fintech

BIG TECH: Apple's Credit Card, Google's Digital Gold, and IBM's Crypto Custody show the reckoning is here

After years of existential angst from finance executives about the big tech companies entering financial services, it is time to pay the piper. Excuses like regulatory cost and complexity, strategic disinterest, and complexity of products are incrementally falling away each and every day. Across every single vertical, something is nipping at the banker's ankles. The splashiest announcement came from Apple, which launched a credit card backed by Goldman Sachs (the storied mass retail financial firm!) and transacted over the MasterCard network. You can sign up for the card directly from your phone, which integrates it into Apple Wallet and Apple Pay, and provides a 2% cash back on all transactions made with ApplePay. There are no fees on the card other than an interest rate on credit.

For Apple, this financial product is one of a thousand features within their platform. It is no more or less important than music, video, news, email, or podcasts. The presence of credit makes customers more sticky within the ecosystem, offering 3% cash back on all Apple purchases. For Goldman, this is a leapfrog into the consumer market, riding a much better recognized and respected retail brand. Finance for the wealthy is just not cool anymore in the era of Bernie Sanders and Alexandria Ocasio-Cortez.

Meanwhile in India, Google and Facebook are battling with Paytm over payments. Facebook's rumored cryptocurrency will target sending remittance over WhatsApp. Google, on the other hand, is working on a service to add a savings account to money movement. This account will be backed by custodied gold, and may include expanded wealth management products -- from mutual funds to insurance -- in the future. None of this should be surprising, as Chinese tech companies have been providing mobile search bundled with online shopping, saving, investing and payments for the last five years. These Asian companies are moving into Europe and the US, sometimes by investing in neobanks or through acquisitions. Our American tech companies are moving into Asia.

Let's round out the whole thing with IBM, the OG of American tech companies. Several young firms like BitGo, Gemini, and Kingdom Trust have all built custody for crypto assets, including a notable recent announcement from Trustology about bringing custody to the iPhone. But IBM is now moving into the space, leveraging its expertise from working on enterprise blockchain projects via Hyperledger. What's important to understand is that financial products -- including their embedded capital, credit and investment risks -- are transforming from legal paper to software. And as that happens, it is technology companies that are best positioned to hold, analyze, report on, and safekeep our money. Among the incumbents, Goldman, JP Morgan, BBVA, Santander, DBS, BlackRock, Schwab, Fidelity, NASDAQ, ICE and several others get it. So many others think it is a false alarm. Which side are you on?

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Source: Apple Card (ForbesBBC), Coindesk (Trustology iPhoneIBM), Deal Street Asia (Google Gold)

BIG TECH: Subscribing to Unownable Assets with Google Stadia, Apple News, and Taxes

Microsoft, PlayStation and Nintendo split the console gaming market today, with a strong focus on devices and online services. Those companies make money either by selling a piece of proprietary hardware (i.e., the console), exclusive software (i.e., the video game around which they may have IP rights), or through a store that takes a cut of third party developer revenue. Google announced that they are entering the market with a disruptive and orthogonal strategy. The firm plans to use its massive cloud infrastructure and AI advantage to deliver streaming gaming services through a subscription model.

What does this mean? Machines far more powerful than a local console or PC will run sophisticated 3D rendering engines on cloud servers optimized for visual graphics. AIs that optimize data center use and compression will package information transfer in ways that other video game streaming start-ups were simply unable to deliver. On sufficiently fast broadband, millisecond responses between a controller in a living room and a cloud service become possible. While such infrastructure is not ubiquitous, you can see the projected growth of 5G and LTE networks below -- suggesting that Google's vision can be meaningful across a large part of the world. Engaging with a high-end virtual world on a mass-produced cheap tablet becomes a reality. 

Let's talk about subscription. Subscription is the solution for monetizing unownable assets. Such assets may be prohibitively expensive in the aggregate and worthless on the margin. Take for example Spotify, which manages to sell you all the music in the world for $10 per month. An individual cannot afford all the music in the world, and yet the marginal song is worth absolutely nothing. Or take the upcoming Apple News subscription service, which gets around the paywalls of sources like the WSJ for $10 per month as well. A reader can't afford the paywalls for every premier newspaper in the world, even though the value of the marginal article is a donut.

