to sanctions since 2014, where several individuals, lenders, and state-owned entities had sanctions applied. There are calls for Russia to be kicked out of SWIFT entirely. But this may not have the impact people hope for. 

Russia is now less reliant on SWIFT and dollars. Russia's central bank built up foreign reserves to more than $600bn (40% of GDP), and most of that is held in Euros and Gold. Commercial banks like Sberbank have also shifted away from dollars.

(Massive hat tip to Marc Ruby at Net Interest for these stats)

The more the West uses sanctions, the more countries like Russia will avoid SWIFT, the US Dollar, and the established global order.

China is building a SWIFT alternative.

China is building an alternative to SWIFT called CIPS (Cross-border Interbank Payment System). Today CIPS is small, but China and Russia could provide a regional alternative to SWIFT. China has also used its RMB currency to invest in foreign infrastructure (like airports, shipping, and roads). 

As these trade routes become established, China can insist payments are made in its local currency rather than dollars, leading to increased regional influence and no impact from US dollars or sanctions. We're heading towards a world where SWIFT and the US dollar have become the political weapon with no bullets left to fire.

Energy matters to Europe and delayed a SWIFT ban for Russia.

The only meaningful step with Sanctions would be to completely ban Russia from SWIFT, and that's an option that has a ton of downside. Many European nations rely on Russia for their energy and have already faced an energy price crisis. Banning Russia from SWIFT would have damaging effects on European economies short term.

Previous sanctions on Russia had a carve-out for energy supplies, and given energy makes such a massive part of the Russian economy that kind of destroys the point of sanctions. Russia may be “under sanctions” but could still make the majority of its income from oil sales to Europe. It now looks like Europe will align with the US and UK to completely ban Russia from SWIFT.

There's a whole conversation about energy security I'm going to sidestep here, but TL;DR, conservatives want to drill for more oil, arguing that pragmatically we're decades away from clean energy and must cut reliance on Russia and OPEC. Liberals will counter that we must dramatically accelerate the clean energy transition to never again find ourselves in this situation. (FWIW, I'm a fan of not destroying the planet, even when faced with WW3).

Long term, the SWIFT ban could push Russia to adopt China's alternative to SWIFT (CIPS). SWIFT was already considered a slow and painful international payment standard, but its use in geopolitics may force alternatives to be adopted that aren't subject to US or Western Sanctions.

Would a SWIFT ban work?

No doubt being banned from SWIFT would be remarkably damaging to the Russian economy. Despite building alternative reserves, if the SWIFT ban included oil that could damage GDP by 5% or even 10%. Perhaps that’s a price Putin is willing to pay?

Putin likely believed that because Europe had previously prioritized energy over sanctions in 2014, he would get away with this war.

In recent moves, it looks like the Russian central bank is banned from transacting its foreign reserves (which includes the Euro). Russian banks will likely be banned from SWIFT. Russia has entered a costly war, that is taking longer than expected. It is burning through reserves it may not be able to spend.

So in short. Yes. Sanctions will work.

Russia went too far and is being put back in its box.

But the West had to deploy its economic nuclear option.

And that could have massive unintended consequences.

So a quick summary

• Sanctions allow the west to exert control over the global economy
• But they rely heavily on banks and the SWIFT messaging service
• SWIFT is slow and expensive
• China is building a competitor
• A SWIFT ban for Russia may result in the Chinese competitor to SWIFT gaining much more adoption in the region
• China is watching what happens with Russia closely and learning lessons
• So if the dollar is to maintain its position, perhaps we need an upgrade to SWIFT to compete with the real threat. China and DCEP.

I think as Fintech nerds, we have a real opportunity to build a better SWIFT and a better dollar global order.

Building a better global banking rail.

Hear me out.

Imagine if there were some sort of global, transparent, and public record of transactions. Let's say this record of global transactions was searchable in real-time and had mature forensics. 

Let's imagine an open-source protocol for the US dollar that is developer-friendly, near-instant, and (in some cases) nearly free to transfer globally. This new global currency based on the dollar would be stable, so we could call it a "Stablecoin." It could be issued by any commercial bank or Fintech company with an account at the central bank (or some specially licensed commercial banks).

This new payment system would be fast, cheap, and transparent. It would compete on openness and innovation in a way that no Chinese system ever could match. Activity in this system would be much easier to detect and enforce than relying on each individual bank.

