digital lending

ONLINE BANKING: Metro Bank and Revolut in the Doghouse

Facebook used to say "Move Fast and Break Things". It sure did. There are many ways to win, and some are sharper elbowed than others. Is growth inevitably tied to bad behavior, or is there a version of sustainable entrepreneurship that doesn't require us to sacrifice Ethics at the altar of Monopoly? Prior marquee Fintech bad-actors include Zenefits (fastest growing insurer whose brokers were unlicensed) and Lending Club (what's a little self-dealing?), not to mention all of Wall Street and at one point or another. Now we are seeing the same sharp elbows from Revolut and Metro Bank.

Metro Bank may be a fast growing operation, but it doesn't seem to be very good at being a bank. Of its £14.5 billion loan book, the company mis-categorized 10% of its assets last month, grading that capital at 100% when it should have been at best a 50% (e.g., commercial property loans are more risky than cash). That means the balance sheet needs way more cash, and Metro Bank is out raising a cushion of £350 million -- a number that will mean chunky dilution given that the public market cap has been under pressure. There is a certain irony here as well. Consider the sins of a bigger offender -- RBS getting a £45 billion bail-out a decade ago and being forced to set aside £775 million to as penance. Of those funds, £120 million are now flowing to Metro Bank to promote banking competition. 

One of our favorites, Revolut, has also been in the news with a spat of ugly news. There are reports of over-clocked, destructive culture. Some Fintech aspirants are asked to sign up 200 funded accounts for Revolut as part of the interview process, without a job guarantee. Once they do land a job, workers are expected to drive 100 mph through weekends and holidays, leading to burnout and churn. Sounds like SoFi two years ago. Money Laundering concerns abound, with information coming out that KYC/AML control lapsed in the middle of last year. For a company that launched Bitcoin trading, this type of news is both embarassing and systematically destructive. And lastly, the main adult in the room (CFO Peter O'Higgins, former JP Morgan) has just quit as well. 

It's easy to say to look at people doing hard things and judge them on style. But sometimes the ambition isn't worth the damage. 

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Source: Guardian (Metro Bank), SharesMagazine (Metro Bank), AltFi (RBS Settlement), Wired (Revolut Culture), Finextra (Revolut CFO), Banking Tech (Revolut AML)

FINTECH: SoFi, Square and Twitter as the Horsemen of the Fintech Apocalypse

SoFi has thrown two bricks through the window of the finance industry this week. The first is a set of no-fee Exchange Traded Funds (ETFs) to be distributed through its proprietary roboadvisor and third party brokers like Fidelity and Schwab. SoFi is the second meaningful institution -- after Fidelity -- to price beta exposure to public markets at zero. We think back to Napster and the collapse of music prices to zero as distribution channels shifted from (a) buying records to (b) "piracy", i.e., kids trading songs with each other on the web. It's not that the cost of manufacturing the song, or the ETF, is nothing. Rather, when distributed to millions of users, the fixed cost trends towards nothing and the variable cost is de-minimis.

The business model implication for Music was to give away the very core offering, and to charge for t-shirst, concerts, and the convenience of using Spotify's neat interface. The business model implication for investment management is to give away the very core offering, and to charge for asset allocation, planning, and a subscription to an easy-to-use financial services bundle. There is more to be said about hiding monetization, about making it hard to see and quantify. Arguably, Google, Facebook and the other web companies have made this trade-off opaque; we get the core offering for free, and pay invisible, unfelt things that aggregate into monstrous compromises. Similar dangers lurk here -- from Robinhood's liquidity selling to algo traders to Fidelity's "infrastructure fee" of 15 bps to mutual funds on its brokerage shelf. Money will be made somewhere, and as a mere human consumer, you likely won't see how.

The second brick from SoFi is an agreement with Coinbase to power SoFi Invest's crypto currency trading within the lender's digital app. Targeting Robinhood and Revolut with this move, SoFi is delivering on the vision of a broad cross-sell of financial products to a captive Milliennial audience. Coinbase needs the trading, as its revenue is highly correlated with crypto asset prices. The exchange has been fairly indiscriminately listing coins, like the divisive Ripple XRP, to get its 2017 groove back. Maybe the rumored Facebook coin will do the trick. What we want to point out further is that the CEO of SoFi is the former COO of Twitter. Jack Dorsey, the CEO of Twitter and Square is a well-advertised Bitcoin and Lightning network supporter. Square controls Cash, the most popular (sorry Venmo) peer-to-peer money movement app in the United States. In 2018, the app facilitated $166 million of Bitcoin sales. These bits of data tell us one thing -- SoFi, Twitter and Square share a fact base, institutional talent overlap, and a likely vision for the future.

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Source: SoFi ETFs (Wealth ManagementFinancial Planning), WSJ (Fidelity), NY Times (Facebook), Motley Fool (Venmo vs Cash)

ROBO ADVISOR: Digital wealth re-fuels, as Acorns raises $105M from NBC Universal, Nutmeg $58M from Goldman.

Digital investment apps are the American poster-child for B2C financial technology. The vintage of the theme -- over a decade old -- has cooled some of the excitement about the transformational potential of mobile-first money management. Other products, like digital lending, payments, insurtech and challenger banks have grown on the venture radar. The reality, however, is that in each of these verticals, a brand champion has emerged after brutal competition to acquire customers. There is a best in class neobank, trading app, savings app, asset allocation app, etc. Sporting millions of users, these single product companies are fattening out into a multi-product relationship. And the roboadvisor attack into that space has just gotten stronger.