We think similarly about citizenship -- taxes are the subscription cost to membership in a sovereign body, with its social protections, foreign policy, and monetary base. An individual cannot afford those on the margin, nor could those "products" be financed in a case-by-case manner. Or look at the developments in wealth management and roboadvisors, where Assets under Management based pricing (% of total) is beating commission based models (per transaction). AUM fees are a subscription to unlimited rebalancing across thousands of companies, packaged in free-to-trade ETFs on custodian platforms. We go down this road to highlight the right path to follow: all financial services in the aggregate are an unownable asset, but worthless at the marginal product. Price accordingly.

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Source: Polygon (Google Stadia), 9to5Mac (WSJ and Apple), NY Times (Apple News)

BIG TECH: YouTube, Facebook and NVIDIA powering hyper-realistic human avatars

The digitization of the human animal continues unopposed, with symptoms all over. Chinese firm Megvii, maker of software Face++ that has catalyzed 5,000 arrests since 2016 by the Ministry of Public Security, is looking for an $800 million IPO. The other champion of public/private surveillance, Facebook, is working a virtual reality angle. The company is improving the technology used to model rendered avatars of human faces, which can then be displayed across virtual environments. Using multi-camera rigs and hours of facial movement footage, Facebook is building neural networks that learn how to translate realistic facial muscle movement into models. The Wired article linked below is worth exploring for the videos alone, and the uncannily realistic motion these animation possess.

One of our recurring points is that frontier technologies -- AI, AR/VR, blockchain, and IoT -- appear disparate now, but are intricately connected. Take for example the new feature from Google called YouTube Stories. Similar to SnapChat and Instagram, video creators can apply 3D augmented reality overlays to their faces. While this technology looks like virtual reality rendering, it is primarily a machine vision (i.e., AI) problem to anchor rendered objects to a human face realistically. To do this Google provides a developer library called ARCore, not to be confused with Apple's ARkit. Human video avatars can be further extended and customized with code -- the twenty first century version of personal branding.

Another take on the same issue comes from generative adversarial neural networks (GANs). We've discussed before how hyper-realistic images and videos can be faked by a model where one algorithm creates images and another accepts or rejects them as sufficiently realistic, with repeated evolutionary turns at this problem. Highlighted below is a recent software release from NVIDIA, where a drawing of simple shapes and lines is rendered by a GAN into what appears to be a hyper-realistic photo of a landscape. We can imagine a similar approach being applied to the output generated by Facebook's avatars, which still border on creepy, to ground the outcome in reality. Little details, like a reflection of a cloud on water, are hallucinated by GANs automatically, based on massive underlying visual data. Expect these digital worlds to become increasingly indistinguishable from reality, and to spend way more time living in them for the years to come.

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Source: SCMP (Face++), Wired (Facebook Avatars), NVIDIA (GAN drawing)

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)

PAYMENTS: Walgreens, Brex and Citymapper use financial products to make digital commerce physical

First you take a traditional physical industry, and make it digital. Walmart turns to Amazon. Taxis turn to Ubers. Next, you take the digital environment -- online shopping, expense management software, maps and navigation -- and re-instantiate it back into the physical world. This is how you get weird results like augmented commerce, where retail locations of physical stuff grow augmented reality overlays to create omni-channel data tracking for a company's AI. Take for example Walgreens rolling out Cooler Screens digital windows for its shopping venues. The monitors replace fridge doors, displaying products in an idealized state, with (potentially dynamic) digital prices prominently designed. You are interacting with an app, or maybe a website, on a door behind which lies the ice-cream you want to buy. Let's repeat that. A website is in front of you, an ice-cream is an inch behind the website, the website watches you with cameras, records your reactions, advertises things at you, and sends everything to the cloud. Enjoy your online in-store experience!

Or let's take transportation. There are the digital upstarts, arbitraging a phone's GPS to deliver mobility with greater precision than a human transaction. From Waymo, Ofo, Lyft, Uber and Lime littering our phones with icons of summonable critters, to manufacturers like Citroen creating mobile-app connected vehicles like the Ami One, transport is mobile and on-demand. So what's the next meta game? Check out CityMapper, a mere-mortal mapping application focused on beating Google and Apple at giving directions for city travel. The app is not original, but well executed. It charts out public, private and pedestrian modes of getting from here to there with time estimates, and does so locally on a device, which means no internet connection required. After acquiring a userbase for aggregated directions, they are now launching aggregated transportation through a subscription offer called Pass. This physical card costs £30 per week, and includes public transportation, bikes, and ride-sharing, with loyalty points on top. Here is an instantiated financial products that sits on top of abstracted digital infrastructure.

