29th May 2022 - Neobank economics, Fintech web3 wallets and Unit, Modulr & Thought machine raises
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Hey Fintech Nerds 👋
I spent much of this week at the Lendit conference, which despite the talk of layoffs at Klarna, Mainstreet, and rumors of many more to follow, had a "keep calm and carry on" vibe.
There is a feeling the tide is out, and things could worsen (particularly for consumer Neobanks) before they get better. The Chime CEOs' comments stood out to me. Chris noted they're not seeing consumers spend less; they're still seeing demand for their product and significant sign-ups.
This would chime (ha!) with market data that shows unemployment is still at an all-time low (3.6% in the US), and the consumer is still spending. If the consumer is still spending and employed, companies who make money on spending transactions won't be feeling the pain. Yet.
Chris also said during the pandemic, Chime scaled from 300 staff to 1,300 to cope with consumers' demand for digital banking.
Demand hasn't gone away yet, because interest rates haven't risen to a point yet where they would kill demand.
But they will.
You have to imagine when interest rates do rise, companies that scaled staff by 4x could feel some pain. But consumer Neobanks who help low-income segments will also be a lifeline for consumers.
Neobanks have to find break-even. And when less than 5% have done so to date, the next 12 months will be challenging. That break-even doesn't have to look like Uber's sudden price surges in search of profitability. It could look like a product extension and a better cost discipline.
More pain is coming, but the long-term trend is for a consumer who needs support. And Fintech companies are on the front line of trying to deliver that. Not all will do so profitably and sustainably. But some will.
And this is why people in the industry are heads down and building.
Because there's so much to do.
Another long one today. If your email client clips the content remember to check out the website version here so you don’t miss any content 👇
Weekly Rant 📣
Why is everyone doing a web3 Wallet?
In the past week, Robinhood, Revolut, and GameStop announced launching a web3 (self custodial) wallet. As Crypto prices capitulate, is this a hangover from the late-stage euphoria, some cheap marketing trick, or is there a genuine business case here?
Do these web3 wallets stand any kind of chance against the might of the Apple and Google behemoths?
Is web3 itself some crazy collective delusion?
Is asking questions of the reader a worn-out format?
The answer to all of those is yes and no. Because life is never quite that simple.
There are many arguments to lay out to make sense of these moves. There is a solid case for the prosecution and defense, so I'm going to try and tackle it as follows:
Self custody (web3) wallets are a new thing that must be understood
Fintech companies that did Crypto did well
Web3 presents new opportunities
But some people hate web3 (why?)
Where does that leave Web 2 behemoths like Apple and Google?
And will something web3 native out-compete all of the above?
Web3 wallets are a different beast.
"Wallet" is such a loaded term.
In Fintech land, it generally means some app or service that allows a person or business to store value and move value. That's not a web3 wallet.
Then there are services like BlockFi or Blockchain.com that help users hold and move Cryptoassets (and much more). These services hold the asset on the user's behalf, and the user doesn't interact directly with the underlying Blockchain network. That's also not a "web3" wallet, in my opinion. It's a web2.5 wallet.
Lastly, some apps and services allow users to interact directly with Blockchain networks (examples include Metamask, Phantom, and Rainbow). Using one of these wallets facilitates interaction between you and the network as pure software. When an asset sits in your web3 wallet, it's yours as if it sat in your leather wallet or purse.
But web3 wallets aren't a Fintech thing; they're an internet thing. The best way to demonstrate this is with a picture.
With Web 1, you create an account and access it via a username and password
With Web 2, you use an existing account and access via that centralized entity (e.g., Apple or Google)
In web3, you are the account. As a user, you connect your wallet to the service.
If web3 takes off, web3 wallets will become the primary interface used by consumers and businesses to interact with this new world. And wallets start with storing and moving value but can do much more (like signing transactions, voting, and more).
If web3 becomes a thing, operating a major web3 wallet might be a great place to be.
Fintech Companies that did Crypto did well.
FOMO is a hell of a drug.
