Farewell to a Frenzied Fintech Year
Farewell to a Frenzied Fintech Year
Some years in business are more strikingly notable than others, often for the hard times that companies contribute to, or the serious conditions they must work around—a financial crisis, deep recession, pandemic, strong inflationary forces, high interest rates or war—and not for the innovation and progress that occurred. Yet 2023 will be remembered for its highs and lows without businesses having to deal with many of the aforementioned negative triggers. True, the United States is dealing with inflation and the Federal Reserve’s rate hikes to counter it, but by October headline inflation was cooling—good news—and the Fed is expected to begin cutting rates next year, but let’s not get ahead of ourselves.
In fintech, the year saw spectacular downfalls of once-iconic leaders (think FTX founder and now-convicted felon Sam Bankman-Fried and Binance’s ex-CEO Changpeng Zhao); a social media-driven bank run that toppled three banks in short order (Silicon Valley Bank, followed by Signature Bank and First Republic); the surge of artificial intelligence, invariably prompting fierce debate about its prospects and perils (e.g., could lenders be making decisions that are unintentionally biased, or is insurtechs’ ability to more accurately predict losses from climate risks going to accelerate climate migration?); the growing appeal of Buy Now, Pay Later services; and faltering efforts by the U.S. Securities and Exchange Commission to rein in the cryptocurrency industry—on track to finish 2023 with a bang—from what it deems to be no-holds-barred behavior (Just ask Coinbase CEO Brian Armstrong, who isn’t afraid to take on any regulatory battle while steering the crypto exchange to strong gains).
What follows are some of FIN’s favorite pieces that captured the players, pace and remarkable, if not at-times chaotic innovation that dominated the fintech industry, and how things stand heading into the new year. —Holly Sraeel and James Ledbetter
Coinbase: Thriving In Crisis Mode
In March, Coinbase announced that it had received a “Wells notice” from the Securities and Exchange Commission (SEC), a warning shot indicating that the SEC had reached a “preliminary determination” to file a regulatory action against Coinbase. At issue is the cloud that’s been hanging over the U.S. crypto industry for years–namely, that the SEC considers many or most of the currencies that trade on exchanges like Coinbase to be unregistered securities.
Coinbase declared the investigation unfair. The company’s chief legal officer wrote in a blog post: “Coinbase provided multiple proposals to the SEC about registration over the course of months, all of which the SEC ultimately refused to respond to.”
The disclosure of the Wells notice caused Coinbase’s stock to tumble. “Perhaps some sad Coinbase investors were surprised by these events, but no one paying attention should have been,” FIN wrote at the time, noting that the SEC had a month earlier gone after the Kraken exchange on similar grounds.
Where Things Stand: In June, the SEC filed sweeping charges against Coinbase, implying that the company has been violating securities law for decades. Coinbase is fighting back vigorously, and was no doubt emboldened by the SEC losing a crypto case in July. Coinbase petitioned the SEC to make new crypto rules, and when the agency refused in December, the company said it would appeal. In the meantime, Coinbase stock is up about 420% since January 1. –James Ledbetter
Buy Now, Pay Later Branches Out
Buy Now, Pay Later (BNPL) has been one of the fastest-growing consumer trends of the 21st century. Within the industry, people point to a study showing that the BNPL market will grow to $3.68 trillion by 2030, from $132 billion in 2021. Even if it’s half that, it’s still a fintech rocket.
And yet at the beginning of 2023, many companies that made their names specializing in BNPL did not seem all that healthy financially (see second post). “In the U.S., Affirm; in Europe, Klarna; and in Australia, Afterpay—which was purchased by Square/Block in 2021 for an astounding $30 billion—have struggled to make a profit.” Part of the problem is that short-term loans are a challenging business, and rapidly rising interest rates make capital more expensive for the providers. The regulatory environment is also in flux, and for much of 2022 investors punished companies like Affirm.
Where Things Stand: Affirm’s stock had an outstanding year, partly because the company has reduced its unit economics and branched out into other areas, notably credit cards. Klarna announced its first profitable quarter in years. Advocates and regulators will continue to warn about the potential for consumer harm, but BNPL is here to stay. –James Ledbetter
AI: Double-Edged Sword for Lenders
Artificial intelligence (AI) was arguably the hottest business topic of 2023. “There are effectively no U.S. federal regulations that pertain specifically to artificial intelligence,” FIN wrote in September. “Despite some recent AI guidelines from the Biden Administration, it’s not clear that a legally binding definition of AI even exists.”
Currently, federal regulators must rely on broader statutes written before AI became widely available. In finance, one of the most fraught areas where AI can make a difference is in denial or approval of credit and loans. For decades, federal laws have made it clear that credit and loan decisions cannot be made, say, in a way that is racially discriminatory. Yet the ability of AI to crunch reams of data “makes it possible to whitewash redlining—that is, to use other variables that don’t incorporate race but nonetheless reproduce it as a lending criterion in other ways, such as ZIP code,” FIN noted.
The Consumer Financial Protection Board (CFPB) issued a report in September clearly spelling out that American consumers are entitled to accurate and specific reasons why they’ve been denied credit or a loan.
Where Things Stand: The debate over AI’s role in banking will only intensify in 2024 and beyond. In December, Mastercard issued a Webinar on the topic. Banks bear the responsibility of maintaining trust and ensuring compliance,” it concluded. “It’s a delicate balance–cultivating AI innovation with one hand while protecting against potential misuse and unintended consequences with the other.” –James Ledbetter
Climate Change Is Worsening. Insurtechs Can Now Put A Price On That.