Another Silicon Valley favorite is fintech start-up Brex. It provides a corporate credit card for small business, which consolidates spending and expenses across the entire organization and leverages existing corporate spending behavior to offer higher credit limits. It's never been easier to give WeWork employees their own spending account, and track just how much Starbucks they drink. The interesting thing about Brex isn't that it's a card -- banks know how to issue credit to businesses, despite what the startup may tell you. The interesting thing is that the expense management software for the business owner is the primary proposition (we think), leveraging modern data aggregation into expense management and credit permissioning. The accounting industry got digitized (e.g., Wave and Quicken), and now is instantiating itself back in our physical world through a smart card and financial product. This opportunity to bridge software into the physical world with finance, and payments in particular, is an area we are are thrilled to see develop further.

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Source: Slate (Cooler Screens), Engadget (Citroen),  Techcrunch (Brex), CityMapper (Pass)

DIGITAL WEALTH: Schwab abandons desktop wealthtech as industry moves to open banking and investing platforms

We weren't planning to write about traditional wealthtech, but man, it's hard to pick your jaw up from the floor after reading this. Schwab Advisor Services, a $1 trillion assets under custody business, is selling its desktop portfolio management technology PortfolioCenter (which manages 2,300 advisory firms) to Envestnet for an "immaterial" price. The cost to Schwab of trying to pull those users into the cloud from desktop was higher than giving away the business, which generates about $10 million in revenue. Schwab retains its cloud version of the software, PortfolioConnect, as part of confusingly named AdvisorCenter. Reminder that one of the larger Envestnet shareholders is BlackRock, both a competitor to and manufacturer for Schwab's offering.

Fidelity paid up $250 million to buy eMoney, a cloud-based chassis for digital wealth management in 2015. The industry's conclusion was that custodians were going to be providers of technology in a freemium model, giving away tech and making money on capital. The independent wealthtech software houses (Orion, Black Diamond, ENV, AdvisorEngine, SigFig) could be in trouble. The Schwab sale of its client base given the cost of management legacy tech is enlightening. At the core, custodians are horizontal financial product platforms, enabling brands (e.g., RIAs, Cryptofunds) to deliver services to their customers. Sounds a lot like the other things happening in finance, which is open banking and data aggregation platforms building API-first layers. Can't be API-first with a desktop executable file!

So then what does a real platform look like in 2019? One take is something like Plaid, but we've discussed it before. Instead, take a look at Cambr. A joint venture between a community banking private equity firm (Stone Castle) and a core processing company (Q2), deposit products into tech apps are one integration away. Another version of a conceptually similar play is DiFi -- Digital Financial, previously Market76. Or, if we go one level down, every single bank participating in European open banking initiatives is becoming a financial product platform. See the awesome ranking Innopay has done of these below. And last, Apple itself. The hardware maker owns a massive attention and payments footprint, and is enabling none other than Goldman Sachs to launch a credit card. Apple is the platform, Goldman is the brand. We can see why Portfolio Center isn't super exciting. 

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Source: RIA Biz (Schwab sale), Schwab website, Fintech Platforms (CambrDiFi), WSJ (Apple & GS), Innopay

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)

ONLINE BANKS: $22 Billion from Fiserv for First Data, creating a Public Banktech utility

In one of the most massive Fintech headlines in recent history, core processing company Fiserv is buying merchant acquirer First Data in a $22 billion stock deal. Much of the thinking about the combination is about scale (12,000 financial services clients plus 6 million merchant locations) and synergies ($900 million in cost, $500 million in revenue). The combination is well engineered in a spreadsheet, and has the strategic rationale of defending a competitive position by vertical consolidation -- "if we own all the Payments and Banking products, we'll touch all the clients". Some folks also mention the pressure on revenues across the industry, as Fintech start-ups create transparency and competition in the space. Consolidating business lines in such an environment makes sense, though perhaps this is an afterthought at the scale we are talking about.

There are two angles we want to consider. The first is that enabling financial technology -- i.e., the infrastructure needed to manufacture something financial -- trends towards both utility and monopoly over time. It is a utility in the sense that it should be dirt cheap, easily available, and nobody in their right mind would want to rebuild one (also note utilities are public, as in owned by the government). It is a monopoly in the sense that a single player should win the whole market, consolidate all the costs, and charge only at the margin. As technology evolves, the threat of entry by new players like Alipay and Whatsapp is almost as scary as the actual entry of such players. The infrastructure provider would be wise to compress their own margins to make entry by smarter, faster, better players unattractive. A corollary to this line of thinking is that the long tail of small banks and credit unions rent software from utilities, while firms like JP Morgan and Goldman Sachs get to hire AI PhDs from Google. 

