Fintech 🧠 Food - 22nd Aug 2021 - JP Morgan and Plaid, Robinhood results and would you rather be a Super App or Neobank?
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Weekly Rant 📣
Is it better to be a Super App or a Bank?
Every time I see a Fintech announce they are applying for a charter, I wonder, do you really want to be a bank? Being a bank means you get to lend, and lending is a great way to make money. But being a bank makes it much harder to win at other Fintech business models.
PayPal and Square are crushing every earnings season, and while they both have a charter (PayPal in Luxembourg and Square has an Industrial Loan Charter), their primary way of making money is not the same as banks. Where they started gives them a very different set of options to drive revenue.
Then you have companies like Monzo or N26, who went the consumer banking charter route but have taken longer to hit profitability. Getting a license is hard; scaling with it is harder.
You'd assume then that being a Super App is the only sound strategy for consumer Fintech? Well, no. Look at Nubank, with 40m customers, adding another 1m customers per month, and heading towards IPO, Nubank is crushing it too.
As the first wave of US Neobanks head towards IPO, should they double down on lending, or look towards the Super App strategy?
The reality of if a charter makes sense comes down to how well the banking business model works in your market. To unpack that, let’s look at the banking business model, vs the Super Apps and how geographies impact the revenue potential of these businesses.
Drivers of the banking business model 🚗
(Skip this if you already know finance, but laying it out for completeness vs. the Super App model. And yes, before you @ me, I know I've taken some liberties simplifying things here)
1. Net interest margin: The core banking business model is based on net interest margin (NIM). To grossly oversimplify: This is the difference between banks' price for a loan (e.g., 8%) and the price they pay depositors (e.g., 1%) minus costs. So taking our example above, if a bank had $1000 of deposits, they'd pay $10 out but receive $80 of revenue. That $80 of revenue has to pay the $10 to deposits, leaving them with $70 to cover their expenses (e.g. offices, staff).
So a bank can attract lots of deposits with a high savings rate but would increase its “cost of funds” in the process. This is the balancing act banks constantly have to strike, between growing deposits, and being able to lend effectively.
Banks can't choose any rate they want either. The rates are set by the central bank base rate. If the central bank lowers rates, the amount banks can charge for loans goes down (and vice versa).
Since the global financial crisis (and the pandemic), interest rates have been low and stayed low. This means the banking business model has been under pressure (and you can see this in their long-term share price).
2. Scale: One of the best ways to survive in a low-priced market is to generate scale. Banks with higher deposit bases have a lower cost of funds (again, oversimplifying: because of their ability to use that deposit base to drive better pricing in overnight markets and more).
One of the best ways to drive scale is to attract more sources of deposits through opening more consumer, business, and corporate bank accounts. Typically small businesses and corporates have much higher deposits than consumers but are more complex to serve. The older, larger banks have done well here historically.
This is why I sometimes compare the banking business model to the movie Waterworld. Through M & M&A, competition, and in many market regulations, banking is a game where only the largest can turn a profit.
3. Managing cost: As with all businesses, one of the best levers to grow profits is to reduce cost. The main drivers of cost for banks are people, property, and technology.
Branches have been banks' primary customer acquisition and servicing point, but that property is expensive and requires people to staff it. Still, the assumption for many big banks has been, if you want more deposits, open more branches.
Bank tech is also pretty old, inflexible, and expensive to maintain. So banks spend billions on "digital transformation" essentially to stand still.
The Neobank opportunity: Without branches and with fewer people, Neobanks have a much lower operating cost. Neobanks often don't pay heavy marketing costs to get someone to switch direct deposit, so their entire customer acquisition cost (CAC) can be as low as $10 to $20.
In the US, if that customer is reasonably active and makes plenty of transactions in a given year, the Neobank can break even on the interchange fees they receive from Merchants alone. Interest rates in the US are low, meaning lending requires a good deal of scale.
In Europe, where interchange fees are capped, there is much less available revenue to Neobanks until they find another source of income. Interest rates in Europe are near zero or in some cases, negative, meaning lending requires a scale and low operating costs.
In markets like LATAM there is both more interchange and higher interest rates, so getting to a charter and lending business model quickly makes a ton of sense.
The Neobank problem: If a Neobank gets a charter, they often have fewer deposits as a base than the megabanks do at the outset. The newly arrived bank has a higher cost of funds than their big rivals, so it may not drive profit from their lending activity as quickly. We've seen this in Europe, with Monzo (with nearly 6m consumers and an average deposit of ~$500) and N26 struggling for profitability.