What do CashApp, Robinhood, and Revolut all have in common? They all launched Crypto to consumers in a similar time frame and saw massive consumer acquisition and daily active use due to the demand from consumers.
Frank Rotman from QED investors once told me he saw Fintech companies adding Crypto in the short term as a "CAC hack" - driving new users to the platform and getting attention just by adding Crypto and serving that market demand.
The simplest business case for adding Crypto was the marketing benefit.
So perhaps adding a web3 wallet is just an extension of that?
Or maybe web3 is a genuinely new paradigm, and it was existentially important Fintech companies got on the front foot to deliver it to their customers.
One thing is for sure, the timing of these announcements is interesting. With the Crypto bull run, plenty of Fintech companies will have started internal projects to figure out "how the add DeFi" or Web3, and perhaps now we're just seeing those efforts come to the surface. Just as Crypto prices absolutely crater.
Is this just horrible timing?
Web3 presents new opportunities for Fintech Companies.
Beyond FOMO, I think there is an actual strategic rationale for consumer Fintech companies to do web3 wallets.
Yes, the marketing: Web3 is a hot topic, so announcing you're doing something there, as NFTs exploded, makes a lot of sense to get attention from the press and investors. Revolut also said they're launching a token with its own marketing potential. Would users get tokens instead of loyalty points for using the app regularly? Could users then "spend" that token? And would that drive deeper engagement?
Capture the upside of the new thing: If web3 does take off and become the new paradigm, getting in now and taking users with you before being threatened could be a stitch in time. It may also create a ton of new business models. If web3 becomes the everything account, would people want to finance their NFT collection? Game collection?
Defend the threat: If web3 is a new opportunity, would the new wallets displace user growth and activity like Fintech companies have done to incumbents in finance? Probably yes. So there's a clear defensive move.
Fix the UX: Being your own bank is hard, and today, web3 and DeFi have UX and security problems. They also exist in a regulatory grey area. This is a perfect opportunity for regulated brands with consumer trust to solve. Long-time readers will know I'm a fan of the Bankless DeFi Mullet (Fintech at the front, DeFi at the back). The Fintech companies have done well with fixing the UX of finance; why wouldn't this work for web3 too?
Web3 as better infrastructure for operations: Web3 may help solve complexities that Fintech companies solve today with other providers or tools. Solutions are being built by Protocols like Polygon or startups like Burrata and Spruce to help manage identity on-chain. Why does this matter? Just trying to keep track of users and their activities is a schlep. Now imagine finding the form where they signed up to GDPR or opted into marketing. Web3 infrastructure functions as a global public record of transactions signed by a wallet. Or imagine having a dashboard like Dune for compliance investigations?
If you're a consumer Fintech company that has saturated your home market and with slowing growth, the better question might be. Why wouldn't you do a web3 wallet (or at least investigate it)?
What about Big Tech Wallets like Apple and Google?
Apple has been playing the long game, people actually use Apple Pay, and Passbook is slowly integrating directly with US identity sources like state-level driver's licenses. Apple has also been the most conservative regarding Crypto or Web3. Where Meta is integrating NFTs with Instagram, and Google is announcing its "Big Web3 team," Apple is typically quiet about the subject.
Apple is all about vertical integration and its ecosystem. On the surface, web3 is the opposite of that. It is incredibly horizontal and open. But Apple also positions its products as more private and less reliant on selling consumer data than its competitors. To Apple, web3 could present a set of open source technologies it starts to use as infrastructure. Apple wasn't an early adopter of the cloud, but iCloud was a pretty solid effort when it eventually arrived.
Short-term Apple doesn't have to embrace web3, which could be dangerous. If web3 does become a new paradigm away from the device/app ecosystem, it is an existential threat to their dominance.
Google is a different beast. The history of Google launching a thing early, only to not fully support it, then pivoting a few years later is something even they acknowledged at the latest I/O conference. Google Wallet became Android Pay, which became Google Pay and is now Google Wallet again. Google Plex was an attempt to build the ultimate consumer dashboard for finance, and it was a fabulous product that, again, Google just didn't persist with.