The other lens to think about is where the innovation and associated growth happen. We recently re-discovered 2015 slides from venture firm Andreessen Horowitz, which showed how the flow of investment value in technology -- i.e., the investment returns for taking on some risk -- are happening in large part in the private, and not in the public markets. Said another way, private market valuations no longer have a meaningful ceiling (thanks to SoftBank and Tencent), and therefore private investors get to capture all the capital gains from fintech disruption. To go public merely is to monetize those private gains, whereas in the past going public meant getting capital for growth. That means we expect Payments and Banking industry innovation to stay private, and for large players like Fiserv and First Data to rent or acquire them, rather than lead and source them. 

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Source: Business Wire (Press Release), Andreessen Horowitz (Presentation on Venture), Company Websites for screens

ONLINE BANK: Here's why N26 can be valued at $2.7 Billion

One key prediction for 2019 -- digital, mobile-first Fintech bundles -- is already coming true. N26, a German neo-bank, has raised a new $300 million to fund international expansion at a ridiculous, eye-popping, anxiety-inducing $2.7 billion valuation. After just a few years of operation and some European Millennials downloading the app. Can this thing really be worth it? Our initial bearish take was that this is not about how much the company is worth, but how much it needs. Venture investors are happy to burn money in order to grow B2C consumer brands, which have now gotten large enough to need (rather than earn through revenue or income) their unicorn valuations. Anecdotally, there's a 5x difference between the public and private markets -- so if you divide the billions by 5 and are no longer outraged, then this price is fair.

But on further thought, there is some defensible industrial logic here. Let's assume -- for the sake of argument -- that all the tech and financial product is trivial, and that all of the venture funding is being used to acquire customers. Further, let's assume that each round is responsible for client acquisition in the prior period. This translates into a simple fact: venture money is a marketing budget, so traction acquiring customers isn't an accomplishment. It's just paying for Facebook ads. On N26's 2.3 million users, customer acquisition costs are between $20-100 per user.

Let's assume that deposits are at $1.5 billion, which is about $650 per customer. That looks a lot like Acorns and Robinhood to us. Depending on assumptions, N26 could make somewhere between $3 and $10 per user per year, which is roughly a 5-10 year payback period. Looking at Revolut, who raised $344 million and probably spent about $150 million of that, venture capital per user looks like $40-110, slightly more expensive. Revolut's revenue is somewhere in the $20 to $30 million range, with a per user revenue of $5-10 as well. There are 600+ banks in the US with assets over $1 billion, so this looks ridiculous (i.e., not special) on its face. Until you realize that customer acquisition cost for financial products is $300, regardless of business line, that customer turn-churn is low, and that acquisitions in the market recently happened at $60 per lead. So we think that the customer acquisition machine is fairly reasonable. Deriving enterprise value on that by multiplying money raised by 10x does seem a meaningful stretch.

Another interesting angle is the fact that the last two rounds involved Asian money -- Tencent and GIC respectively. Those are not particularly price sensitive investors, and N26 is -- from that frame -- a cheap experiment to run in order to see what a foreign banking entrant can do in the United States. If I were Tencent, I would be taking detailed, copious notes.

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Source: Autonomous NEXT analysis, Bloomberg (N26), Company website

PAYMENTS: Earthport selling to Visa for £200 million to solve cross-border payments

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One of the first big Finance bets on the Internet was payments. Fast forward 25 years, and we're still talking about payments. But let's set aside PayPal and its early penetration of eCommerce in favor of the enterprise. One such company is Earthport, founded in 1997 and focused on simplifying international money movement. Unlike the correspondent banking set-up and SWIFT, where money bounces between international banks like a plane ride with 5 layovers (wire instruction messages being the equivalent of your traveling luggage), Earthport built lots of local bank accounts across the world and centralized the counterparty. 

Twenty years later, it is in 200 markets and compliant in each regulated jurisdiction. As you know, that compliance is hard and expensive. For whom is the solution designed? Think about businesses paying international contractors, whether other SMEs along the supply chain, or remote workers. Or think about Transferwise, which rented the Earthport network to get its low-cost remittance product up and running. Impressive traction, you would say? 