Nutmeg, the leading but modest roboadvisor in the United Kigdom, has just received nearly $60 million of fresh funding from Goldman Sachs. To earn the honor, the company manages about $1.5 billion (compare to Betterment's $15 billion-ish) and makes 50 bps in revenue. This isn't Goldman's first rodeo either, with prior acquisitions of Honest Dollar and Clarity Money -- neither of which were cheap. Even more relevant is the entry by the company into the UK with Marcus, it's Lending Club clone for personal loans. Unlike Lending Club (or Funding Circle), Marcus is attached to a bank that can provide interest to customers, and therefore natural funding for loans through deposits. That can't feel good to Monzo, Revolut and other neobank friends. We expect Nutmeg to join this lightly integrated family of broad financial products pushed by the investment banking behemoth to retail customers.

The other piece of news is arguably even more sensational. Acorns, serving 4.5 million customers (compare to Robinhood's 4 million, or Coinbase's 15 million), of which nearly 400k have IRA accounts, has raised $105 million from a conglomerate of media companies like NBC Universal and Comcast Ventures. Acorns manages $1.2 billion in assets (compare to $1.5 billion at N26) and now has a $860 million valuation. How does this story make sense? Media and finance are inextricably linked, and in the American case the glue can be financial literacy. CNBC content in the app will drive engagement, the media marketing funnel will create engagement, PayPal provides the payments and bank rails, and the bet is customer stickiness and margin expansion over time. It's starting to feel a bit like Alibaba in there!

So where are the parts of digital financial advice that are still early and not winner-take-all venture bonfires? Most digital-first financial services were built by Millennials for Millennials, and therefore have a blind spot for older generations. Companies that use modern tech for the issues facing Boomers aren't getting picked up in Techcrunch, but have a similarly large opportunity. Examples include Vestwell (B2B robo for retirement), RightCapital (financial planning with focus on tax optimization and pensions), Whealthcare (financial caretaking as clients are no longer medically fit to make decisions), and Mike Cagney's Figure (home equity digital lending). Do good and do well. 

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Source: Companies House (Nutmeg), Mobile Payments Today (Acorns), Company Websites (RightCapitalWhealthcareVestwell)

ARTIFICIAL INTELLIGENCE: "Financial Deadbeats" map is the worst things about Chinese Fintech

In our continued amazed gawking at the Chinese fintech landscape, we bring you the following. There is now a feature within WeChat, one of two channels for all mobile chat communication, to show a map of "financial deadbeats" around you. That's right -- a shaming visualization of people who are in financial trouble, like some sort of public sex offender list. We link to the article below, and assume that it is true despite how preposterous the whole thing seems. 

Offenses that could land you on the blacklist include serious ones like being the founder of a digital lender that collapsed with 12 million unpaid accounts, and trivial ones like being a single mother embroiled in a divorce proceeding. Once you are on the list, not only will your full name and financial information be public entertainment on this app, but access to credit, commerce and university admission could be revoked. To add insult to injury, a special ringback tone is added to the "discredited" person's mobile phone, alerting any potential caller about your poor financial management skills.

We add to this soup the idea of algorithmic bias exhibited by AI based on training data. We've covered this issue in the past, but point to Rep. Alexandria Ocasio-Cortez (D-NY) recently bringing it up into mainstream conversation. From propaganda bots to algo-racism, these arcane issues are starting to concern the broader Western polity. So when you combine historical training data reflecting past social and economic biases with social media enforcement systems, dystopia calls. One of the most important financial innovations in the West was bankruptcy, allowing entrepreneurs to fail and start over. This normalization of financial wipe-out led to an equilibrium with higher risk-taking and innovation. It is chilling to see technology being used, with potential for error and misuse, to stifle that spirit. Based on the US personal bankruptcy data below, you can see that 6 out of 1000 people would be guilty according to WeChat, skewed in large part to minority populations. No thanks. 

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Source: Abacus News (deadbeat map), Independent (deadbeats), Vox (algo-racism), On bankruptcy normalization and bankruptcy zip codes

ARTIFICIAL INTELLIGENCE: Evolution of Creative AI and WeChat's Payment Score

One ongoing, false refrain is that machine learning does not generate creative outcomes. Increasingly, this is proven wrong by the technologists and artists playing with the technology. What started several years ago as "neural style transfer" (i.e., transferring Picasso's visual DNA to any photo) has moved on to BigGAN, which is a machine learning algorithm to manufacture images that appear realistic but are made from machine hallucination. Notably, artists are playing not just with the realistic versions of these hallucinations, which you can see below, but with the "latent space" in between. This mathematical term for interpolation is filled with abstract, surprising, and surreal outcomes. Our takeaway from these results is both (1) that machines will be far more precise in understanding and approximating humans than we assume, and (2) that machines will be far better at creativity that we assume.

