Fintech 🧠 Food - Jan 9th 2022 - Opensea's $13.3bn valuation, Razorpay's round and Finding the emergent properties of finance.
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I've wrestled with this week's rant as something I've been trying to say for a while, but I just couldn't quite get it out. I really hope it makes some kind of sense :).
PS. Thanks to all 30 of you that emailed last week; I couldn't reply to all of you, but I read and appreciated everything!
Weekly Rant 📣
The future of finance; finding the emergent properties.
Last week I wrote about how with DeFi, we're building a new global financial system alongside the existing one. I also spoke about the benefits and drawbacks of DeFi itself and the properties that make it a paradigm shift.
This week I wanted to think about what stays the same, and what changes.
The idea that we're building a new alternative global financial system is hugely exciting, but it's also a victim of perspectives. Many have described Crypto as being like a Rorschach test. And, like an inkblot test, what you see in it often says more about you than it does about the ink shape.
The way we see the world colors our perspective of its future. The temptation when building something new can be to throw away the old. When you have a lot of experience in the old, the temptation is to assume everything that's done is necessary.
If we want to build a map of finance's future, we have to ask some hard questions to get past our own biases and experiences.
These three questions torture me as I think about them.
What only exists because of tech or design limitations?
What has to exist, and what do we only assume has to exist based on our life experience?
What was, is, and will always be true about finance regardless of technology?
What makes answering these three hard is the interplay between them.
TradFi (Traditional Finance) and DeFi (Decentralized Finance) have elements of all three.
TradFi: Current Tech and design limitations
Most systems were built with the best technology we had at the time. Bridges were built with stone, then wood, iron, and then steel. The same is true in finance, we started with precious metals, then coins, checks, and mainframes.
The Mainframes and code that runs the global financial system were engineering marvels when they were first built. They have incredible uptime, reliability and dramatically reduced bankers' workload. But, they had storage and network limitations. Engineers were extremely prudent with the amount of data they would send over the network to get around this.
The industry essentially compressed massive amounts of information into tiny character sets. For example, file formats like ISO8583 messages, where a list of two-digit codes can convey information like "this customer has insufficient funds for a transaction they're trying to make" or "this customer is trying to pay with a card marked as lost or stolen."
Because modern software engineering practices haven't evolved, many of those design choices are now baked into the fabric of the financial system. So do we have to move money using ISO8583 messages? Can currency codes only ever be 3 letters?
The answer is clearly no. But right now, the incumbent financial system still has all of the users and all of the money. That's a heck of a network effect.
TradFi: Things we assume have to exist.
In Fintech and finance can be very hard to separate what has to exist vs. things we do because we've always done them. The tension is between schlep blindness (a tedious task we barely notice but just get on with) and emergence (properties of a system that don't belong to any part of the system but to the system as a whole).
When Paul Graham first wrote about schlep blindness, he gave the example of Stripe. For more than a decade, any developer who tried to accept payments knew how painful it was, thousands must have known about this problem, yet none of them fixed it.
In the past 10 years, various Fintech companies have attempted to solve product, business, and infrastructure schleps that incumbents were blind to. When incumbents made their products digital, their customers performed a staff member's role. It is often literally taking an internal system and putting an interface over the top of it. No wonder Fintech companies and Neobanks had so much traction with "better UX" initially.
Building abstractions over the existing infrastructure created improvements, but that infrastructure doesn't have to exist; it just has excellent network effects.
But with things like the business model, regulation, and compliance side of finance, it can be tricky to tell if they have to exist or not.
TradFi: Things we assume have to exist that probably don't. The classic example is the branch; as recently as a few years ago, the strategy for most major banks to acquire more customers was to open more branches. Branches were the only place a customer could sign up for products and the fallback in case digital failed.