Well, the market says it is only worth $40 million in revenue and $250 million in acquisition price. That is roughly 15% of the latest valuation for TransferWise at $1.6 billion. Even worse, it is a mere 1.6% of the $14 billion market cap for Ripple's cryptocurrency (and maybe unregistered security) XRP, supposed to be used for cross-border money movement. Same requirements for compliance, same underlying problem being solved, different generation of technology and entrepreneurs. While Visa is getting a neat capability, we can't help but scratch our heads at why Earthport didn't turn out to be a bigger deal.

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Source: The Block (Ripple class action), Crowdfund Insider (Earthport), Transferwise Graphic (By EdMercer - Own work, CC BY-SA 4.0), Penser (Ripple Graphic)

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)

2019 FINTECH PREDICTION: Government and Enterprise Platforming, led by AI and Mixed Reality

Source: Images from Pexels,     2019 Keystone Predictions Deck

Source: Images from Pexels, 2019 Keystone Predictions Deck

Over the last decade, consumer tech has undergone a cycle of platform building, user aggregation, data mining, and value extraction, resulting in GAFA monopolies. Exhaustion with Facebook and the adjacent issues of privacy and radicalization, in our view, will lead to problems building new splintered consumer attention platforms for AI, AR/VR and other new media ground up.  This implies that consumer platforms based on new technologies will be much more long-tail oriented, serving niche markets with very strong fit. Communities may be passionate, but smaller.

Enterprise tech lags retail adoption by, give or take, 5 years. Similar platforming has not fully penetrated on the enterprise side -- Salesforce is not yet the AI monopoly we should all fear, and Open Banking is barely a fizzle. Therefore, we expect increasing data transparency, aggregation and monetization to occur in enterprise underwritten by venture capital investors. As an example, augmented reality adoption and economics will be driven primarily by municipalities, utilities, large industrial manufacturers, and the military. Similarly, artificial intelligence at scale (and its meeker cousin Robotic Process Automation) are to be directed largely at the workflows and manufacturing processes of large corporates. Dont' get us wrong -- consumer AI is extremely important -- but within Financial Services, the scope for this in the corporate world is even larger.

The corollary is that the pricing pressure that started in consumer Fintech -- roboadvice (150 bps to 25 bps) or in remittance (600 bps to 10 bps) -- will spill over into B2B banking, money movement, insurance, treasury management and product manufacturing. An inevitable outcome is pressure on profit margins as prices equilibriate. For those companies that are able to re-design operations using a digital chassis, they will be able to compete on the margin with Fintech unicorns. Those that are not should exit, or retreat into more bespoke, relationship-driven business lines. 

2019 FINTECH PREDICTION: Real Autonomous Organizations Take Shape

Source: Images from Pexels,     2019 Keystone Predictions Deck

Source: Images from Pexels, 2019 Keystone Predictions Deck

The last 5 years have seen fundamental innovation in crowdfunding, regulatory technology, the digitization of financial services, blockchain native organizations, and automated propaganda bots to attract human attention. 2018 brought with it sobriety and a back-to-traditional regulatory treatment of financial assets and their structures. In particular, the crypto asset movement (and its crypto-anarchist community construction) has been put into a well-understood, regulated box by most national regulators. While many interesting lego pieces exist, none of them have yet to fit together. Still, regular people have gotten a taste of both the distribution and manufacturing sides of financial mana.

2019 will re-combine these pieces to instantiate functional autonomous organizations that work in a constrained market environment and perform useful services. Unlike the failed experiments of the DAO or BitShares, these new DAOs will have a clear corporate form, a regulatory anchor, and will focus on delivering products and services to regular people, but scaled through machine strategy. The automation of company formation (Stripe Atlas) will combine with the outsourced human/machine assembly line (Invisible Tech) and distributed governance (Aragon) to create companies that scale frighteningly quickly.

Such creatures need a safe environment in which to operate, with a narrow set of functions and constraints. We see labor platforms like 99Designs or Upwork as useful sandoxes to test whether software-based organizations can compete in a human market. Such experiments will require a re-thinking of the tokenized approach, leveraging the micro-economic discoveries but avoiding the need for a poorly adopted crypto wallet or token. Designers will need to reduce friction, not just lump together coding ideas. But the timing and soil for this could be just right.

