Fintech 🧠 Food - 6th March 2022 - The role of Crypto in a Crisis, Klarna raising @ $60bn and Payhawk the Bulgarian Unicorn

Hey everyone 👋, thanks for coming back to Brainfood, where I take the week's biggest events and try to get under the skin of what's happening in Fintech. If you're reading this and haven't signed up, join the 11,806 others by clicking below, and to the regular readers, thank you. 🙏

Hey Fintech nerds. I hope you're finding some way through the world this week. 

It seems the SWIFT explainer went down well, and I think that's because as we live and breathe this industry, having a way to just comprehend what the hell is going on is helpful to orient ourselves. 

The global financial system is the primary weapon in economic warfare, and if you understand the system, you can understand how to make it more effective. 

🔌 Reminder I'm talking at the MX Fintech festival this week, and you can watch along virtually by clicking here. 

Weekly Rant 📣

The role of Crypto in a Crisis

More than $83.7m has been donated to the official (and verified) Ukraine wallet from ordinary Crypto users. These donations have gone directly to the Ukrainian government, charities, and foundations. The funds are being used to purchase protective, military gear, and humanitarian aid. Crypto's traceability has led to real-time analytics on how the funds are used on the front line.

In a week where we've seen the worst of humanity, we also sometimes see hope. Crypto and Financial Services are front and center in this new economic warfare, and if done right, Crypto could be a lifeline for millions of people.

Gold was historically the store of value in troubled times, but the historians among you will remember that many of the Jewish people fleeing Nazi Germany had their gold confiscated. Physical stores of value can easily be stolen, especially from migrants fleeing a crisis.

Crypto can (and has) become an alternative to carrying gold and jewelry while fleeing home or surviving an economic crisis for a small number of Ukrainian citizens. 

Meanwhile, Crypto could also become a safe haven for Russia, not for the Russian State or Oligarchs, but ordinary people whose currency and savings are vanishing in an economic war they didn't start. The on-chain evidence suggests Crypto use by ordinary Russians is limited, but in economic warfare, limited isn't good enough for some folks. 

In economic warfare, the West also sees more risk in Crypto than opportunity. Crypto exchanges are being pressured to ensure they implement sanctions and entirely block the country of Russia. Crypto exchanges are pushing back, saying they won't block ordinary Russians until the US passes a law to compel them.

This is becoming a conversation in which nuance is missing. 

So let's unpack 👇

1. Why are governments using Sanctions?

2. Sanctions are being used at an unprecedented scale 

3. Russia has some loopholes it could exploit, and we need an upgrade to the global financial system

4. Politicians are calling for greater controls from the Crypto exchanges

5. The Crypto exchanges are pushing back (for the right reasons, but need to read the f*cking room)

6. We have a window of opportunity for a much more effective system

Why are Governments using sanctions?

Sanctions run on 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.

If you want to go deeper, I covered sanctions in more detail last week, but the key to remember is it's up to the organizations themselves to implement sanctions.

Sanctions are a non-violent, non-military form of warfare. Their use in trade can be traced back thousands of years, but they became a weapon of choice after 9/11. When fighting an insurgent enemy, the battlefield isn't where you win but removing their finances is. Banks really became the enforcers of Sanctions, but historically Sanctions were slow, steady, and stung at the edges.

All of that changed this week.

Sanctions new unprecedented scale

What we have seen in the past week is banks and Fintech companies going well beyond the letter of the law with Sanctions. The assumption being Russia is now economically toxic, and any effort to cut ties with them is now the right course of action. That means blocking any trade, any transaction, anything that looks connected to Russia.

This "mass de-risking" is something we saw previously with Iran, where western banks cut trade and ties completely with Iranian entities. Now the situation is even more delicate and severe, given we're witnessing an invasion.

We've never seen sanctions used at such scale and spread so quickly. We're witnessing a genuinely unprecedented set of measures.

In the past week, we saw:

• Visa and Mastercard block Russian banks and FIs.

• Russian bank's share prices declined by 97% as investors dumped those assets.

• BP, Exxon Mobil, and Shell are all disposing of their Russian assets.

• Shipping companies like Maersk and MSC refuse to send containers to and from Russia (which would cripple energy exports).

