Global Fintech Founder & Investor | ex-Adyen, ex-Franklin Templeton
The COVID19 crisis has been playing out globally for over half a year, or almost a year counting its early phase in China. It’s been hurting a lot of sectors, but one particular sector stood to benefit — Fintech.
First of all, the pandemic has significantly accelerated the adoption of contactless payments in the US, as it took banks and Apple years to convince shoppers to switch to contactless cards or use ApplePay while it had already been a trend elsewhere in the world. Moreover, many shops and shoppers have even made a 180-degree turn on their attitude towards QR-code, which many investors and experts used to heavily doubt to have a future in the developed markets in the US and Europe.
Second, as offline shopping was dead, the skyrocketing demand in e-commerce has benefited many fintech companies in the online payment space. The “buy-now-pay-later” superstar Klarna’s recent fundraise put its valuation at over $10bn. Adyen’s market cap more than doubled since the beginning of the year to more than €47bn as of Oct 1. Square’s market cap even quadrupled to almost $75bn from its lowest point in late March.
Third, with most people sitting at home, online banking and trading start to gain mainstream status competing against the incumbent traditional financial institutions. The dispatch of the US federal stimulus package has given neobank startup Chime the opportunity to acquire tons of new customers by pre-funding the stimulus to those who live paycheck-by-paycheck. In mid-September, Chime raised $485mn giving it an eye-popping valuation of $14.5bn.
Meanwhile, Robinhood benefited from millennials and gen-z’s trading on mobile phone at home and achieved a valuation of almost $12bn in September, even as the incumbent Morgan Stanley acquired the mighty E*Trade for $13bn and another giant Charles Schwab purchased TD Ameritrade for $26 bn.
The pandemic has certainly triggered a lot of buzz for fintech companies to take advantage of, but how much of the tailwind is ephemeral? How can we know which of these trends are here to stay in the post-COVID world? More importantly, what are the fundamental trends that can sustain the long-term vision of these fintech stories?
First of all, the buzz of mobile and online financial services is far more than just bringing offline experiences to the virtual world. In fact, it involves a much more radical change in the business model. Traditional financial services can easily build an interactive website or an app to appear millennial-friendly, but it’s much harder for them to re-invent their risk management and operations for the new age.
For example, a friend of mine was kicking off his own startup last month, and the process involves setting up a bank account to take in investor’s money. Since her personal bank account is with Chase, naturally she was thinking about opening the commercial account with Chase. So she tried the registration process on Chase’s website. While the website’s design and interaction looked cool and tech-ish, it was clunky in so many ways. Not only did she have to re-enter much of her personal information again, but after 20 mins of filling out the details, she was still not able to set up an account via the website and was instead asked to go to a local branch — the closest of which being 3 miles away as the closer ones were closed down during COVID.
Later, she found out that Chase only allows setting up a bank account via website for LLCs, not for C- or S-corps. It would have been much easier if Chase made it clear on the website, and also, Chase’s old-fashioned risk management system forced the unnecessary difference in how it can treat LLC vs a Corp.
Furthermore, my friend was told that even if the new company has already been incorporated and has a legit EIN, Chase still requires the proof of filing with the local Secretary of State, which has a backlog of 1 month in California under the impact of COVID. So instead of wasting another month to close the funding round, she went with a neobank startup Mercury and managed to open a corporate bank account within 2 days.
For any old banks to seriously think about compete against fintech startups, they will have to consider which part of their back-office logic, risk assessment, and operational flow should be completely redesigned and rebuilt with the help of tech. Again, it’s much more than just a fancy website or app.
Second of all, fintech companies’ strategy should focus on how they can fundamentally disrupt the traditional cost structure, instead of tricking consumers with no real cost-saving. Many startup ideas centered around taking for granted what interest rates they can charge as “market rate” and charging consumers (invisibly but effectively) more.
One of the fundamental reasons behind the take-off of many lending fintech startups is the fact that millennials and gen-z’s grew up after the 2007–2008 financial crisis and don’t trust financial institutions with their credit system. Thus, they tend to prefer debit cards over credit cards, partially for the sake of goodwill and reputation, but with the burden of student debt and sometimes even mortgage, they find these lending apps quite handy.
With 60% Americans having less than $400 in their bank accounts — and btw that number has got to be outdated since the COVID crisis — no surprise they need financing, in the form of either buy-now-pay-later or payday loans.
Besides, with the insufficient level of mathematical and financial literacy, most people can’t mentally calculate the effective annualized interest rate when they are charged $5 or $10 every time they loan out just a few hundred bucks or advance their paychecks. It seems to be just coffee money or beer money.
Many startups claim to have genius machine learning and artificial intelligence models, but few have proven to work better than the commonly criticized FICO scores. So instead of competing on data science, it’s basically a battle of who has the better marketing strategy to acquire the larger consumer mindshare.
A potentially drastic shift comes from payroll startup Gusto’s new product Gusto Wallet, which allows salary employees to flexibility adjust paydays without being charged — effectively a free payday loan. This is a product that’s really beneficial to the financial wellness of the underpowered population. To be able to afford to forgo the lucrative interest payment, Gusto is in a unique position compared to many banks and fintech companies, as it sits directly between the employees and their salaries. Many banks spend hundreds of dollars trying to convince their account holders to add direct deposit, while Gusto controls that direct deposit endpoint. From this gateway, Gusto has the potential to add on more financial service products and controls more distribution channels.
In the end, finance is a game of distribution, and the role of data/algorithms is to make that distribution more effective and efficient. In the traditional world, given lack of data and transparency, many investment funds with poor return track records still manage make money from commission, as long as they can maintain good relationships with financial advisors which shielded them from individual investors. The earlier ETF revolution and more recently Wealthfront / Robinhood solved the transparency and accessibility problem but cannot solve the curation and selection problem, which is at the core of the distribution game.
Perhaps a peek at the allocation of the upcoming Ant Group IPO can offer some insights into the future of the distribution game. As a completely new IPO allocation model, the Alipay wallet opened up Ant Group IPO allocation to any individual Alipay user starting as low as 1RMB via a group of 5 mutual funds selected and curated by Alipay. Within 2 days, 3 of the 5 funds were already fully subscribed, each fund with a cap of 12bn RMB (about $2bn), breaking all public fundraising records. This highly innovative curation/distribution model is underpinned by the unmatchable financial and transactional data that Alipay has via its connection with Alibaba the largest ecommerce platform in China.
It remains to be seen which fintech companies in the US can win the data war against the large banks, who are finding a hard to realize the full potential of the vast data they possess. The fintech landscape in the US is a lot more segmented than in China, so the picture may become clearer as we see more partnership and consolidation among the fintech superstars.