Google has all of the pieces, though. Gmail and "login with Google" is already massive in enterprise and consumer ecosystems. If they simply adopted some web3 technologies there (like acquiring a major wallet, using decentralized identifiers and verifiable credentials), they could significantly get ahead of the curve.
The real question is can they execute? (and I say this as a Pixel owner).
If these companies don’t do something in web web3 soon Fintech companies and others have a window of opportunity. If Big Tech was to get into web3, the best route might be via acquisition.
Can Big Tech afford to ignore web3 wallets? Maybe if there’s too much risk.
Why will some avoid doing web3 wallets?
Some people really don't like web3.
Like, really, really hate the thing.
Regulators see all of the risks, hacks, scams, and fraud of an early space, and there is plenty of consumer harm. When apps offer 20% APY to consumers (via things like TerraUSD and Anchor protocol) only to collapse, that's what causes consumer harm. People lost money on false promises.
There are also plenty of scams. If you've ever used Discord or Twitter and interacted with Crypto, there's always someone with a "giveaway" competition that wants you to connect your web3 wallet. If the wallets and protocols aren't preventing this, who is?
The problem with consumers being their own bank is they're not a fraud team and compliance department. Being your own bank is fraught with risk for most people. In TradFi, you'd expect the consumer interface (e.g., bank or Fintech company) to help manage the risks. But in web3, that would be like asking your leather wallet or purse maker to help you manage the risk of cash. Stupid.
As a result, (some) regulators call web3 or self-hosted wallets "unhosted" wallets. That gap of "nobody is stepping in" is scary sounding. In reality, we could do plenty of things* to help manage those risks that don't turn web3 wallets into banks. This is an opportunity for Fintech companies to find the line between their TradFi business and web3 wallet.
Many Fintech companies (especially regulated banks like Monzo, Starling, Nubank, and Varo) will tread carefully regarding web3.
*A topic for another rant
Web 2 maximalists believe there is always a better way to solve a problem with existing centralized technology. The most efficient way to build a new payment system would be to simply develop it in a centralized way and open the API. Stablecoins that require wallets, miners, and other actors add complexity that reduces efficiency. And if our goal is to reduce the cost of payments and financially include people, having a slower, more complex ecosystem is illogical.
Perhaps the best example is Moxie, the founder and lead of the secure messaging app signal, whose criticisms include. Users don't want to run their own servers, and protocols are slow to develop. As such, decentralization isn't possible, and threats can emerge faster than the ecosystem can react. If web3 is about decentralization, why does everyone use Opensea and Coinbase?
The nuts thing here is all of these criticisms are correct. Web3 has points of centralization and bugs, and it's not very efficient (yet). And yet, Blockchain networks function as a global CRM of asset ownership. Yes, Opensea is the dominant marketplace, but it is also not captive in the way a Web 2 platform is. Moving all of your NFTs to another market is trivial. Moving all of your photos from Instagram to another app is less so.
The user benefit comes from a global record on a Blockchain network, which has some level of decentralization at its very core. This persistent state of what a wallet has and did is potent. The argument is often about the trade-offs between decentralization and user experience.
Bitcoin maximalists find web3, not decentralized enough.
Jack Dorsey and Elon Musk are the least likely candidates for Bitcoin Maximalists but articulate the worldview well. Essentially, anything that is not Bitcoin is not credibly decentralized enough. As Ethereum looks to scale, it introduces points of centralization (like Layer 2 scaling solutions or API abstraction layers like Infura and Alchemy).
Many web3 projects are backed by VCs who do incredibly well from token sales in liquid markets. By contrast, Bitcoin is quietly sitting there, not changing, and gradually delivering lightning network (which may function as another payments rail).
It's interesting how much momentum this argument has with some Big Tech companies. Bitcoin is both the least ESG-friendly network and the lowest regulatory risk. Yet David Marcus left Meta to build a Bitcoin lightning network-based solution, and Block is building a decentralized wallet for Bitcoin (not web3). Bitcoin presents a paradox, it might be Big Tech's entry into web3, but it might also mean they miss the party.