2019 FINTECH PREDICTION: Collision of Fintech Bundles and Pivots to New Channels

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Unicorn fintech startups like Robinhood, Acorns, Revolut, Monzo, N26, Betterment, SoFi, Lending Club and others will all converge on the same multiple financial product offering across lending, banking, payments and investments. This is driven by the need to cross-sell new revenue in order to justify high spending on customer acquisition. Large financial incumbents will be following the same bundling playbook through their mobile apps, intensifying the progress of Goldman Sachs, JP Morgan, UBS, DBS, BBVA and Santander along this axis. Tech and finance (as well as incumbents and startups) will all be pursuing the same customer-centric solution for the digital consumer. Great for the customer.

As a result, customer acquisition costs will rise and the digital model will become more competitive as servicing costs commoditize at a cheaper price point. What we mean is that if everyone -- including large operating businesses -- will understand how to market to and serve Millennials, driving away the arbitrage opportunity Fintech companies have had to date. As a result, at least one unicorn will implode when the cross-sell does not materialize. Most likely this will look like a devaluation of the equity component in the capital stack, such that new money is raised to maintain profitable marginal operation, but the hundreds of millions already invested in the business are mere sunk cost.

New revolutionary entrants will use channels that are foreign to existing Fintechs and financial incumbents, like video, Twitch, Discord or AR/VR. One example would be credit-as-a-service, similar to Stripe payment-as-a-service, built into a B2B customer journey. Another would be native payment systems for digital experiences and environment. Yet another idea could be social currency within chat streams for video gamers. It will be foreign territory for many, and the key to success is correct market timing balanced with adoption.

Source: Images from Pexels, 2019 Keystone Predictions Deck

2018 FINTECH PREDICTION IN REVIEW: Social Selling & Propaganda Bots

Here's what we said would matter in the past year year:

How can financial advisors, insurance agents, bank tellers and other human front office staff compete with bots? How can they compete with Kim Kardashian and kitten GIFs for attention? They can’t — at least not without some automated help. We think that 2018 will see a much fuller implementation of Social Selling, i.e., using social networks like LinkedIn to prospect for business, and that this channel will become plugged into roboadvisors, neobanks and insurtech startups. Further, social selling is all about content marketing by using writing, podcasts and video. To distribute these at scale, we expect the technology behind propaganda bots to find a way into the mainstream economy and become a more acceptable strategy. Call it demand generation.

We were strongly correct in thinking that the social media pipes of LinkedIn, Twitter and Facebook will be used for selling financial products; the claim that these tools will be supported by some of the shadier aspects of propaganda bot networks also came true in particular cases. The second largest crypto currency, Ripple, is associated with a large and active bot and sockpuppet network, which has supported the market value of XRP to be $15 billion, only behind Bitcoin, and in competition for second place with the far more functional Ethereum.

Various social influencers – like DJ Khaled (6 million followers on Instagram) – peddled digital assets during the ICO mania and have faced regulatory fines; Youtube similarly was filled with investment advice content from enthusiasts. We were wrong about the pace at which traditional businesses will do this in the short term, but are still convinced this is a longer term change that will happen with the generational shift in both sales and regulatory roles. People are spending 12 hours a day on media, increasingly on LinkedIn, Youtube, and Twitter, and marketers are well aware. And if you have a LinkedIn account, so are you. 

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Source: 2018 Keystone Predictions Deck, Twitter visualization of the XRP network by Geoff Goldberg, B2B Media Channels from State of Digital Marketing by Demand Wave

2018 FINTECH PREDICTION IN REVIEW: Augmented Commerce

Here's what we said would matter in the past year year:

Let’s go out on a limb, with that limb being a 3D rendered object in virtual reality. We think there’s a storm brewing in digital goods spilling out into our real world (think Crypto Kitties), and physical goods becoming virtual (think Ikea). Machine vision combined with Whole Foods, Amazon’s augmented reality app, and the iPhone X signals to us that a new type of commerce is emerging. Symptoms like the dominance of eSports and the popularity of sponsored SnapChat filters will only increase, and lead to new purchasing and payments experiences. Financial companies will miss this completely.

How did we do? Not so great with the timing of the theme. While we continue to think that augmented reality, machine vision and edge computing will be combined by Amazon, Alibaba and other retail tech giants into digital shopping experiences in a physical space, this certainly has not happened yet. Tests for a cashier-less shopping experience are happening, as is the gradual but certain adoption of mixed reality on iPhones and Android devices, but we have not seen a consumer tipping point. The $125 million funding of Trax by Warburg Pincus is a start.