Also, in Europe, Starling, with 2m consumers and 200,000 small business customers, has driven closer to profitability. Starling got into the SMB market early and was a significant provider of lending during the pandemic to SMBs. So profit is possible in the banking business model; it just takes a long time and requires banks to go wide and drive towards the right kind of scale for that model. (Side note, this is why I'm excited to see if Brex or Mercury get a charter).
Drivers of the Super App business model 🚗
This is where things get interesting. The term Fintech "Super App" is loaded, but I'm thinking about Fintech companies whose primary business model is not (or has not been) banking and lending. For example, PayPal, Square, and even Revolut.
Payments: PayPal and Square both started in the Merchant payments sector but also have consumer offerings. Square gained significant adoption by offering "real-time payments" for a fee. Consumers valued the ability to move money instantly, and Square Cash App had an excellent wedge feature.
Product line extension: In the past two years, both PayPal and Square have layered on other services like stock trading, Crypto, and now Buy Now Pay Later for Merchants. Revolut also offers stock trading, Crypto, and increasingly merchant payments to its SMB customers. Each of these products generates revenue in its own way, but the trend is these Super Apps often start by partnering to deliver them (for example, Paxos powers much of the Crypto trading in PayPal).
Merchant / Consumer ecosystem: With both consumers and merchants on their platforms, the Super Apps can build intelligent ways to connect the two. Whether creating insights for merchants or rewards and offers for the consumer - having both sides of the transaction is powerful. It's technically true; banks could have similar data, too; they just don't. For the incumbents, the issue is legacy tech, and for the Neobanks, its focus.
The Super Apps as a result often solve more of a problem for their customers than a bank would typically. Most banks (even Neobanks) don’t tend to go deeper into adjacent merchant problems like inventory management, advertising, or payroll. Some of the Neoabnks are going there, but their starting point is still the bank paradigm.
The Super App opportunity: With more data comes the ability to identify user behavior and solve for more of the customer's financial lives. With a digital operating model, the Super Apps have a low cost of acquisition and more sources of revenue than the chartered banks. The Super Apps also don't have the same regulatory and tech debt overhead as the incumbent banks. Once you become a bank, the regulatory scrutiny levels up several notches.
These Super Apps often have all the features you'd expect in a bank account (like direct deposit or bill pay). In effect, they're better than a bank and reducing banks to paycheck motels for many consumers. Some consumers even consider their Super App their primary bank account.
The Super App problem: Regulatory loopholes don't last forever. The banks are moaning about the "lack of a level playing field" and lobbying hard to see that change. If Super Apps look like banks, act like banks (and in many cases can do more), shouldn't they be regulated similarly? The Super Apps would argue they are already.
The significant difference is that the banks have capital requirements and controls since the global financial crisis to prevent overly risky lending. The Super Apps have been wise to not get as deep into the lending (and financial markets) game as the big banks to avoid this kind of overhead. Technically both Square and PayPal have a charter and do some of their own lending, but they’re unlikely to head towards “universal bank” status any time soon.
It comes down to what’s the best business model?
Picking the model
Depending on your Geo, different models may make more sense.
In LATAM, there is so much money to be made from just good banking and there’s a greater need. That doesn't prevent LATAM-based banks from evolving their offering towards a Super App strategy, but it may delay it. Perhaps in LATAM, we'll see non-banks (e.g., ride-hailing companies) start to try and take the Fintech Super App crown, much like Grab has attempted in APAC.
In Europe, Starling is slowly, steadily making the banking business model work, but Revolut has seen much more growth with its Super App strategy and expansion. It's too early to say which model is correct, and perhaps they're both not wrong. But in Europe, with low interchange, maybe the worst place to be is halfway between a Super App and a traditional bank. (That's why I'm so interested to see what the new UK entrant Kroo does as it becomes a bank. Will they find revenue sources beyond lending?)
The US is an interesting halfway house. Neobanks can make a good existence from their Interchange revenue to scale the business. The question becomes, what next? As I think about Chime, in particular, I wonder if they should push for a charter or is the better outcome to never get the charter and become a Super App? Or is there something in the middle I’m just not seeing?
The US isn't LATAM, but it isn't Europe. Being a bank with scale is rewarding, but maybe not as much as being a Super App. (Unless of course, central banks start hiking rates. But medium-term, that doesn’t seem likely.)
So how does it play out?
Every company wants some of that sweet Fintech revenue.
If an app has all of the features of a bank (and more) with a better user experience, it has a real chance of winning market share and revenue. Banks will always struggle to ship at the same pace as non-banks. The banking business model works well at scale but comes with the overhead of actually being a bank.
