#239—What the future of fintech looks like

Also, regulators find their moment

Jan 23, 2023

Welcome to Yaka Stuff, our weekly newsletter that covers news, industry perspectives, and updates from the Hard Yaka ecosystem. Check out last week’s report here.

This week:

What the future of fintech looks like
The regulators have arrived
Greg’s greatest investment regret featured in the WSJ
This week in contagion
This week in stablecoins
Stuff happens

1. What the future of fintech looks like

Coatue published a great deck last November outlining how fintech will play out over the next decade (via Jun). This is fintech’s time:

Over the last decade, $5 trillion of market value has been created in financial services.¹ The sector’s gross profit pool has swelled to an amount larger than any other major group – larger than software, e-commerce, semis, and even healthcare. Since financial services are ingrained into nearly every aspect of our life and work, it is a natural target for disruption and innovation. Fintech has just experienced its very first venture-fueled innovation cycle with the percent of venture dollars rising from <5% of dollars deployed in 2011 to ~22% in 2021.² Hundreds of billions of dollars invested in the space has fueled a new wave of technology evolution around the world from omni-channel payment providers to B2B payments and fully re-bundled digital banks.

One point of note—"FinTechs should not be afraid to own balance sheets in order to control their destiny":

Balance sheet businesses in fintech have traditionally been viewed in a negative light. The market had valued fintechs at 40x - 60x forward gross profit, and that made sense at the time.⁶ However, in a rising interest rate environment, legacy banks, insurance providers, and asset managers have the potential to weather down cycles better than capital light business models, e.g., insurtech and consumer-facing fintech. The increase in the federal funds rate to above 2% has forced the current cohort of fintech operators and investors to grasp new business model concepts and metrics such as Net Interest Margin.
Throughout this cycle, we have witnessed a variety of deals with partner banks that have led to compressed gross margins due to high funding costs and/or acquisitions. While we do not believe this will disappear at the very earliest stages of company building in fintech, we do believe businesses can and should embrace a balance sheet sooner than later.

Also, "FinTechs acting as their own issuer and processor see significantly improved unit economics resulting in a lower beta and a book value valuation methodology":

Relevant:

2. The regulators have arrived

First up is the SEC, who last week went after Gemini and Genesis. Here’s Politico:

The Securities and Exchange Commission’s move last week to charge two digital asset giants — Gemini Trust and Genesis Global Capital — with selling unregistered products to individual investors was a stark warning to crypto exchanges, lenders and other platforms that they need to follow U.S. securities laws.
“It’s about compliance,” Gensler, who chairs the SEC, said in an interview days earlier, while discussing the agency’s broad crypto enforcement strategy. “There’s so much non-compliance in this field. It’s part of the business model.”

They also reached a settlement with Nexo. Here’s Axios:

Crypto lender Nexo has entered into a consent agreement with the U.S. Securities and Exchange Commission (SEC) to pay a $45 million fine for offering an unregistered security in the U.S., in its "Earn Interest Product."
Why it matters: It's the latest in a string of actions by the agency that indicates any program where users deposit assets to earn interest in exchange for letting others borrow them must be registered as a security.
What they're saying: “We are not concerned with the labels put on offerings, but on their economic realities. And part of that reality is that crypto assets are not exempt from the federal securities laws,” Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, said in a press release.

Here’s how Nexo framed it:

It is Nexo’s belief that the company has been recognized for what it truly is - a pioneer, like Uber and Airbnb, providing disruptive solutions in a fast-paced environment. As innovators do not quite fit into existing provisions, constructive dialogue for the enhancement of the prevailing regulatory frameworks is of paramount importance.

Not to be left out, CFTC chief Caroline Pham weighed in on the need for global standards:

In an interview with Bloomberg, Pham mentioned that discussions with global players over crypto regulations are ongoing. The government official said many foreign discussions are currently happening about global industry standards for crypto regulation.
According to Pham, she has had more than 75 meetings with various parties to discuss topics concerning crypto regulation. The CFTC commissioner highlighted that “very advanced discussions” were happening outside of the United States about what kind of standards could be applied globally.

She added:

“What I’d like to do is to see the CFTC and other regulators provide more guidance this year and I’m very hopeful that perhaps we will see more clarity in the United States.”

Over in New York, the NYDFS is taking notes from the FTX debacle. Here’s Reuters:

New York’s chief financial regulator is set to release new guidance on Monday dictating that companies separate customers' crypto assets from their own, after alleged co-mingling of funds at collapsed crypto exchange FTX and its affiliated trading firm Alameda Research led to hefty losses for clients.
The New York State Department of Financial Services (NYDFS), which leads one of the few state agencies with a regulatory system in place for cryptocurrency companies, will also stipulate that state-regulated companies disclose to customers how they account for clients' digital currency.

Also taking notes from the FTX debacle, U.S. enforcement agencies are going after offshore exchanges. Here’s WashPo (via Vadim):

U.S. law enforcement officials have arrested the Russian owner of a cryptocurrency exchange for allegedly failing to implement required anti-money-laundering safeguards, enabling criminals who used the platform to traffic drugs and steal people’s money and identities, the Justice Department said.
Anatoly Legkodymov — the 40-year-old majority owner of Bitzlato — was arrested in Miami on Tuesday evening and has been charged with conducting an unlicensed money-transmitting business. Legkodymov, who lives in China, was indicted Wednesday afternoon in a Florida federal courthouse. His company allegedly processed more than $700 million of illicit funds from 2018 to 2022.

There’s also the Binance connection. Here’s Coindesk:

Binance, the world's largest crypto exchange, was named as a counterparty in an order against the little-known cryptocurrency exchange Bitzlato, accused of laundering $700 million by U.S. authorities on Wednesday.
Binance, the world's largest crypto exchange by trading volume, was named as one of the receiving and sending counterparties associated with Bitzlato, according to the order from the Treasury Department's Financial Crimes Enforcement Network (FinCEN).
"Approximately two-thirds of Bitzlato’s top receiving and sending counterparties are associated with darknet markets or scams. For example, Bitzlato’s top three receiving counterparties, by total amount of BTC received between May 2018 and September 2022, were: (1) Binance, a VASP [virtual asset service provider]; (2) the Russia-connected darknet market Hydra; and (3) the alleged Russia-based Ponzi scheme “TheFiniko,” the order said.

Relevant:

3. Greg’s greatest investment regret featured in the WSJ

WSJ:

Greg Kidd, a co-founder of early-stage venture firm Hard Yaka, got in on the first round of Robinhood through another fund. But he is still smarting over passing up on the seed round for Revolut, which got a $33 billion valuation in its most recent funding round in 2021.
“I don’t know why I was so concerned about the company making money from Day 1,” said Mr. Kidd. “It was a hit and I blew it. I tried to cover up my mistake by buying in at a later round at a much higher valuation.”

4. This week in contagion

Yaka Stuff

#239—What the future of fintech looks like

Also, regulators find their moment

1. What the future of fintech looks like

2. The regulators have arrived

3. Greg’s greatest investment regret featured in the WSJ

5. This week in stablecoins

6. Stuff happens

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