We could also do so in a way that is privacy assured for consumers. If we adopt Web 3 wallets and issue KYC credentials to those wallets (as a non-transferable NFT for example). We could follow transaction activity, and whenever someone interacted with a wallet that had been identified as sanctioned our US Dollar stablecoin would refuse to travel to them (because stablecoins are programmable money).

The Stablecoins we have today have some way to match this reality (mostly because it would take banks forever to adopt them). But suppose I were the Fed, the US government, or anyone sufficiently motivated to f*ck Russia up right now. I'd focus on having the best, most transparent, capable financial rail for the US Dollar ASAP and have everyone in the world adopt it. Hell, I’d airdrop dollars to the US and non-US citizens alike, and especially to Web 3 wallets in Ukraine.

We’ve already seen Crypto be a way for individuals to donate directly to the front line in Ukraine.

We saw in the pandemic banks and governments can get their act together in an emergency. 

There is no greater emergency than preventing WW3.

Stablecoins are a geopolitical weapon we must deploy. Now. 

ST

4 Fintech Companies 💸

1. Humanode - Web 3 Biometric Identity layer

• Humanode binds digital identities to biology, not documents, and authenticates identities with "biometric liveness detection." The goal is to allow pseudonymous identities and still have online security and safety. Initially, this uses device sensors like cameras, but the longer-term ambition of Human node includes DNA sequencing. Humanode has a concept of "one human, one vote" and will run a consensus mechanism and governance mechanism to ensure it continues to be decentralized and widely available.
• 🤔 Like many things in Web 3, Humanode sounds high concept and ambitious when you first hear it, but at a minimum, this is directionally correct. The rise of pseudonyms is incompatible with our existing KYC frameworks, but we know KYC is broken. It also leaves out billions of undocumented humans on the planet from the financial system. If we had a way to prove a unique human exists, and manage the risks associated with that human, perhaps we can credit underwrite them, financially include and risk manage too?

2. Intrino - Plaid for Markets Data

• Intrino provides an API for markets data like financial statements, IPOs, fillings, real-time equities, and options prices. The data is available directly as an API via CSV or FTP with SDKs in languages like Ruby, Java, and Python. 
• 🤔 Fintech disruption is coming to capital markets (slowly). Any Fintech company that wants to build a data dashboard (for consumers, SMBs, or capital markets) can now do so. Bloomberg had this market wrapped up for decades, but I'm excited to see what others will do with this capability. (Stuff like Atom.finance already exists calling itself the SaaS version of Bloomberg, but what else?)

3. Detected - KYB (Middesk) for Global Companies

• Detected provides KYB (Know your Business) solutions for Fintech companies and platforms building for SMB and e-commerce merchants. It includes a global company finder, ID verification, company ownership finder, and decisioning engine. 
• 🤔 The Detected story is interesting; one of the founders became frustrated during the pandemic at those exploiting the pandemic for personal gain. This motivated a robustly identifying any supplier globally and a pre-seed round in September 2020. Ultimately KYB is a global problem, especially for folks in e-commerce or any form of import / export. Where Middesk has focussed on Fintech companies and the US market, Detected may have a more global market and work for platform companies just as much as Fintech companies. 

4. Koia - Fractionalized collectibles 

• Koia allows consumers to collect, trade, and own assets like comics, watches, NFTs, or Pokemon cards. Users can also own fractions of an asset with investments starting at $60. Koia helps source, verify and store the assets on behalf of investors. Koia also has "drops" of the fractions of assets owned on the platform that can be later sold on the Koia marketplace. 
• 🤔 The team has a banking and hedge fund background, so it has been able to structure alternative financial assets and make them easy to digest for consumers. It also stood out to me that they're incorporated in Estonia but clearly selling to an international audience. Estonia is quietly an excellent market for launching companies because it opens up access to the broader EU market and has a clear regulatory framework. But isn't it interesting? They're pricing in USD, so it looks like the team has built Koia to have the widest global appeal. Global is the new default. 