Fitting a financial product to a ranked "perception" of a human being matters -- especially when it is done at a scale of a billion people. Tencent's WeChat is running a new initiative called "WeChat Pay Score", which is analogous to the Alipay's "Sesame Credit", both of which (we expect) flow to the Chinese government to make up the national social credit score. Sesame Credit looks at 5 dimensions: safety, wealth, social, compliance, and consumption from over 3,000 specific data points collected by the app. The WeChat version is collecting data on how users chat on the messenger, what they read and buy, where they travel, and how they run their life in general. These combined attributes grant access to perks, like waiving bank account minimums.

Listen, in a massive nation where a large swath of the population doesn't have traditional financial data or bank accounts, machine-learning based estimates of credit-worthiness are a life saver. Not every economy comes with a FICO score and legacy credit agencies (though the Equifax breach wasn't particularly kind to incumbents).  But they key question comes back to the two picture sets below. Do the machines see us like those perfectly generated, accurate pictures of people? Or like the surreal goo in abstraction? The former means distributed access to well-suited financial products, while the other is a Black Mirror nightmare.

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Source: Medium (GANs), Joel Simon (GANreeder), TechCrunch (WeChat)

BIG TECH: Chinese Uber rival DiDi launches financial services to get profitable.

You likely heard that Apple is getting beat up. The two main reasons are (1) the trade war with China, a market in which it both sells phones and makes phones, and (2) consumer boredom with its products, which are seeing a slower upgrade cycle than previously. But at least we know what the company does -- makes hardware/software bundles, and sells them to us. In the parallel reality that is China, Huawei is trying to regain face after having its CFO captured, while Tencent and NetEase are not being allowed by the government to sell new video games because these games are too addictive for young people (not kidding). No existential dread over privacy (since it's the Party and not Facebook that does the spying, and election tampering is ... less important), but lots of dread over global competition and national pride.

This next bit is quite weird though. We know that financial services are bundled into all the tech companies in China -- whether into video games, online shopping, or search engines. But even more than that, financial services are seen as the seasoning that helps make your unprofitable venture-backed firm profitable. The Chinese version of Uber, called DiDi Chuxing with 550 million users, is burning about $1 billion per year. The solution? Launch insurance for critical illnesses, crowdfunding products, credit, lending, and wealth management services bundled into your taxi-hailing app. Huh? While the app certainly owns a nice consumer pipe, the idea that you can sell over-priced financial products at scale in your taxi experience to make up for poor operations is bonkers.

Who would even buy insurance from their Uber app? Quite a few people in China, actually. Unlike the West, where finance is Old Hat, Boring, and Terrible -- the unbanked narrative is much stronger in the East. As a great data point, let's revisit our recent Digital Lending analysis, that showed thousands of P2P digital lenders rushing across China to generate credit and liquidity. But reality was far from vision, with most of these enterprises revealed as Ponzi schemes and scams. The government's crackdown on the space could result in 70% closures of the industry this year, with Yingcan Group predicting that only 300 companies will remain. Doesn't look too profitable to us.

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Source: Slate (Apple), SCMP (AppleHuaweiTencentDidiDigital Lending), Autonomous NEXT (Digital Lending Evolution)

DIGITAL LENDERS: Our new keystone deck finds $100B in global originations, merely 10% of market opportunity

We are excited to share with you our latest keystone analysis titled “Digital Lender Evolution”, which expands on our 2015 white paper on digital lending. In the updated deck, we highlight the major drivers of the space across the US, Europe and Asia -- from venture funding, to addressable market sizes, to current origination volumes, as well as operating performance. Additionally, we highlight systemic risks and technological opportunities facing the sector today. 

A few key takeaways: despite the difficulty in the public markets, the digital lender model continues to raise $5 billion in annual venture capital investment, dominated by the US, with Asia becoming a close contender year-on-year. We find that the opportunity remains large and under-penetrated: (1) in the US, the addressable market is $250 billion in originations or $1 trillion in outstanding debt; (2) for Europe, including the UK and the continent, it is $150 billion in originations or $450 billion in outstanding debt; (3) for China it is $600 billion in originations or $2.7 trillion in outstanding debt (though the Chinese market is undergoing major crackdowns on fraud and the collapse of SME lending).

Digitization of the lending process shows clear cost advantages across onboarding and ongoing servicing (up to 70% reductions). However, platform economics are challenged -- marketing costs have been unable to scale lower than $250 per loan, the high cost of capital hurts pricing from being competitive with banks, and surprise expenses, like legal fees or new product development, have eaten into margins. Initiatives like digital identity verification or AI-based underwriting can add meaningfully to cost-saving, and perhaps improve the marketing conversion funnel as well. We were also surprised to see that large global banks have begun to track digitally active or mobile-first customers as a KPI, going from <20% to 40%+ digital penetration at some of the key institutions.

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ONLINE BANK: Lloyds to cut 6,000 jobs to create 8,200 digital ones, Natwest launches SME neobank

Digital hurts! In a sort-of-confusing announcement, Lloyds is getting rid of 6,000 jobs; but it's also adding another 8,000 jobs, for a net gain of 2,000, as part of a £3 billion plan to invest in digital banking. Why have a call center in Kent, if you can have a chatbot in Facebook Messenger? Reportedly, many of the existing staff will be re-skilled for new roles. But the reality is economic dislocation as a paper industry moves online -- data scientists and engineers are not the same as branch operators and lending officers.