That's before we get to sports, entertainment, auto, or retail sectors, who are all pausing or leaving Russia entirely. This has resulted in long lines at banks as Russians try to withdraw cash in fear those banks will go under. 

In effect, the entire private sector has now been recruited (mostly voluntarily) to enforce not just sanctions but a complete economic shut down of Russia. 

Russia is toxic, and almost the entire private sector is de-risking any trade with Russia.

Can Russia Avoid Sanctions with Loop Holes in the existing financial system?

Yes, but it's getting harder. The new scale of these Sanctions is a game-changer, but loopholes exist.

A significant loophole is the carve-out for energy trade. Anyone in the economy can work with Russian banks or individuals for oil or gas. While the private sector and some nations are now refusing to use Russian-supplied energy, it will take some time to wind this down. And energy is an economic lifeline to Russia and its Oligarchs. 

But perhaps the most significant loophole is the global financial system itself.

The long-term effectiveness of Sanctions against Oligarchs and the Russian State is still an open question. For decades law firms, jurisdictions, and smaller banks have enabled secrecy. As Casey Michael points out in this thread, law enforcement has been outgunned for years by lawyers working for the Oligarchs even when assets are identified. 

We've seen sandals like the Panama papers, 1MDB, and the Paradise papers all show the sheer scale of money laundering in the financial system is enormous. Some of the geographies that enable these loopholes are small, but places like Delaware, South Dakota, and the UK are as guilty as anyone. 

Without significant new legislation and funding, the game of cat and mouse will continue. And the mouse has a billionaires budget and the whole world to go hide in. (Unless, of course, Twitter accounts start tracking yacht movements).

Some politicians just hate Crypto.

But instead of a conversation about closing these loopholes in the existing system, several Politicians used the opportunity to challenge Crypto. Perhaps the most vocal has been Senator Elizabeth Warren, who said Cryptoassets "risk undermining Sanctions against Russia."

Sunlight is the best disinfectant. 

The same technology that allows companies like Merkle Science and Chainalysis to track donations to the Ukrainian government in real-time allows law enforcement to track the bad guys. We've seen this countless times as law enforcement has taken down darknet markets, scammers, and criminal groups. The DoJ recently seized $3.6bn worth of Bitcoin in its "biggest bust ever."

That's the kind of thing that only happens if we get a whistleblower or a leak in the existing system. 

The Crypto forensics tools show little to no evidence of the Russian State or any sanctioned entity using Crypto networks to evade sanctions. The Russian government's efforts had been to diversify into gold and other foreign reserves. Why use Crypto, which is transparent when you can use the existing system full of loopholes?

Crypto, if adopted widely, would be a dramatic upgrade over the existing system.

Banning Crypto wouldn't hurt Russia, but it would hurt innovation.

But Crypto exchanges need to read the room.

Binance, Coinbase, and Kraken have taken a public stand against banning Russian nationals from using their service. Coinbase CEO Brian Armstrong said the US would have to compel them by law to take actions above those already required (i.e., banning anyone on the sanctions list).

Some of this has gained traction because headline writers love "Crypto bad" (it gets clicks), but some of it is just making a valid argument at the worst possible time. So despite Binance launching a large charity initiative and many others following, the "we won't ban Russians" story is the one that got picked up.

Binance used the line that such a ban "goes against everything Crypto stands for." And with that one line, played right into the hands of every politician who wants to ban Crypto.

The exchanges argument is that de-platforming ordinary Russians who have done nothing wrong is beyond the limits of the law. I think they have done this for two reasons.

1. It was a genuine attempt to allow the Russian people to "opt-out" of their national financial system into a global one, free from Russian state control.

2. To appeal to the Crypto audience's values of liberty and freedom from state control.

When the private sector is voluntarily de-risking all of Russia, there are so many things you could say. But "we won't ban Russians unless a law is passed to do so" isn't high on that list. Point out all the pro-Ukraine things the team is doing, discuss how sanctions need improving, and how you're proactively building standards to make them better in Crypto. Mention how you're going above what's asked of you in some way, shape, or form.

The only CEO who got it right is FTX’s Sam Blankman-Fried 👇

Crypto is a lifeline for both Ukrainians and Russians who have done nothing wrong, and if we’re going to keep it that way we need to upgrade the financial system, not goad the politicians into enforcing the rules of the old system on the new one.