But even hidden schleps like terms and conditions pages. Incumbents start from having the most airtight, low-risk terms and conditions and give little consideration to how understandable or consumable they are. Neobanks will often provide a plain English description and make the experience during onboarding much slicker. That shifts the dynamic from T&Cs to cover the ass of the bank vs. T&Cs that customers actually understand (and drives conversion). This creates a crazy size effect; customers truly trust you more if you elegantly explain your T&Cs to them.
Ask anyone who's ever shipped a product in a bank; you wouldn't believe the arguments, committees, form filling, and sheer amount of effort that has to take place to change something like T&Cs. And this sort of thing is rife. As an industry, there are deeply held beliefs and memes about the way the industry has to operate, that are not true.
As an example. one of my favorite stories is from the early days of cloud usage in big banks. A plucky CIO wanted to move all of their core systems to the cloud, but their risk leadership committee said that "the regulator wouldn't allow it." So the cunning CIO asked the risk committee to return to the same room in two weeks. He had a plan.
Two weeks later, the CIO said to the reconvened risk committee, "please say again what you said last week?" and the risk committee said, "we don't believe the regulator will allow you to use the cloud." To which the CIO replied, "this is my friend from the regulator who owns tech policy, do you agree?" And the regulator, of course, said (words to the effect of) "we don't care what technology you use, so long as you manage the risks, we have no objection to using cloud vendors."
TradFi: Things that probably always have to exist. Understanding what has to exist can be tricky because of our friend "schlep blindness." But a map I'm using is to think of finance as a complex system.
A complex system is defined as:
a system whose behavior is difficult to model due to the dependencies, competitions, relationships, or other types of interactions between their parts or between a given system and its environment
Self organize (sponteniaty)
Does things as a system that no one part of the system can do alone (emergence)
Changes over time, based on events or interaction (adaptive)
Making its behavior hard to predict (nonlinear)
The global financial system is about as complex as systems get. Billions of people and companies use parts of it in different currencies, using various technologies under various laws. The system can be impacted by everything from nature to human psychology, and it underpins everything we do. From spaceflight to catching a bus to running a country, finance is always just there, being complex in the background.
This is especially interesting as we look at Web 3 and building an alternative financial system alongside the existing one. There are so many vested interests, bag holders, or incumbents and regulators with schlep blindness it's hard to create a map.
DeFi: A map for what will always be true.
You need to collect value, send value, and possibly invest/save it. Perhaps you haven't been paid in a while and need to borrow value. It would be great to have some other pool of capital to borrow from, but that lender faces risks like what if you don't repay? These things feel universal.
Certain actors and interactions exist today, which will probably exist in some form for the coming century. Nation-states, people, regulators, corporations, and lawyers :). There will likely be new actors, too (e.g. DAOs, internet-based states, who knows)
The way these entities interact will be governed by some consistent concepts like:
Risks: e.g., credit risk, AKA will my borrower pay me back? Market risk, AKA the price changes impacting my finances. Liquidity risk, I have to pay someone but don't have the cash available. Successive generations throughout history have tried and failed to remove risk from finance. Risk is a feature, not a bug. Those that have been in payments, lending or other types have finance have seen some of the risks. They’re often good at pointing to where the problem is, but maybe not the solution.
Behavioral economics: The cognitive, emotional, and cultural biases that drive human behavior. Humans (for the most part) hate admin. They’re unlikely to want to be their own bank, and they’re likely to try to gain wealth and status. We see this playing out in Crypto and DeFi almost alarmingly quickly. As consumers rapidly enter the Crypto space and buy NFTs for status, but also meaning and culture.
Great UX will help, but it is a matter of time until there’s a major social controversy around a hack or scam in Crypto. As we saw with memestocks if this gains traction the cry of “something must be done” will come. In this lens, regulation served a purpose to prevent a risk that arose due to consistent human behavior. In DeFi those closest to the user need to be thoughtful about how they use behavioral design to mitigate those risks. In DeFi I don’t think the need for regulation goes away. But maybe there’s a better solution.