As another example, take RBS/Natwest and their latest launch of Mettle, an SME neobank. The tech was built mobile-first by fintech consulting outfit 11:FS and Capco, with the capabilities of opening a business current account in minutes, build invoices, and automate payment reminders. Business financial management and forecasting would sit on top -- trying to apply the personal financial management concepts of the retail market in an SME market that would get immediate, tangible value of a Quickbooks with a bolted-on bank account. Think about who built this thing -- a third party composed of entrepreneurs who launched a set of neobanks and roboadvisors in the UK (Monzo, Starling, Nutmeg). You can't get something new without trying something new.

And the last data point is Zopa, which is the UK-based digital lender that hasn't gotten public (that would be Funding Circle). They've just raised £60 million to build out another next gen digital bank. The company already has the revenue side built out in place from p2p loans, having lent about £4 billion of personal credit since 2005. But without a banking license to take deposits, it doesn't have reliable capital for the bumpy economic cycle. Like every other personal finance Fintech out there, the company plans to offer savings accounts, credit cards, investments, and various other financing options. Everyone pivot together now!

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Source: Finextra (Mettle), ComputerWorld (Mettle), Independent (Lloyds), Techcrunch (Zopa)

ONLINE BANK: Varo Money Banking License and the OCC Charter

Let's review. In the US, the OCC hands out national banking licenses at the federal level. States also regulate and charter banks at the State level. Such regional banks and credit unions are subscale relative to players like Bank of America or Wells Fargo that have a national branch footprint and digital apps. But these small banks have community ties and are protected business interests within the States through lobbying. If the OCC makes it too easy for digital players to create online banks that live in our pockets through mobile phones, regional banks (with poor technology and digital client experience) will lose out. That dynamic actually has not at all played out with roboadvisors, who face the same regulatory jumble with the SEC and local Registered Investment Advisors, but so the story goes. 

Digital lenders perform a banking function (i.e., lending), but don't have a banking license or FDIC insured deposit capital. Their money comes mostly from investment funds, which is a shadow banking set up. They got around licensing by partnering with Bank-as-a-Service players. Some, like Square and SoFi, have looked at becoming an Industrial Loan Company in Utah -- a sort of quasi bank entity -- but haven't been able to pull the trigger. Neobanks in Europe got around licensing by riding the rails of pre-paid cards from the likes of Visa and MasterCard, pretending to have checking accounts while really just digitizing gift cards. Until now, as Monzo and Tandem have powered up the ability to take deposits via the FCA. So now we come to the point.

Recently, the Treasury encouraged the OCC to issue Fintech bank charters, and the OCC opened its doors for business. And immediately, the Board of Directors of the Conference of State Bank Supervisors (CSBS) announced that it is moving forward with litigation against the OCC. Way to kill the vibe! But that has not stopped fintech Varo Money / Varo Bank from getting a conditional de novo national bank license -- it can take deposits, move money and underwrite lending. Almost none of these have been granted since 2008, and so such a charter going to a digital-first player is a shot across the bow (granted, Varo needs to raise $104 million). The other interesting piece is that Varo is going to use Temenos, a European B2B2C bank platform for its core processing. Not FIS and Fiserv, the US versions of the same that power that long tail of State banks and credit unions. That's a big shot across the bow.

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Source: CrowdfundInsider (Varo Money), CSBS (States suing OCC), Davis Polk (Varo Charter)

ONLINE LENDING: $65 Million Venture for Lending Club CEO's "Upgrade".

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The world is full of second chances it seems. Renaud Laplanche is a rare entrepreneur, building Lending Club into a public company ($575mm in revenue, $1.6B market cap), and kickstarting the P2P lending industry. But he was also caught up in a governance scandal in 2016, which resulted in a resignation and questions around ethical conduct. Within two years, Laplanche has raised $142 million of venture funding for his new company, Upgrade, of which $62 million came in this week. The startup, which (similar to Lending Club) offers personal loans, already has over 100,000 customers and more than $1 billion in loan originations. This man knows how to build a digital lender!

Another persona that knows how to build a digital lender is Mike Cagney. Cagney was the founder and CEO of SoFi, the student lending giant known for its $1 billion investment round from SoftBank. But, he too was ousted from the seat in 2017, amidst allegations of sexual harassment and problems with an aggressive culture. Cagney's new startup is called Figure, which is a home-equity lender leveraging a blockchain infrastructure, funded to the tune of $50 million. It is a smart bet on just how unprepared people are to retire -- likely needing to extract value out of their homes, without selling them. 

What's going on here? Online lending is a mature theme, where even Goldman Sachs is originating personal loans to consumers. And didn't the IPOs of Lending Club and OnDeck fall 80% since the offering? Yet, from the Fintech Treasury report, we see that US originations are showing healthy growth, from less than $5 billion in 2013 to nearly $40 billion in 2017 across consumer, student and SME financing. That's a far cry from the $200 billion addressable market we identified in 2015. Software can be better at customer acquisition than the retail footprint, and it can also be better at underwriting the risk, using machine learning. Sure, we have not seen the other side of the credit cycle. But so far, digital lenders are one of the few categories in Fintech that have generated cashflows (e.g., Elevate Financial at $670mm) because they manufacture an asset class, which solves an accute pain point for the borrower. 