This is why we can't have nice things.

And yet.

We have a window of opportunity to build a more effective system.

The entire global economy and western world are now focused on the financial system, sanctions, and Russia. This is an opportunity to do several things.

1. Close the loopholes. We need laws everywhere and fast, making it harder to use complex company structures to hide from the law.

2. Fund law enforcement properly. The banks were recruited as enforcers, but the enforcers themselves need to step up and get much more sophisticated.

3. Embrace transparency. We need Crypto like levels of transparency in the existing financial system. The easiest way to do that would be to adopt the free, open-source technology that's sitting out there.

It would really help if this sort of thing was what the headlines from Crypto CEOs said.

But the most helpful thing would be if we could keep the nuance.

This is a horrible time for the world.

But finance touches everything we do, and if we fix finance, we might just make things a little better in the process.

ST.

4 Fintech Companies 💸

1. Rise - Deel for Web 3 (or Web 2.5).

• Rise is a Web3 enabled SaaS platform helping traditional businesses and DAOs manage their contractors/contributors' compliance, contracts, and payments globally. Rise is KYC compatible and lets Web 2 or 3 organizations set flexible payroll schedules like Crypto or Fiat. 

• 🤔 At first glance, Rise reminded me of Deel, helping onboard a global workforce and deal with local tax laws. But Rise is built on Eth L2 Arbitrum and uses ERC725 to make each org "on-chain." Contractors can get paid how they see fit (in Fiat, Crypto, or a blend). If you've seen Utopia or Multis (Web 3 CFO / COO tools), then Rise really is like those but more like Deel. Rise 10 live customers and is still early, but I like the approach.

Speaking of Payroll...

2. Earnipay - Earned wage access in Nigeria

• Earnipay integrates with company payroll or HR systems, whose employees can then track and withdraw their salary to date via the app. Earnipay makes the payment on behalf of the company, and the company settles at the end of the month. Earnipay collects between $0.50 and $1 from employees each time they access their salary early. The goal is to displace payday lenders and loan sharks and increasingly build financial wellness for employers.

• 🤔 Any service designed to reduce payday loans and the reliance on loansharks has to be a good thing. I do worry that the fees associated with Earnipay could add up over time (e.g., if I'm taking $30 a day for a few days in a row, 10% of my paycheck is now going on fees). That's not extortionate, but it's also significant. It would be fantastic if the earned wage access companies could provide more data and success stories. The measure of these tools is how they eventually build good financial habits. If that data exists already, I'd love to see it.

3. Attune - Financial Health data dashboard

• Attune provides a breakdown of customers' financial health for FIs, employers, and Fintech companies. The Attune product creates quick quizzes for the customer and then scores the user. It instantly offers the customer recommendations to improve their own financial health. Attune then provides a dashboard for FI's and employers to improve the financial health of their customers over the longer term. 

• 🤔 This feels like something every bank, FI, and Fintech company should support by default. Measuring customer financial health and actively trying to improve it is the ultimate win win win. It's a win for the customer because they get a better life. It's a win for the FI because they get higher average deposits, and it's a win for society because it's just the right thing to do. We have the data to make this possible; we just need to up our game as an industry on product design. I can't help but think it would be much more impactful if it was Attune API first. Any Fintech company could then just use it as they see fit.

4. Leasy - Auto loans for ride-hailing drivers (Latam)

• Leasy provides auto loans with competitive down payments (e.g., 5% vs. the 20% required by most banks and lenders in Peru). Leasy is already profitable as a lender and saw 1.7x revenue growth from 2020 to 2021. Leasy bakes insurance into its payments and offers drivers a no-fee car return if they move or change jobs. 

• 🤔 Lending is a business model that most find easy to be profitable at first, but losses can quickly pile up. However, Leasy uses its driver data for background checks, tickets, potential income to identify the risk of default. New data for underwriting is always compelling but unproven at scale. Lending is hard, but there's something nice about using industry-specific data to identify default risk. That could be a pattern others in auto loans could learn from. 

Things to know 👀

1. Klarna losses grow to $748m

• Klarna's losses grew by more than 4x compared to the previous year, driven by customer growth, it says. Operating income increased 38% to $1.6bn. Klarna says it has more than 100m active customers in 45 countries. Much of the losses are driven by expansion into the US, which it expects to be its primary market by next year. Reports suggest Klarna is weighing a new round valuing them at $60bn. 