If anything, mixed reality seems to be headed more towards large, enterprise use-cases like city planning, construction, low skilled worker on-site instruction for utilities or manufacturers, and the military. However among young consumers, the behavior of buying digital goods in video games, and the associated monetization of content from video games using channels like eSports continues to be a powerful secular trend. Billion of revenue are generated by free games that only sell cosmetic in-game objects. See as proof points the fast growth of Twitch users and the $1B+ in revenue Fortnite made from microtransactions. In addition to being trained to value imaginary objects, they are also being trained to use virtual currency issued by brands.

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Source: 2018 Keystone Predictions Deck, Trax via Bloomberg, Twitch data via SuperData/Nielsen

2018 FINTECH PREDICTION IN REVIEW: Crypto Eighteen

Here's what we said would matter in the past year year:

If you thought 2017 was loud about crypto, just wait till 2018. Up or down, that doesn’t matter — what will certainly be in play is massive volatility as the crypto economy beats on against traditional finance, regulators and sovereign power. The largest mountains to climb are the development of institutional crypto custody and a vanilla ETF product to absorb the splurging demand, and we think this will happen. In terms of creative destruction, we expect one of the top ten 2017 currencies to collapse 80%, one of the enterprise blockchain consortia to fall apart. New technical solutions like the Tangle or Hashgraph to challenge our assumption that Bitcoin is the endgame.

How did we do? Pretty well overall. We predicted massive volatility and we got it. The massive market capitalizations of 2017, rounding up to $1 trillion, have deflated down to $100 billion and change. Many assets melted 80%+, but we will call out Bitcoin Cash specifically, which fell from $40 billion to less than $3 billion after yet another rough fork at the end of the year. On the other extreme, EOS raised $4 billion in ICO funds. New smart contract platforms indeed came to market – from EOS to Hashgraph to Dfinity – but Bitcoin dominance has stayed fairly flat at 40-60%. 

The negotiation against incumbent sovereigns and traditional banking moves forward; regulators across the world have placed many 2017 digital assets in a regulated “securities” bucket, with enforcement actions starting to target individuals and exchanges. At the same time, institutions like Fidelity have launched crypto custody divisions, the NYSE is launching crypto exchange Bakkt, and the number of enterprise players in the space has grown like weeds. While no ETF was launched due to SEC concerns around market maturity, an Exchange Traded Product did launch in Switzerland using VanEck index data.

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Source: 2018 Keystone Predictions Deck, Coinmarketcap (total capitalization, % BTC dominance), Fidelity, Amun ETP, Bakkt via ICE/NYSE

ONLINE BANK: Killing the Banks softly with Robinhood and Good Money

But wait, there's more! Certainly all top-3 neobank champions by geography are hungrily eyeing international expansion . The US is looking delicious for Revolut and N26, Europe is interesting for Ping An as it invests over EUR 40MM into fintech venture studio Finleap, Fidelity wants to open a roboadvisor in the UK, and so on. Technology does not have borders. This is why we are particularly interested in Good Money, funded to the tune of $30 million by Galaxy EOS VC fund (remember EOS raised $4 billion). Good Money is a "banking platform" whose equity will be owned by users when they take certain actions, like opening an account, installing the app, or referring friends.

If that sounds like tokenized equity intermingled with Binance referral codes, you're right! One thing we've learned from the ICO mania, other than that some people are sharp-elbowed opportunists who will go to jail, is that human beings like being in communities, and that communities grow way faster and cheaper than "customers". By combining crowdfunding with account actions, this play has a chance to build viral loops, and pioneer a model where a corporate structure (equity) and utopian philosophy (communal ownership of money) have mutually-reinforcing benefits. The blockchain software progress of the last two years makes this possible. Whether it will work or not is another fun story. 

Last, but not least, is Robinhood and their announcment of banking service to their 6 million mobile-first customers. The products is called "Checking & Savings", will deliver a 3% interest rate (vs. Goldman Marcus at 1.85%) and rebated ATM access with a debit card. It is not a bank account and therefore not subject to FDIC insurance. In fact, the whole thing is old hat -- Schwab does this well now (albeit with lower rates on its money market funds), and every HNW wealth management shop ran such an offering for the last 20 years. But you know, Robinhood actually knows how to sell and position a product for its audience, and are willing to burn venture money to deliver a 3% return. Steve Jobs made a killing announcing previously existing products as inventions of Apple -- and he won, because Apple's re-inventions were better suited for the times. Who will you bet on? 