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Source: TechCrunch (UpgradeSoFi), Bloomberg (SoFi), FigureUpgradeTreasury Report

REGULATION: Landmark Treasury Report Supports Special Charters for Fintech Banks and Lenders.

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The recent trend has been that Fintech and Crypto startups can jurisdiction shop across the world for a friendly location, like Singapore. But in reality, the United States is still a massive gravitational force for both innovation and technology, and is the world's deepest capital pool in financial services. So with that context, we are thrilled to see a landmark 200+ page fintech report from the United States Treasury, touching on issues from payments, to lenders, to financial planning, to artificial intelligence (where we contributed our thoughts from Augmented Finance). Not crypto yet, though we are sure that will come. 

There is little to say, other than download and read it. Here are a few of the choice takeaways. First, the Treasury sides with the OCC on the idea of a special bank charter for technology firms. This charter would be less onerous than both an industrial loan company (ILC) and a full banking license, making life easier for digital lenders like Lending Club, On Deck, Square and SoFi. Digital Lenders could built out deposits, rather than relying on the shadow banking systems (i.e., credit hedge funds) for funding. The OCC has immediately jumped on this recommendation and is inviting fintech firms to apply. But remember, this hurts small and regional banks -- just imagine a local bank trying to compete with Stripe's new card issuing API. Such regional players have strong lobbies into industry groups and State regulators, so expect some type of allergic legal reaction to come. 

Other recommendations that jumped out at us include: (1) develop regulatory sandboxes like that of UK's FCA, (2) make it easier for bank holding companies to invest in tech, (3) smooth out the various regulatory bodies and interests that touch Fintech firms, (4) develop digital identity and strengthen the protection of consumer financial data (e.g. Equifax breach and GDPR), (5) digitization of the workflows in the mortgage sector and exploration of new approaches to credit modeling, (6) update the IRS income verification system, (7) modernize payments through faster retail payments systems, (8) level set digital wealth regulation (e.g., fiduciary rule from DOL vs SEC), and (9) take strategic efforts towards creating artificial intelligence within finance. We think these are all in the right direction of travel, and hope that the appropriate regulatory and legislative bodies are able to turn these non-binding recommendations into reality.

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Source: Treasury (SummaryFull Paper), Bank Charter (OCC response), Stripe (Issuing)

ONLINE LENDING: Outstanding Personal Loans at $120B, thanks to Fintech

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After the 2008 financial crisis and during the Great Recession that followed, banks slowed down risky lending and were mandated to shore up capital to protect the overall financial system. That left an opening for fintech startups like Lending Club and SoFi, which used the web and Big Data to (1) distribute product more efficiently, and (2) manufacture / underwrite product that the banks were unwilling to consider. Based on Transunion data plotted in a magnificently interesting Quartz article, unsecured outstanding US personal loan balances are at $120 billion.

The truly interesting data point is that digital lenders account for 36% of those loans, up from 1% in 2010. Imagine if roboadvisors accounted for 36% of new assets raised this year, neobanks had 36% of new deposits, or insurtech companies issued 36% of new policies! That would be a total and complete customer acquisition coup. The type of coup that would see Goldman Sachs build out its fintech Marcus to have 1.5 million customers and $4 billion in consumer loans. Similar non-bank lending is happening with Square Capital partnering with eBay to provide $100,000 business loans to sellers, and Amazon funding its own merchants. Don't need banks to do banking!

Here's the Crypto twist. BlockFi, a lending company that provides cash collateralized by crypto holdings, just raised $52.5 million from Galaxy Digital and ConsenSys Ventures. If you're sitting on BTC or ETH, you can get 35% of that lent to you by the company at a 12% interest rate. That's a way to monetize your holdings without capital gains from selling the underlying asset. In the same spirit, Coinbase is partnering with WeGift to convert holdings held in brokerage accounts into gift cards at various retailers. Mechanically, this is like retailers extending users credit based on digital assets. All that to say, we see the digital lending delivery and underwriting model continue to be massively relevant, despite the operational and risk challenges at some of the larger players.

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Source: CrowdfundInsider (eBay and Square), Quartz (volumes), Business Wire (BlockFi), TechCrunch (Coinbase giftcards)

FINTECH: If Amazon Did It -- Entry into Mortgage Finance and Wealth Management

Ah, the constant specter of BigTech gobbling up finance. In this installment, rumors are circulating that Amazon may be interested in acquiring LoanDepot, a non-bank lender founded in 2010 with over 6,000 employees and 180 locations in the United States. The asset in this case is geographic reach, loan underwriting software, and the human presence that is still necessary to deliver financial products to the long tail of the American population. But such rumors are most likely false, especially since the CEO of LoanDepot sarcastically shot them down. Also, imagining such an acquisition betrays a lack of understanding of Amazon's platform strategy, which optimizes around users within the Amazon ecosystem, and not sales of financial product. 

So we want to point you to two resources to help anchor that platform strategy. The first is a comprehensive analysis by CB Insights on the financial services moves that Amazon has made to date. Highlighted below are a few of the key graphics. Amazon's product strategy has been around growing payments and lending -- in order to facilitate commerce in their core offering. Meaning, if underbanked customers can use Amazon's cash products or consumer credit to purchase goods, that's great! If merchants can get an SME loan via Amazon that helps them offer more products on Amazon's platform, that's great! If purchased products are insured via Amazon's partners, that's great! You can see why re-financing a mortgage doesn't quite make sense in this context, until Amazon sells residential real estate that is.