What about web3 native projects disrupting?
What if web3 wallets are your new home on the internet? Your digital backpack to access applications, your personal balance sheet, and buy a coffee becomes a critical piece of your digital life. The new players who get to own this space become not only the banks of the internet but the next big tech players aggregating data on behalf of users and managing services. This is a generational opportunity.
But today the wallet ecosystem looks like bank cards before Visa or Mastercard. Each decentralized application has to build connectivity to each wallet (or use Wallet Connect). This lack of standards makes it hard for larger players who have to worry about things like data privacy or regulation.
But for disrupters, it creates white space.
And that means opportunity.
Web3 wallets create a new user behavior and that’s going to take time to develop and gain adoption. But as the real-world use cases of web3 start to appear, the tech will disappear.
Web3 wallets need better interoperability between DApps and each other. Dare I say it they need standards and need to figure out as an industry, how they become backwardly compatible with the real world, with compliance, risk, with reality.
When the tech is ready it disappears.
Perhaps today these web3 wallets are too technical and lost in the weeds. Perhaps they’re focussed on their ecosystem or infrastructure. But there are some focused on the user, and thinking a few steps ahead. Can they build a sustainable business over time that users love, and delivers on the promise of web3?
Where do I stand?
Fintech companies would be crazy not to experiment with web3 at a minimum. Big Tech companies don't have to do anything and can create much more value by focussing on their core business and owning government identity and finance. Long term, this could be their undoing.
If DeFi has almost no labor and marginal cost for finance as infrastructure (per the IMF), then the opportunity is to manage the things that go wrong. That's something Fintech companies are very good at.
A question this rant didn't play with that warrants further exploration.
Which Fintech infrastructure companies are best placed to enable this new world?
Digital Assets-as-a-Service and BaaS providers are already making moves, as are payments companies. The next phase will be helping consumers and businesses manage the risk and complexity of living across both worlds).
If web3 emerges as the future of the internet, then being the interface to that future is a great place to be building. Because controlling ownership and value is intrinsic to web3 as a concept, those who understand Fintech (and have user bases) could be an interesting bridge between the two worlds.
And speaking of bridges, TradFi (and Web 2) won't disappear overnight. We'll need to be backwardly compatible. This is where things like open banking could play a crucial role.
For me, web3 is about the new business models.
And growth opportunities always come from business model innovation.
To unlock the future wallets need a network for web3, standards around managing risk, and getting backward compatibility for reality.
The eternal question is always, can the innovator get scale before the incumbent gets innovation.
But who knows, maybe web3 is a Ponzi and collective delusion.
I doubt it, though.
4 Fintech Companies 💸
1. Prograd - Credit Karma for Gen Z Education Funding
Prograd is building a marketplace of lenders and students to help match students to the right financial products for their life goals. The team has a solid banking and lending background and a mix of serious AI skills. The team says lenders struggle to lend to Gen Z because bank brands are less desirable, and their underwriting models often struggle to price risk for this generation. Prograd uses education signals (e.g., what course someone is on) and other data sources to help recommend products for users and price risk for lenders.
🤔 What if credit karma and the apple watch had a baby? Price comparison websites often suffer from information asymmetry. They ask for data from users and provide that to lenders. Credit Karma fixes that with educational content, but Prograd wants to fix it with design and become more "apple watch" in how it guides users to the best outcome (including products other than lending). Pricing lending (even in a marketplace) is a hard business, but I'm less worried about that here because the team has a strong lending background. The question is whether they can get an adoption flywheel going with Gen Z and materially improve underwriting in time vs. traditional models.
2. Themis - The compliance collaboration tool
Themis allows banks, Fintech companies, and even DeFi organizations to collaborate on compliance. Featuring a hub for policies, document storage, complaint management, vendor management, audit, and even logging complaints with regulators, Themis is by compliance nerds for compliance nerds. But makes any Fintech or Crypto company at least quite good at demonstrating compliance by default.