Things to know 👀

1. Chime to delay IPO

• Forbes is reporting that Chime is delaying its IPO from Q1 to the second half of the year to "focus on new products and features." Public Fintech stocks have fallen 40% since October '21, with both Paypal and Block being down more than 60% from their high. In August '21, Chime raised $1.5bn at a $25bn valuation. Chime claimed to have more than $1bn in 2021 revenues but faces potentially high fraud rates with companies like Hertz and Avis banning the use of Chime. 
• 🤔 Has Chime missed its window to IPO? Yes. No doubt the investors in the last round are expecting an upgrade on the $25bn valuation. Paypal is currently trading at $117bn market cap, on $25bn FY'21 revenue (so 4.7x revenue). That would make Chime's market open close to ~$4.7bn.
• 🤔 Stripe and Klarna are also in the category of recently raised big and would struggle to live up to that at IPO. Some very large, very late companies may look to stay private and hit profitability. And there's potentially a new type of patient capital on the horizon.  
• 🤔 VC firms are changing shape into more patient investors. If Sequoia, a16z, and others start to look more like PE firms, they could help these companies stay private and look to sell when the time is right. 
• 🤔 The dirty little secret of Fintech and e-Commerce is how often companies get hit hard by Fraud. Underneath merchants like Avis and Hertz are payment companies (PSPs), and underneath the payment companies are acquiring banks. Those acquiring banks see high fraud rates come from cards at Neobanks and "de-risk" that entire Fintech company. 
• 🤔 Fraud happens at banks, but the banks work together (through Early Warning Services). Chime is likely being blacklisted at this level, and ripple effects show across the sector in merchants and PSPs. Fintech has no equivalent to EWS (or access to it). So once again, Fintech companies need to up their lobbying game (!!). Most Fintech companies see Fraud as something they have to do, but not what they specialize in. That's why "Fraud-as-a-Service" is becoming such a critical component of Fintech companies (and e-commerce). Even the mighty Stripe Radar doesn't prevent Fraud nearly as well as a specialist solution would. 

2. Flutterwave now valued at $3bn

• Flutterwave has 3x'd its valuation to $3bn after a $250m Series D. Flutterwave is now live in 34 countries and processes 200 million transactions worth more than $16 billion. Techcrunch also reported that 900,000 businesses globally use Flutterwave to process payments in 150 currencies. 
• 🤔 Flutterwave's growth had been built on enterprise clients and payment acceptance, but it is now positioning itself to be as much "Paypal for Africa" as it is "Stripe for Africa." New offerings like Store for e-commerce or Send for remittances are now their fastest-growing products. 
• 🤔 PayPal is a partner of Flutterwave, which would make a great acquisition target, but it's unlikely Flutterwave will sell. Flutterwave continues to grow incredibly rapidly and is expanding into North Africa, the Middle East, and even LATAM. If this growth continues, they could become a monster Stripe / PayPal hybrid for historically underserved markets.
• 🤔 Global as the default. Flutterwave has also begun to allow African businesses to incorporate in the US and have things like ACH access. In a post-pandemic world, it matters less where you found the business and more where you operate and sell from.
• 🤔 Fraud and partner banks will always be there in the background as a potential issue for companies like Flutterwave to be compatible with western finance. Flutterwave is at the frontier of African markets, where fraud prevention models that worked in the West start to break down. Banks in the US fear companies like Flutterwave don't have "adequate" fraud controls and may begin to de-risk them (deny access) as Flutterwave enters the US. My sense is companies like Flutterwave are best placed to figure out local market fraud and will make things work for customers regardless, but there's a gap for a "Fraud as a Service" play that understands African context and markets.

Good Reads 📚

1. A product managers guide to Web 3

• The role of Product in Web 3 is different from Web 2 because they now own unique characteristics like token incentives, community, and how all products are built in public with rapid feedback loops. In this phase of Web 3, making an excellent viral meme is more important than writing a good email. While most projects don't feature product teams, the larger ones with high user bases are starting to (e.g., Axie Infinity). 
• 🤔 Given the talent looking to transition to Web 3, this article is timely since it's unclear how skills translate. Perhaps in Web 3, we'll call this role something else (like community manager) because so much of the roadmap is voted on by the community. Community leaders need to create narratives and win authority. Product leaders become personalities and leaders more than the silent observer of data.
• 🤔 The sheer scale pace of change makes keeping up with the industry a full-time job. Some have done well by betting on an ecosystem like Ethereum or Solana, but the infrastructure landscape is constantly shifting. It can be hard for Web 2 talent or businesses to build on Web 3 to this day.
• 🤔 But I think there are some obvious, no regrets choices. My advice to anyone in Web 2 is to download a Web 3 wallet, buy an NFT, swap a token on a decentralized exchange, and stake a token for yield directly. (If you're reading this and you haven't done that already, you absolutely must). From there, if I had to bet, I'd say for Fintech companies, anything involving Stablecoins for payments (and possibly yield) likely has a good future and is worth investigating further, especially for cross-border.

Tweets of the week 🕊

Available on substack

That's all, folks. 👋

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