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And second, we spent some time with the 2018 World Wealth Report from Capgemini. It surveys the growth in global HNW investors, their preferences and asset allocations. And this year, they also asked whether investors would hire a BigTech firm as a wealth manager. About 40% of the respondents said they would give such a firm 10-50% of their share of wallet, with Asian and Latin American millionaires showing the highest appetite. Further, the report suggests that most likely outcomes for BigTech entry into finance are: (1) partnering with manufacturers of asset management product, (2) unbundling the financial services industry through competitive payments and banking products that are priced below industry levels, (3) providing services and software into incumbents, and (4) partnerships via messaging platforms. Least likely outcomes are (a) no market entry at all, and (b) acquiring a wealth management firm. Google, Apple, Amazon, Alibaba and Tencent are all desired entrants into the wealth space. So if you're a financial incumbent, time to accept your fate and get into a pole position for partnership.

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Source: CBInsights (Amazon summary), Inside Mortgage Finance (Loan Depot), Capgemini (World Wealth Report

PAYMENTS: $2.2. Billion for iZettle by Paypal

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If you're PayPal, maybe it's frustrating to see people talking about the future of money and not mean you. But it would be a mistake to count them out of the game. The company has been expanding expertly across the Fintech ecosystem, with the latest data point being a $2.2 billion acquisition of iZettle. iZettle is a European version of point-of-sale dongle manufacturer Square, processes $6 billion in payment volume and accepts Google/Apple pay. The success of this model is a consequence of the adoption of mobile phones and tablets -- meaning that smart devices are cheap, everywhere, and can accept payments. Thus the (slow) power shift from dedicated hardware, to payments as a feature within tech ecosystems.

Two directions to think about. First, payments is a great entry into a broader fintech business model. When looking at Chinese messaging company WeChat, we see the world's largest messenger user base, tech payments app, and money market fund. Associated with such a messenger is a large data set of conversation and commerce -- which powers lending and investing. The same playbook could happen in the West. For PayPal, such logic would drive the partnership with micro-investing app Acorns and the acquisition of social payments app Venmo (and developer focused Braintree). Lending is the next logical step -- for analogy, look at Square's merchant lending business or Goldman's success with Marcus and its expansion into Europe. 

The second direction is augmented commerce. As AR/VR penetrate the world with devices and change how people shop, we think it will be important to own a hardware asset that can adapt to the opportunity. iZettle gives PayPal an option for success in the next wave of tech transformation. Of course, it will be complicated to rationalize capability, especially in relation to Google and Apple pay. Looking at the Venmo acquisition, PayPal is now stripping out its web functionality and limiting Venmo to the mobile app -- there is no sense in having two separate web standards. And on retail commerce, there is still the question of crypto. Companies like Basepay (support Ethereum as currency at 11 million retail location) and Revolut (prepaid card that can index to crypto and be swiped at point of sale) are building a bridge that PayPal is yet to cross.

 

Source: Reuters (iZettle), Crowdfund Insider (Goldman Marcus), Reddit (Venmo), NewsBTC (Basepay).

ARTIFICIAL INTELLIGENCE: $1 Trillion in Exposure from Artificial Intelligence on Finance.

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We looked at the applications of AI across the front, middle and back offices of banks, investment managers and insurance companies, highlighting a rich ecosystem of sophisticated software. The outcome is Augmented Finance --  an investor’s guide to how AI is pulling apart and breaking down the financial services industry. We estimate the economic impact of AI on financial firms globally, finding nearly 20% of costs potentially reduced through implementations, equivalent to $1 trillion by 2030.

AI is not a panacea nor a single thing. It's math, data and software, searching for the right use case. In this dive, we looked at conversational interfaces, biometrics, workflow and compliance automation, and product manufacturing in lending, investments and insurance. In the front office, the most promising applications focus on integrating financial data and account actions with software agents that can hold conversations with clients, as well as support staff. In the middle office, as regulations become more complex and processes trend towards real-time, artificially intelligent oversight, risk-management and KYC systems can become very valuable. And in product manufacturing, we see AI used to determine credit risk using new types of data (e.g., social media, free text fields), take insurance underwriting risk and assess claims damage using machine vision (e.g., broken windshield), and select investments based on alternative data combined with human judgment.

In the US alone, 2.5 million financial services employees are exposed to AI technologies. There is potential cost savings of $490 billion in front office, $350 billion in middle office, $200 billion in back office, totaling $1 trillion across banking, investment management and insurance. Not surprisingly, many firms talk about AI, but very few actually hold intellectual property in the space. And the best performer -- Bank of America -- is still leagues behind the GAFA. Talk about Black Swan risk!

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In mapping out the future of AI in financial services, we saw several routes. One potential path is that AI tech companies like Amazon and Google continue to add skills to their smart home assistants, with Amazon Alexa sporting over 20,000 skills already, outcompeting finance companies and stealing their clients. Another potential path is the example of China, where tech and finance merge (e.g., Tencent, Ant Financial) to build full psychographic profiles of customers across social, commercial, personal and financial data. And last, but increasingly tangible, is the path is towards decentralized autonomous organizations that are built by the crypto community to shift power back to the individual, with skills made from open source component parts. 