Power laws: the majority of the wealth/influence will be controlled by a tiny minority of very large actors. There’s a narrative that DeFi is the great wealth transfer between generations. Perhaps it may one day be that, but the reality of Crypto is most of the coins are concentrated in a tiny fraction of wallets and institutions. There’s plenty of behavior that looks very similar to what you’d see in Wall St. “Trustless” networks haven’t removed power laws nor the ability to move markets.
If we take the core of what has to stay the same and have a thesis on what risks could exist, then maybe we can contextualize the Web 3 and DeFi opportunities in Fintech.
DeFi: Web 3 is a genuine paradigm shift for finance.
Crypto introduces entirely new primitives, infrastructure, and mental models. It doesn't require mainframes, checks, or ISO messages, and as mentioned last week, it creates programmable money and is composable.
DeFi isn't being designed as a system; it's emerging.
DeFi has created the space for a new generation with little historical experience in finance to quickly experiment, build and adapt products, services, and protocols that change finance. The lack of historic exposure to finance means two things are happening simultaneously.
The developers are finding the path of least resistance for building a new financial system
The developers are also finding out what remains true in finance
But on that second thing, some of the downsides of "what is true in finance" are hidden. Some lessons take a long time to learn. Edge cases suck because they rarely happen but really clang in finance. Recessions mean that acceptable risks for the last 10 years are suddenly alarming.
Crypto has a habit of massive boom and bust cycles (every 4 years so far), so it has seen plenty of risks. But, the vast majority of that has been taken by the crypto in-crowd to play speculative games. We haven't started to see the consequences of this infrastructure making mortgage payments. That's why I suspect that banks won't go anywhere near DeFi in retail for at least another half-decade.
Disruptive innovation always starts at the edges.
That's why DeFi has started out looking like a toy to play speculative games with. The new financial system is most adaptable to new use cases. But, if we in the Fintech world want to use it we have to understand where the Fintech knowledge is helpful and where it's not.
Fintech is great at managing the trade-offs between UX and risk. This means Fintech experience becomes the bridge from the old financial system, where all of the wealth and capital is to the new system where all of the wealth and growth will be created.
That's why I think DeFi mullets look rare.
Who knows, maybe everyone will lose interest now the market appears to be crashing.
Or maybe this is just the beginning.
It’s time to build indeed.
4 Fintech Companies 💸
1. Credix - DeFi Lending to Fintech companies in LATAM
Credix connects Fintech Lenders in LATAM to investors in the US and developed capital markets. Fintech companies can build a private (KYC'd) DeFi liquidity pool for their investors. Investors buy loans with stabelcoins (like USDC or USDP), the Fintech company makes the loans, and then Credix helps take those loans and turn them into smart contracts. Those smart contracts are exchanged for stablecoins in the liquidity pool.
🤔 Last week's Rant was about how DeFi could make a meaningful difference in debt capital markets. A big reason is that buying bonds (loans) across borders is incredibly expensive for investors. Credix has some complex compliance challenges to overcome, but given the explosion in demand from asset managers to buy this kind of debt could be interesting to watch.
2. Sperta - The Risk rules engine
Sperta offers a ~No Code / SQL-like interface for Fintech and tech companies to build risk rules. Users can plug in data providers like identity (e.g., Socure, Middesk), fraud (comply advantage), and credit (Experian) to build rules like "if Fraud score > 0.0 then approve." Sperta also provides case management for transactions or users that need to be looked at by a human.
🤔 Every Fintech company, Neobank or non-bank that offers finance quickly learns fraudsters and risks are everywhere soon after launch. To solve those risks, they had three main choices. 1) Buy legacy risk software and integrate it 👎. 2) Build their own rules engine by pulling together many data sources (many early Fintech companies ended up doing this). 3) Work with a company like Alloy that sits above those data sources and provides tools to manage the risks. Sperta is much earlier than Alloy and much more focussed on the fine-grained rules building, than Alloy which is more of an operating system, but no doubt that will appeal to some builders.