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Source: Cointelegraph (Good Money), TechEU (Finleap), Newswire (Good Money), Bloomberg (Robinhood)

ONLINE BANK: Killing the Banks Softly with Plaid, Cross River, and Open Banking

A great set of symptoms this week for the theme of banking-as-a-service / open banking. To recap, due to regulations like PSD2 or plain old web-forced transparency, banking information and products are getting popped out from behind the curtain and made to compete within the foreign land of tech platforms (i.e., App stores and e-commerce). This means prices falls and economic rents go to fewer winners that have strong APIs, integrations, and a nimble balance sheet. The long tail of banks evaporates into commodity providers as their regulatory and distribution moat falls away. Maybe true, maybe just a fun story!

Symptom number one is the $100 million raise of Cross River Bank, of which 75% came from private equity firm KKR. Cross River provides the balance sheet to Affirm, Coinbase, and TransferWise. Those companies in turn are building credit-as-a-service into points of sale (think Stripe), custody and banking for digital assets (dozens of millions of users), and the destruction of international money transfer margins. Finance is correctly integrated as a product/feature within a much more meaningful and long customer journey. This means customer ownership leaves the product manufacturer and goes to the point of actual economic activity.

Symptom number two is the $250 million fundraising into Plaid, a data aggregation company, backed by Mary Meeker as her coup de grace from Kleiner Perkins. Remember Europeans, there is no PSD2 in the US, so we have to screen scrape the information out of the protesting bank hands. In the early 2000s, a number of data aggregators were built, the winners of which were Yodlee (bought for $500mm-ish by Envestnet), ByAllAccounts (bought by Morningstar), Finicity and a few others. Plaid's venture valuation of $2B+ boggles the mind, but the answer is in the product. It powers authentication and banking detail provision -- not "personal financial management" only -- for the hungry host of Silicon Valley. Any tech startup that wants your bank account and routing number goes to Plaid, not to Yodlee. Thus is built a major open financial data infrastructure for tech companies in the US. And in Europe, open banking is progressing bit by bit, with the largest incumbents opening the door to barbarians. It's a fun story.

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Source: Payments Source (Cross River), Open Works (APIs), CNBC (Plaid), Fortune (Plaid) 

PAYMENTS: Can Facebook be trusted to provide Whatsapp Payments to 200 million users in India?

Facebook's hair is on fire again. A set of company emails from around 2015 have been acquired by a UK parliamentary committee, despite being sealed by a court in the United States. The emails were on a private computer of a person of interest (Ted Kramer, CEO of Six4Three) who was traveling in the UK. The sovereign issues are interesting in themselves, as global technology companies stretch across jurisdictions to be subject to the laws of each one of them. Case in point is the US arrest of the Huawei (massive Chinese phone manufacturer) CFO in Canada as part of a feud on intellectual property and selling goods to economically sanctioned countries like Iran. So, if you're running a tech company with global impact, maybe just telecommute lest you be snatched by a regulator.

What we learned from the emails is that Facebook acts like a monopoly, using its control over APIs and data to (1) starve or (2) reward players that help cement its position at the center of the attention economy. It is ruthless in its taking and leveraging of customer data, it does so with minimal warning, and it is largely unconcerned about the social consequences unless they have negative PR implications. What else is new ? It's a successful capitalist organism following its incentive structure. But from this vantage point, let's take a look at Whatsapp in India.

Whatsapp has 200 million users in India, and like several other tech companies, wants to power payments to this population. It has formally written to the Reserve Bank of India to get permission. Why do we think India is a better target for tech company wallets than the West? A few reasons. The first is the large percentage of the population that is unbanked, and therefore not served by a financial incumbent, but served by a chat app. The second is the cost of customer acquisition is far lower when a user is already captured, vs. when you have to convert them cold. And third, consumer preferences have not been set with "good enough" services as in the West, and China's example shows the way. A takeaway concern we have is around Aadhaar, India's digital government identity. If Facebook can't be trusted with data we permission it to store, can it be trusted to ingest the equivalent of Social Security numbers?

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Source: Guardian (Huawei arrest); Slate (on Facebook emails), CNN (Facebook), Telegraph India (Whatsapp)