ONLINE BANK: Amazon's "Checking Account-Like Product"

Source: Edelman

Source: Edelman

Lots of chatter last week about how Amazon is in discussions with JPMorgan about partnering on a "checking account-like product". This is right on the heels of similar discussions with Bank of America about putting capital behind its SME lending business. So since when are banking products or lending products or investment products just a "-like" product. Meaning, don't you have to have a bank to offer the trusted service of a bank account? Don't you have to have a trusted banking brand to hold on to people's money? Quaint questions for the last century.

Not really. According to a study from Bain, 74% of 18 to 24 year-olds and 68% of 25 to 34 year-olds expect to buy financial products from technology firms. And according to the Edelman trust barometer, people still trust Finance less than absolutely every other industry, while trusting Technology more than any other industry. There goes your core value proposition.

The implication of a GAFA sector that offers all the financial products without manufacturing them isn't the safe passage for the financial services industry to the future. Rather, it is the full commoditiziation of financial services, as the main manufacturers of financial products squeeze themselves into the customer acquisition and engagement channels of the big tech AI companies. When the AI knows clients better than anyone else knows clients, financial services are mere features within the rich tapestry of services called Amazon Prime. Why would anyone choose the pain of shopping for and opening a third-party bank account, if one comes pre-installed in our virtual assistants?

So you can see how puzzling it can be to read that JPMorgan is investing $20 billion in 400 new branchesDoes 75% of deposit growth really come from customer visits to those branches? Do 60% of Americans still prefer to open an account at a branch, rather than digitally? Maybe, but these are decreasing data points in time, part of a larger trend towards digital. As shown below, each year these numbers go down, not up. Or, maybe, JPMorgan recognizes a corporate responsibility for its employees in a world that is moving towards automation and unemployment, and is doing its part in trying to stabilize local communities and the industry's reputation?

Source:&nbsp;Bain

Source: Bain

Source: Edelman, Bain, Tradestreaming/Cuebiq

Source: Edelman, Bain, Tradestreaming/Cuebiq

ROBO ADVISOR: Should Roboadvisors Maximize Assets or Accounts?

Source: Autonomous NEXT

Source: Autonomous NEXT

Here is an interesting property of digital wealth management and B2C Fintech startups building brands in the space. We took a look at the most recent regulatory filings of the first wave of roboadvisors (e.g., Betterment, Personal Capital) and the following wave of micro-investing services (e.g., Acorns and Stash). And there seems to be some invisible tradeoff between devoting resources to gathering assets versus gathering users. 

Betterment has $11 billion or so in assets under management with a $40,000 average account size. Personal Capital is at $4 billion ($6.5 billion according to their site), with a $150,000 average account size. From an attention economy perspective, the numbers of accounts is quite modest -- 400,000 and 30,000 respectively. In the tech world, less than a million users is not particularly impressive. Their audience however is an order of magnitude greater than that -- the Personal Capital freemium model has 1.6 million registered users, which is about a 2% conversion rate.

When looking at the micro-investing services, we see around 1.3 million users for both Acorns and Stash. This is an impressive metric on its face, until we dig into average account sizes - between $100 and $600 per client. So the overall assets under management are really quite small at $200-500 million. If this were a single advisor team at Goldman Sachs, with a $50 million budget for marketing (i.e., VC money), they would have been fired for under-performance on asset gathering by this point. But from the point of a tech play, they are similar to a more modern Mint.com (25 million users), with a monetization option bolted on that is attached to workflow automation.

Similar things can be said about digital banking and lending. For example, take the multi-million user bases of Venmo, Digit, Transferwise or Revolut which maximize for engagement. The transactions and balances are all small. But their account totals will be much higher than that of neobanks trying to gather assets and underwrite loans, like Bank Simple or Moven. We don't think this is just a matter of going downstream in a market to smaller customers. Instead, it is about focusing the product to behave like a media/tech company or a finance company. There is an exception to this trade-off today, and that is Coinbase and other crypto startups. There, we see both a massive number of users and the associated economics behind the business. Coinbase custodies $9 billion in assets from 13 million users -- that's not quite the $5 trillion of BlackRock, but certainly a win both for the operating business and the attention economy. No surprise then that Robinhood is betting on crypto as well -- digital wealth will collide with digital assets.

FINTECH: Amazon and Bank of America

Source: Amazon

Source: Amazon

Remember how Amazon has a lending business line that makes loans to merchants on its platform for up to $750,000, competing with OnDeck, Kabbage, Square and Paypal? We've discussed before how the online retailer has proprietary data that indicates company revenues before those revenues even materialize -- the traffic on product pages by consumers on the Amazon website. The key advantage in underwriting is the reach of your data and the quality of your algorithm, so having a data set broader than payments and an AI smarter than one built by a bank should allow the company to drive a wedge into financial services.

Except it doesn't really want to. CNBC reports that Amazon's lending activity has been purposefully capped at an annual $600 million, and that the firm has partnered with Bank of America for future capital. My colleague Brian Foran at Autonomous Research put this in context. Even if Bank of America doubles the Amazon program to $1-2 billion, it will not be material for the bank in the context of a total loan book for $930 billion. And second, by outsourcing the capital to a bank, the tech giant is (1) side-stepping regulatory financial oversight, and (2) is using capital more efficiently in higher-growth businesses than just lending. Like robo-retailing and augmented commerce.