🤔 Often, compliance collaboration is manual and left to the people in a compliance team to figure out, or a provider helps with a part of the puzzle. Regtech as a category has a ton of room to run as we move from just optimizing how a department works into the gaps between organizations. The nature of the financial system is highly interconnected, but those connections are often loose and based on humans. A way to proactively collaborate that bakes in the rules and workflows limits the variability and simplifies life for everyone. Given the proliferation of partner banking and the sheer scale of the Fintech industry, there's a massive need for this sort of thing. If you work in a bank, Fintech company, or regulator, you should get a demo of this.
3. Cytus Finance - DeFi rails for Real-World Lending
Cytus brings higher yield investment opportunities to DeFi investors. Users deposit a stablecoin with Cytus (e.g., USDC), which is lent out to borrowers. Borrowers repay between 7-10% APY. Unlike other Real World Asset (RWA) protocols that require a deposit that cannot be withdrawn, Cytus claims no lock-up period; investors can exit. Instead, focus on the investor incentives via its CTS token and staking incentives to bring liquidity.
🤔 Why do we need DeFi if investors can get these yields from TradFi? For me, the answer comes down to efficiency and composability. The IMF published a paper showing DeFi has almost zero labor or marginal costs. As it scales, those efficiencies can win. And because anyone can build on any other DeFi protocol or DApp, the space for innovation is much broader. We've just seen leverage go wrong in DeFi yield; what if that happens in real-world yield? IMO, DeFi would likely be the fastest to switch to whatever is new.
4. Shares.io - Social investing app for Europe
Shares.io allows users to buy over 1,500 US stocks from €1 with no fees. The app is designed to be social, and users can start conversations, network, and learn from experts within the app experience. Shares.io is initially available on a waitlist for UK customers and plans to expand into Europe.
🤔 There is currently no equivalent to Public.com available across all of Europe. The UK's Freetrade is perhaps the largest player, with a successful track record and online forum (and soon to launch in Sweden). Folks like eToro have the copy trade functionality and a mobile app but aren't really social like Public.com is. Revolut is available in many European markets, but stock trading is one feature. The gap in the market is there, but is the demand? Europeans don't have a history of being in the stock market like the US. With the market downturn, you also must wonder about the short-term customer acquisition and daily active usage potential. European expansion is also hard. If someone can nail the Europe-wide investing first wedge product in the long term, it's a giant opportunity.
Things to know 👀
Unit allows companies to embed financial services in their product, from building Neobanks to earned wage access or solutions for the freelancer economy. Unit says transaction volume is up 7x in the last 6 months and crossed an annualized transaction volume of $2.6bn with over 430,000 cards issued.
🤔 So much for Fintech is dead. You have to imagine this round was wrapping up before the market went to absolute turd, but there are questions about the long-term multiple of "Fintech middleware" companies. Unit delivered much more than "up and to the right" here with 7x in 6 months and grew with its customers. Traction solves everything. Unit also runs famously lean, and the founder and CEO Itai noted they estimate to have 10 years of runway.
🤔 There are many types of BaaS provider. Unit, in particular, has focussed on developer choice and experience. Want to get to market quickly? Here's the "one we made earlier" set of integrations. Want to change those later? Here's the power-user version. This ability to scale with developers and be responsive to their needs could be what helps them stand out. Unit has also executed a massive amount quickly, founded in just 2019. Supporting multiple partner banks, providers, and use cases all in a coherent platform is hard.
🤔 I still wonder where the long-term equilibrium is for BaaS. It is a very crowded market that no provider is close to dominating. Often when a platform begins to scale, they want to ditch the middleware for better unit economics (ha!). But there are so many partner banks, product types, and Fintech providers that doing so is time-consuming and burns Capex. Perhaps BaaS providers can offer so much choice and value that no developer would ever feel locked in. If anything, the opposite.