The banks have an opportunity to become more horizontal and gain ever more scale. But they can’t both have a license and ship at the pace of the non-banks (unless they dramatically shift their operating model - more on that; next week).
The Super Apps have a chance to bring together the merchant and consumer ecosystems with data and deliver more value to both sides.
The incumbent banks are unlikely to execute a Super App strategy effectively. But what about everyone else in the middle? What about the Robinhoods and Chimes of the world?
Pace of change is a power law in Fintech. Those who ship fastest win customers and revenue. A license slows you down unless the game you’re playing is scaling deposits and lending. But if you’re playing that game, do it intentionally. (Or pick a market with great interest rates)
Does Fintech get re-bundled under the super app, or do consumers want many apps for many contexts? Is the future of the Neobank being an also-ran to the Super Apps or competing with them?
I honestly have no idea.
Not knowing is half the fun. 😁
4 Fintech Companies 💸
Kroo - Multiplayer Banking (with a license) UK
Kroo has launched a debit card in the UK that includes spending insights and zero fees for spending at home or abroad. Kroo also has a groups feature for spending, tracking, and settling in one place together. Kroo has just received its UK banking license with restrictions, and its business model will be predicated on lending.
I love the design language Kroo has, and planting 20 trees for every referral is a smart marketing acquisition strategy. The group's feature is elegant, too; it feels like the thing missing from every Neobank. Kroo's execution is a quality feel to it. They've done well getting so far with their banking license so early in their journey, but looking at the path in front of them, I wonder, is that the right move?The UK doesn't have a winning Super App (nor does Europe, for that matter). But maybe they've timed it well, watching the road others have taken. Good to see another up-and-coming challenger in the UK too!
Pngme - Open banking for the underbanked (Nigeria, Kenya)
Pngme collects and aggregates data from Fintech companies, Microfinance institutions, and Telco wallets across Nigeria, Kenya, and Ghana. Pngme creates a single view of transactions, identity, and balances from all connected accounts. They have also built proprietary ML models for credit scoring.
Pngme aggregates the aggregators (e.g., Okta and Mono) and institutions and data sets not covered by those aggregators. Pngme is looking to differentiate on the value add from its ML models and customer insights dashboard. This is an interesting model. Plaid is heading in a similar way, and Credit Kudos on the UK. It's not just the data to enable the use case; it's enriching the data and driving decisions and outcomes through a single API. The future of open banking is about value add.
Jenfi - Revenue-based finance in SEA
Like many revenue-based finance platforms, Jenfi provides loans based on sales and accounting data. Jenfi takes data from payments platforms (e.g., Stripe, Braintree) and accounting platforms (e.g., Xero) and analyses monthly sales to take a percentage to pay back a loan.
Indonesia, Thailand, the Philippines, and Malaysia have large populations and are in a Tech and Fintech boom. Revenue-based finance has been massively successful for companies like Clearbanc and Uncapped, so it's not surprising to see it appear elsewhere. I do wonder, though, if we'll see more marketplace models like Pipe.com emerge? I also wonder if regional players will eventually become M&A targets for global players. Does Uncapped or Pipe raise a mega-round and go global?
Ondo - Programmable DeFi Loans
Ondo allows lenders (in this case, anyone with Crypto) to provide liquidity either at a fixed or variable rate. Meaning you as an investor can choose between the safety of return or making your own lending strategy for higher yield.
DeFi yield has been a significant feature of Crypto over the past 12 months, with consumers and institutions enjoying returns on "USD like" investments between 4% and 8% (sometimes higher). While these "investments" risk profile is arguably higher than money market funds or US Dollar savings accounts, investors have nonetheless been very attracted. Protocols like Uniswap, AAVE, and Compound have consistently performed well but have their opinion baked into the code about the return profile. DeFi investors are increasingly institutional and sophisticated, and to them, I imagine a "build your own return profile" feature could be attractive. It's a derivative as a programmable primitive.
Things to know 👀
Plaid, fresh from breaking up with Visa in January, and scooping $425m in April, has extended its Series D funding, adding JP Morgan Chase (a new investor) and American Express (who had previously invested in Plaid from Series B) to the round.
🤔 My Analysis: What's interesting here is this comes just months after JP Morgan CEO Jamie Dimon accused Plaid of "improper use of data." This may have been an out-of-place comment because Plaid's response at the time was that Plaid and JP Morgan were already working on a data partnership. Still, holy optics, Batman.