Compare this with China. Alibaba's commercial bank MYbank, Tencent's WeBank, and 6 other private lenders that were started in 2015 now have a loan book at over 80 billion yuan ($12 billion). Still a drop in the bucket for BAML, but quick expansion for a technology-first financial institution that faces more favorable regulation.

Or take the even more interesting example of Microsoft and Bitcoin. The tech firm is building an off-chain layer on top of the public blockchains to re-invent identity services, and find a way to give at least some data back to the user. Solving an old problem with a solution on new infrastructure (paper > database > chain) gives room for the solution to breathe. A $1 billion in loans may be peanuts for Bank of America as part of a $1 trillion business. But in Crypto, $1 billion in loans through something like SALT could be a market leader. Combine that with the Microsoft user base, and why do we need banks?

Source: SALT

Source: SALT

FINTECH: Digitization of All Asset Classes

Source: Roofstock

Source: Roofstock

So here's the good news. While we wait for blockchain to change the infrastructure of financial services, amazing things are constantly happening across the financial front office. The Fintech change is really here and we can see it -- especially if we look past cashflow and to customer experience. Using last decade's innovation of mobile and web, platforms have created access to previously expensive financial products. Digitization has led to the democratization of each and every asset class.

Here are a few data points, more of which you can always find in the body of the full email. First, digital lending -- 2017 saw increasing online lending activity. Even companies like Goldman Sachs are boasting about $2 billions of loans originated and $5 billion of deposits in their Marcus platform. That's Goldman, not Lending Club, but the consumer shouldn't care. The other side of the balance sheet, neobanks, are also maturing and growing their offering.Revolut has added insurance to its product portfolio, as did SoFi and N26 earlier. Monzo is opening up current accounts, while Tandem gets its banking license after buying Harrods. Such European startups have over a millions of eager users, which is why a $45 million check just went into an American neobank called Varo.

In digital wealth, Vanguard peaked over $100 billion in AuM, and the hybrid roboadvisor platforms (those where a human and algorithms are combined) are booming. Venture investors keep pouring money into the combination of traditional and digital -- see for example NextCapital's $30 million round. Access to and manufacturing of alternative investment products is moving along too. Real estate marketplace RoofStock gets a $42 million funding round on $1 billion transactions moving through its platform. And Wealthforge, a private offerings platform announced more than $500 million in investments processed. Insurance is not far behind -- take of example how insurtech Betterview used drones and machine vision to assess damage for claims during hurricane Irma.

Source: Betterview

Source: Betterview

Source: AdvisorEngine

Source: AdvisorEngine

So this is Fintech -- multifaceted, difficult, working with industry to impact the most people possible. Access and democratization are its core values, even if it is not decentralized nor truly disruptive. For the Crypto movement to have the most impact, it needs to retain this driving spirit to create services that help all people access better financial services to live better lives.

REGULATION: The Ethics of Sovereign Technology

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The Chinese tech companies sit comfortably between media, software and finance. No distinction needs to be made between using someone's social media data, search history, shopping habits, education and financial track record -- all of these data points flow into massive AI power-houses with half a billion users, inside Alibaba, Baidu, Tencent and others. Now, imagine if your Facebook friends and Google searches and Amazon shopping and Visa purchases determined if you could get a student loan to go to university. China's social credit system will do just that, reports Futurism.com while referencing an infamous Black Mirror episode that explores a dystopian view of this concept.  While countries like the US certainly struggle with systemic bias in the commercial activities of free participants, at the least such bias is not put into software by the federal government and used to determine access to services. 

Or is it? Consider that a regulatory agency, the Federal Communications Commission (FCC), is working to remove net neutrality rules in order to allow Telecom companies to meter how and where Internet traffic flows. While Comcast may not turn off access to some particular site, they could in theory tier the speed of the Internet according to economics, politics or whim -- such that, for example, Goldman Sachs or Amazon load quickly, while Crypto Kitties or Telegram load slowly. And loading time is a major determinant of consumer behavior and information exposure. We can't trust the Telecoms to not extract economic rents. Therefore, this policy choice will strengthen the ability of entrenched commercial interests to determine what people have access to, and consume.

And what if the rationale for such policy decisions is not even driven by the sovereign, or the collective will of that state's people? Data Scientist Jeff Kao deed a deep dive on the FCC comments using natural language processing analysis. In the best case, at least 1.3 million of the pro-repeal comments sent to the FCC were automated. In the worst-case, only 800,000 of the 22 million submitted comments came from real people, with 99% of those opposing the repeal. In the graph below, the height of the bar shows how often a campaign was repeated on an exponential scale. The color Red is associated with repealing and the color Green with keeping net neutrality. The clustered Red middle suggests the work of spambots that can generate slightly different language with the same meaning. The long Green tail is likely to be written by real people, though the first top bar shows a form letter repeated 7.5 million times. This cuts in every direction.

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And of course, other examples of propaganda bots are well documented -- already in use by 30 governments, with election impact in 18 countries. According to a recent report from Freedom House, Internet freedom is declining on a global basis. The mental stretch from a government controlled social credit system to global information warfare over national policies is not as unlikely as it may first appear.
 

Source: Freedom HouseJeff Kao