3. Quo - Mortgage Broker helps you own a home sooner
Quo connects to your deposits, savings, credit, and loan accounts to show its customers the best path to homeownership. It then provides actionable tasks like "pay down credit card" to improve the speed of deposit saving. When the deposit is full, Quo is a licensed mortgage broker. Quo claims their average user has "increased buying power" by $158k.
🤔The mortgage industry has been built for those who already afford a home. Yet, almost 3m American's are denied a mortgage every year. Aggregators like Nerdwallet mix helping consumers with their financial health and buying credit products, but Quo's singular focus is fascinating. The whole service is architected around that one goal, and every other financial data point is put in that context (the reality of buying a home for first-time buyers under 40).
4. Better Banking - The Neobank with Healthcare benefits
Better is a no-fee Neobank that offers $5,000 accident insurance, 85% off prescription meds, emergency cashback, and an emergency cash advance. Better also includes a community advocate (via chat) that helps users lower medical bills and remove medical debt from a credit report.
🤔 For anyone with a chronic mental or physical health condition, the ongoing costs can be astonishing. For anyone who's had an expensive procedure in the past, that debt can prevent them from getting new credit or moving forward with life. Or, take someone who's managing their mental health with meds, those costs can quickly add up, and financial problems can soon become mental health problems (and vice versa). This is a really well thought-through proposition for people in any of these positions, and it comes from quickly being able to partner with a BaaS provider (Unit), insurance provider (AIG), and pharmacy discount partner (RX saver). These things already existed, but Better thoughtfully packaged them for the audience thoughtfully. We need this.
Things to know 👀
Opensea raised $300m, led by Coatue and Paradigm, after seeing more than $2.4bn in transaction volume in the past 30 days. Transaction volume is up 600x over the past year, and despite having plenty of competitors, Opensea dwarfs its competition in volume and adoption.
Axios is also reporting that Opensea is in talks to buy Dharma. Dharma was originally a DeFi lending platform but has pivoted into a wallet that differentiates on wide token support (up to 76k tokens vs coinbase 144), and much lower fees.
🤔 Opensea takes a 2.5% cut of transactions, which would give them a $60m monthly revenue run rate in the past 30 days. That's massive, but like Coinbase, it risks being seasonal as interest in Crypto rises and falls. Clearly, the investors believe NFTs are a trend that's not going away and that Opensea is in a prime position to benefit.
🤔 An on-ramp is an excellent place for Opensea, which has capitalized on the NFT boom. But the on-ramp also benefits the ecosystem of companies that serve Opensea like Moonpay and Sardine AI. DeFi mullets everywhere.
🤔 Opensea having their own wallet makes sense. If Coinbase and FTX are adding NFTs, why can’t Opensea add a wallet? The Dharma acquisition could be a simple acquihire, but you could imagine several other opportunities. Would Opensea reduce their 2.5% take rate for users of the wallet? Would support for more tokens = more transactions? Opensea has arguably done more for mainstreaming Crypto than any other business, so their wallet could be very well placed to be the PayPal of Crypto. Also, what does this move mean for Moonpay long-term (the main payment on-ramp for Opensea)? 🤔🤔
🤔 What if Opensea did a token? (AKA "wen token ser")? Opensea has been tight-lipped about if it will ever release a token. Given their revenue and valuation growth, they have no need to create a token. Ok, but what if they did? The Crypto early adopter crowd is powerful and influential, and they like their decentralization pure. If Opensea has a long-term weakness, some "Web 3 native" NFT exchange could eat their lunch. Creating a token could help mitigate that.
🤔 Opensea is staying on the right side of regulation: Consider Coinbase vs. Binance. Coinbase's primary customer base is in the US. Binance is everywhere but the US. Coinbase has focussed on staying on the right side of the regulator and has made it public and done well. Binance launched a token and has more trouble with the regulators, done well. Given that Opensea is US native and its volume comes from, if they launch a token, I suspect it will be when there's much more regulatory clarity there (if they do it at all).