• 🤔 Losses leading to growth are no bad thing for a growth company. If the loss rate is really related to an expensive US market entry and starts to come down, it could be a great long-term move for Klarna. Especially if Klarna can repeat the trick and increase revenues by another 40%.

• 🤔 Losses due to a bad credit model would be a whole different ball game. Klarna published its 2021 annual report with confusing credit losses figures. Klarna says if its GMV was the same as 2019, its credit losses would be 30% lower than 2019. But, because its GMV has increased, the raw credit loss figure has also increased. And, because new markets see "initially higher credit losses," the figure has increased. 

• 🤔 Klarna needs repeat business. Put another way, Klarna builds its credit model based on repeat customers. Market entry and first-time customers have high (or even very high) credit losses.

• 🤔 Klarna addresses the risk of persistent debt in its annual report saying that Klarna typically represents less than 2% of that customer's outstanding debt. This is because the average transaction size is $100. Klarna says it scores a customer's risk for each transaction rather than once and offers a credit limit like $5,000.

• 🤔 BNPL has a genuine love/hate thing going on. Haters have two main criticisms. They're not wrong, but they're not right either (don't you just love nuance).

• 🤔 Firstly, they say lending is easy in a bull market, and we'll see what happens as credit tightens. That's undoubtedly true, and we saw with the first wave of Fintech lenders that they struggled when the market changed. But I think that point of sale lending for low ticket items using new data is a genuine innovation. It requires a lot of data to work, but Klarna now has a lot of data. There will be a credit tightening, and BNPL may lose its luster, but it's also here to stay. 

• 🤔 Secondly, haters say Klarna is a company that allows people to spend on things they can't afford (and probably shouldn't buy). Again, that's likely true for some customers, but it's a great tool to smooth income and find things they want for others. Ultimately affordability and financial health matter, and the whole industry need to be better at helping consumers achieve better outcomes. 

2. Pawyhawk becomes Bulgaria's first-ever Unicorn

• Payhawk the "Ramp.com for Europe," has raised $100m to extend its Series B and, in the process, become a Unicorn. Payhawk serves scale-ups in 27 markets across Europe and provides a unified platform for cards, payments, and invoices. Payhawk aims to add more corporate-friendly features like Oracle Netsuite integration and increase its team size with the funding.

• 🤔 The SMB expense management space continues to be white-hot as a category. The investors are still addicted to customer growth, but there's significantly more revenue growth potential in SMB than in consumer. If you just take card (interchange) revenue, for example. Where Chime can do $1bn in revenue from 15m customers, the average spend per corporate is much higher (and in some cases, the transaction value if they're buying flights and hotels). Then you add in the potential for invoice financing or ACH transactions, and there are more sources of revenue over time. 

• 🤔 Long term, I'm curious to see if these businesses manage to find good alternative revenue lines (and what they are). Block (AKA Square) did a great job in the physical POS space. But the category has so many well-funded players that there's a non-zero risk of a pricing war. Ultimately if you add a ton of value, customers are generally willing to pay for that, and there's no doubt these businesses do that with cost savings, time savings, etc. 

Good Reads 📚

1. Western Banks have been reducing Russia exposure since 2014

• According to the bank of international settlements, foreign banks have $121bn outstanding to be repaid by Russian borrowers in September 2021. However, this is down from $275bn in 2014. UniCredit, Raiffeisen Bank, and Société Générale have the most exposure to Russia and will suffer the most from Sanctions. Soc Gen said to a journalist on Feb 28th, "Sanctions are still being rolled out; it's impossible to forecast the impact so far."

• 🤔 This ban will still hurt the banks with exposure, but it will also take time to unwind. Do these banks write down all of the loans? Would those banks be bailed out in some way because their losses are due to government sanctions? What happens if those banks become unstable due to these losses? Right now, it's too early to say if we'd see a banking crisis (and we probably won't), but how much further can things go? We're talking about 40% of Europe's natural gas supply. 

Tweets of the week 🕊

That's all, folks. 👋

Remember, if you're enjoying this content, please do tell all your fintech friends to check it out and hit the subscribe button :)