🤔 My Analysis: Plaid has been very smart in putting in place data partnerships with financial institutions. Banks get their pound of flesh while the market continues to access account data that has unleashed a wave of Fintech innovation. Especially considering Plaid did this in the absence of any regulatory regime forcing banks to open their data. The Biden administration bringing in Open Banking regulation may be a day late and a dollar short.
🤔 My Analysis: I really like how Plaid is now thinking about the data dashboard (My Plaid). This ability to see where your data is, manage it, update it, revoke it is neat but can lead to much more in time. The product spin-out ideas are endless. Imagine an aggregated view of the market, which apps are getting adoption and which aren't? More excitingly, Plaid is placed to help manage your digital financial identity. Therefore, it's set to help manage your digital identity. Now that would be something.
🤔 My Analysis: You just have to look at the rise in identity theft and hacks in the past decade to see the value of a good digital identity service. Or how painful it is to do just about anything with government or healthcare without one. Nordic countries have "Bank ID," where you can use your bank credentials to log in to other services. Plaid is placed as a sort of BankID service that doesn't rely on any particular bank. Imagine identity as a service, with many identity providers in the network.
Robinhood reported revenues of $565m, with Crypto trading ($233m) representing more than 51% of all transaction-based revenue. More than 60% of accounts traded Crypto in Q2. Assets under custody are now $102bn. Robinhood is forecasting less trading in Q3, and its stock finished 8% lower on results day.
🤔 My Analysis: By all accounts, Robinhood has performed phenomenally well financially and is scaling its business in the middle of a consumer stock buying boom it helped fuel. It can also lay a claim to helping millions of people benefit from access to the stock market like never before. But something still looks wonky to me. For example:
🤔 My Analysis: As @ODELL pointed out, Dogecoin made up a high percentage of all Crypto trading fees. And it's no surprise when this is the Robinhood Crypto trading page 👇.
🤔 My Analysis: A user has to click "Ethereum family" or "Bitcoin family" to find the less speculative assets. This would be like making penny stocks the first thing a user sees and blue chips harder to find. You have to question the motive of why these assets appear first. No doubt there is massive user demand for assets like Dogecoin, but Litecoin? The psychology of having an asset that looks affordable and has hype may drive buying behavior, but this is arguably creating speculative user behavior.
🤔 My Analysis: Robinhood appears to optimize for clicks and user engagement, not long-term financial health. In a world where people are free to gamble, that's not illegal, but it feels icky while wearing the clothes of regulated financial services. When this market bull run eventually comes crashing down, you have to wonder how many fingers will be pointed at Robinhood and what they're doing to help themselves. I believe in Crypto and that consumers should have access to it, but let's do so responsibly.
Good Reads 📚
FTX is best known as the "expert mode" Crypto exchange that has grown massively in the past 12 months and recently secured $900m at an $18bn valuation. Mario concludes his three-part trilogy into Crypto exchange FTX with a look at its longer-term strategy.
FTX is expanding to be more consumer-friendly in Crypto (e.g., its acquisition of Blockfolio); it is betting on sports (e.g., sponsorships like the Miami Heat). Longer-term, Mario wonders if FTX will become a bank or even enter social media.
Sports represent an opportunity to get into betting (e.g., Draft Kings with better tech), ticketing for events, NFTs (like NBA Topshot), and even involving the consumer in sports star contract ownership. FTX's user base skews institutional (or large), and trades love its technology platform. Could "tokenized stocks" make FTX a better exchange than existing incumbent exchanges like NASDAQ or NYSE?
As with everything Mario writes, my summary will never do it justice, and you should check it out.
🤔 My Analysis: FTX has the kind of regulatory profile that raises eyebrows (much like Binance), but unlike Binance, their media (and I would assume regulator) engagement is much more sophisticated. If you listen to their CEO Sam on any podcast or CNBC interview, his comments are always well placed, considered, and precise. That won't absolve them of regulatory trouble, but it really helps. FTX has less of a middle finger to regulators than a "how do we make the innovation the market needs work" vibe.
🤔 My Analysis: Brokerage API Drivewealth raised $450m, and one of its new investors is FTX. Drivewealth is the "default" API used by apps to build a Robinhood clone for share dealing. The FTX strategy is definitely thinking multi-year. The more you stand back and look at FTX, the more it seems like an upgrade for exchanging stuff.
🤔 My Analysis: FTX is well placed in the macro trend of the financialization of everything (h/t John St Capital). Younger generations have grown up in a world where everything has an element of finance. Trading sneakers, game skins, and Crypto. FTX is by default, 24/7 and instant, and with some well-placed bets, if everything becomes finance, FTX could well be the everything exchange.
Tweets of the week 🕊
That's all, folks. 👋
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