🤔 When will Opensea IPO? The window for hitting IPO might have closed as markets hammer tech stocks with interest rates rising, but you have to imagine Opensea IPO's at some point. Imagine a stock analyst trying to value NFT markets?
Razorpay of the primary "Stripe for India" contenders has raised £375m, led by TCV, Lone Pine Capital, and Alkeon. Razorpay allows merchants to accept more than 100 payment types and offers a suite of tools around payment acceptance.
🤔 Razorpay goes deep into merchant payment workflows (in the same way many payment orchestration startups now do in the west). The "router for money" is becoming table-stakes for any marketplace business.
🤔 India's payment acceptance market is competitive, vast, and complex. The sheer scale of India's 1bn population presents a massive opportunity that is being attacked from many sides. This means there are likely to be several colossal category leads in Fintech and payments. It feels like India is just getting warmed up. Same for Razorpay, consider Stripe went from $9bn in 2016 to ~$95bn in 5 years; what could Razorpay do?
🤔 Can any international Fintech companies penetrate the Indian market? The US-based and Chinese-based Fintech and Big Tech companies have all played a role in India, but the Indian native companies are thriving.
Good Reads 📚
Albert Wenger at Union Square Ventures penned a piece to try and articulate the benefits of Web 3 / Crypto with a rounded perspective. He starts with Clayton Christensens' definition of disruptive innovation as "being worse at everything except for one dimension, that winds up really mattering."
PCs at their invention were worse machines than Mainframes in every aspect, slower, less memory, etc. But they were cheaper. A blockchain is a slower database that requires more compute and is harder to use. But, no single entity controls it (often called being "decentralized," but that's a bit of a misnomer).
Today, the nature of the internet is predicated on databases controlled by single companies (Facebook for identity, Amazon for shopping). This means a user's data, your data, is permissioned, owned, and controlled by corporations.
🤔 In Web 2, your data is held by the corporation, and they let you access it. In Web 3, your data is stored in many places, and you control how to access it. This is such a massive mental model shift that some struggle to make the leap. This picture has been floating around the internet, and I think it describes it quite well.
🤔 As an example today, there's almost no way for a new e-commerce merchant to see my shopping history at Amazon (even with my permission) unless Amazon gives permission to. Facebook owns your social graph; if you want to take all of your Facebook friends to another platform tomorrow, there's no easy way to do that (because it's not in FB's interests).
🤔 Albert does a great job of discussing how we solved the internet's inability to remember things by tracking cookies and then databases in the early days of the internet. Blockchain's track things differently. They create a public record of which wallet, signed which transactions / own what assets. That record becomes the single global "cookie database" available to everyone and anyone. In turn, that enables data, features, and states to be composed across applications by different developers, companies, and individuals.
🤔 There will always be limits to what a centralized company is willing to do for users and the market. For example, Twitter turned off its developer API, leaving small companies and developers in the lurch. If a companies business model is predicated on monetizing data, it tends to fight hard to keep it to itself. Web 3 forces portability, of not just data but functionality, and re-orients data and asset ownership back towards the user.
🤔 One way to fix Web 2.0's broken incentives is with regulations like Open Banking. Another is by creating an open, permissionless internet, where the user is the center of gravity. Wallets, blockchains, and tokens matter.
Tweets of the week 🕊
Lot’s of Vitalik this week, the second tweet especially is a really good back and forth between the Signal founder and Vitalik, and speaks to the point above. There are lots of valid criticisms of Crypto and Web 3 that don’t matter. Because Crypto is worse at just about everything except for the one dimension that really matters. The possibility for true data portability away from platforms. Worth reading both if you have time.
Brian Chesky @bcheskyIf Airbnb could launch anything in 2022, what would it be?
That's all, folks. 👋
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