European payments infrastructure provider Modulr has raised $108m to accelerate its vision to allow "any software platform to embed payments capabilities." Modulr aims to build on its $100bn annual transaction value and has customers like Revolut and Sage.
🤔 Modulr is an all-in-one provider for Europe; it offers card issuing, open banking payments, open banking, SEPA, and UK local clearing. That's all the things. It also has many payment orchestration features for receivables, disbursements, etc. This product breadth is quite powerful.
🤔 The payment provider middleware landscape in Europe is a long way from having a winner, but it's all to play for. Some massive payments companies are based in Europe but they have tended to focus on acceptance (Checkout, Adyen), as have international players going deeper into product extension (Stripe). The middleware providers like Railsbank and Modulr rub against newer providers like Weavr, Swan, and Hubc. They all occupy a mix of geographies and product lines. Will the big ones buy the small ones? Can they all co-exist in the market? Will the big international companies look to acquire? Interesting times.
🤔 Unit raises $100m on $2bn of transaction volume, Modulr raises $108m on $100bn of transaction volume. Did that stand out to you too? Granted, the growth rates may be different between the two companies, but generally, I find European companies tend to be at a discount to their US counterparts. Perhaps partially because European expansion is slower, so are growth rates in some cases.
Core banking platform Thought Machine announced a Series D raise of $160m led by Singapore's Temsek holdings. Investors also include several large banks like Chase, Morgan Stanley, and ING. The UK's Lloyds Banking Group also extended its contract with Thought Machine until 2029.
🤔 Being the supplier to the incumbent with a long contract is a nice place to be. Core banking deals tend to be very long because they're mission-critical. I mentioned last week that we see some of the public issuer processors like Marqeta and Galileo starting to win incumbent banks as customers. The same is true of core banking platforms.
🤔 Getting a contract used to be the barrier for core banking; now, it's scaling them. These core banking providers had won mostly Neobanks (or digital spin-off banks for incumbents) from 2015 to 2020. Thought Machine, Mambu, Finxact, and 10x are now all in the conversation for long-term core banking replacement (although I wonder if the FiServ acquisition of Finxact helps or hinders that). The next question will be going from having a contract to having millions of customers using the platform.
🤔 scale for the core banking provider relies heavily on how effective its customers are at launching and scaling their products. Thought Machine rival 10x used by Chase UK just surpassed 500k users. Chase launched in the UK with a simple, clean app and the market's best savings rate. Not all incumbents have been that bold and committed. Often "core banking replacement" has meant massive internal transformation programs staffed by big consulting firms. Providers are a tiny piece of that puzzle, no matter how good their platform is.
Good Reads 📚
God damn, the team at a16z is good.
This super digestible report is packed with data on web3, and DeFi, like the daily transactions on Ethereum, is 1.1m, Solana 15.3m, and Polygon 3.4m. Or that Polygon, Avalanche, and Ronin (Axie) are the top bridges used to and from Ethereum. An amazing chart shows the Solana developer ecosystem growing at the same pace Ethereum has.
🤔 In terms of a beautifully presented snapshot of the current web3 ecosystem, you'll have to go a long way to find anything better than this. There is a little bit of poetic license with some of the points being made (e.g., DeFi would be the 31st largest bank in the US by total value locked). But the downside of presenting data in a primarily visual form is the space for nuance is limited.
🤔 The report clearly outlines the argument vs. Web 2 business models. This is a bit of a religious war in some circles, but the space for artists to find new revenue streams with NFTs and games to build new business models is wide open. Often incumbents don't die; they just don't grow. And Web 2 companies look, sound, and act like incumbents.
🤔 Right at the back, there are some examples of organizations already reaching scale and being used (i.e., Goldfinch, Spruce, and Helium) that you should pay attention to. When explaining with web3, I find that people need to understand two things. 1) A case study like those named and 2) How users interact with that via a web3 wallet. If you can understand those two things, you get why web3 is different (at least conceptually).
Tweets of the week 🕊
That's all, folks. 👋
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