Climate change is worsening, the global consequences of which are rapidly unfolding in once-unthinkable ways, with no end in sight. By July—the single hottest month on record—it was clear that extreme climate change, coupled with El Niño conditions, would continue to smash records and wreak havoc in 2023, prompting climate scientist Brenda Ekwurzel to declare protection from the unprecedented record heat a “human right.”
In America, homeowners now confront the sobering reality of the catastrophic effects of the climate crisis: Climate migration is a distinct possibility as a growing number of people in some states have limited or no access to affordable property & casualty (P&C) insurance. Residential real estate in high-risk states and emerging climate hotspots—California, the Pacific Northwest, parts of Minnesota, Wisconsin, Michigan, and East and Gulf Coast states—is being ravaged by more frequent and intense wildfires, flooding, hail and convective storms. Between 2022 and 2023, climate and weather disasters in the United States have caused $259.8 billion in damages.
The mounting losses are unsustainable. State Farm, Allstate, AIG, Nationwide and Farmers, among others, stopped underwriting new P&C insurance policies in California and Florida. If huge climate losses continue to pile up in other states, insurers might pull out of those areas, too. Artificial intelligence (AI)- and machine learning (ML)-driven analytics from Cape Analytics, ZestyAI and Kettle can help change this pattern by enabling insurance companies to more accurately model and predict the likelihood of climate risk-related losses and transparently price them into new and existing P&C policies.
Since insurers can gather climate risk intelligence, in some cases down to the property level, another likely outcome from increased usage of the insurtechs’ AI- and ML-based modeling is that it could price some U.S. homeowners out of certain markets, accelerating climate migration. This might not be a bad thing: While migration is a costly adaptation strategy, and not all people can afford to relocate, if AI modeling increases the precision of risk calculations and pricing for policyholders, “this improved information could help people make their own best decisions about migration by accurately weighing the costs and benefits of moving,” noted Tamma Carleton, assistant professor of economics at the University of California, Santa Barbara. She also pointed out that “distorting the insurance market by not allowing the insurance premiums to reflect true risk would lead to too many people located in high-risk areas, imposing private- and public-sector costs for recovery when disaster strikes.”
Where Things Stand: The final agreement at the 2023 United Nations’ Climate Change Conference (COP28), held in Dubai earlier this month, fails to explicitly call for fossil fuels to be phased out. As it stands, 2023 is already the hottest year on record, worsening the impacts of severe climate change globally. “Socially vulnerable” populations are disproportionately affected by climate change, facing greater employment and financial hardship, more health issues and death from air quality and heat, inadequate protective adaptation measures, and property damage and loss. Climate migration in the U.S. is being reshaped by more than drought and wildfire risks; new research found that between 2000 and 2020 over 3.2 million Americans left high flood-risk areas across the country, and projects that flood-related migration numbers will climb faster. Homebuyers should expect more mortgage lenders, working with climate risk modeling firms, to assess and incorporate climate risks into property values and mortgage underwriting. Climate change will also have a profound negative impact on property taxes in at-risk and emerging hotspot states. CAPE, ZestyAI and Kettle could face new competition, as a growing number of insurance companies turn to insurtechs with AI-based climate risk modeling and prediction analytics. The bottom line: The costs of buying and insuring a home will steepen significantly in some states as insurtechs and AI advance the ability of insurers and lenders to put a price on climate risks. What’s next: Predicting the impact on housing prices, property taxes, infrastructure, public services and employment in states where in-migration is going to surge because of climate change, as well as how to assist those left behind in abandoned areas because of out-migration.—Holly Sraeel
SVB’s Bubble Burst. That It Shocked Everyone Should Surprise No One. And Yet.
In retrospect, Silicon Valley Bank (SVB) was asking for trouble. Its business was overly concentrated in the high-risk tech sector, with Silicon Valley venture capitalists, startup executives and companies pouring money into the bank. (Its deposits tripled in the couple of years before 2021.) For much of the prior year before the bank collapsed in March 2023, it operated without a chief risk officer. As interest rates rose and venture capital began drying up, what began as a handful of cash-strapped customers making withdrawals became—thanks to God-knows-how-many tweets from venture capitalists and internal Slack conversations—a full-on bank run, with customers withdrawing $42 billion in a single day (so much for the presumed financial genius of Silicon Valley). Within two days, SVB, once ranked the 16th largest U.S. bank with $209 billion in assets, was shut down by regulators, becoming the third-largest bank failure in the country’s history. This left thousands of customers unsure of whether they would get some or all their deposits back, and tied up money that companies needed to make payroll and pay bills.
Worse still, SVB’s failure also picked the pockets of all sorts of people who didn’t even know they had any connection to the bank. Nima Olumi, an economist who runs the Boston-based marketing firm Lightyear Strategies, was among those unknowingly tethered to SVB, thanks to his relationship with Rippling, which provides his company with HR and payroll services. Olumi’s SVB tale goes like this: On Friday morning, he received a disturbing text message, labeled URGENT, that read: “You need to inform your bank immediately about an important change to the way Rippling debits your account. If you do not make this update, your payments, including payroll, will fail.” The message went on to note that Rippling “has historically relied upon Silicon Valley Bank (SVB) as our banking partner for processing payments,” and that “out of an abundance of caution,” Rippling was moving parts of its payment infrastructure to JPMorgan Chase. (It’s worth noting that Ripple investors include Kleiner Perkins, Sequoia Capital, and Y Combinator, among others—all intimately tied to SVB.) Olumi was gobsmacked, telling FIN: “I didn’t even know I was banking with SVB. TD is my bank.” Olumi may be a bit player in this drama, but there’s many more like him out there, all unwittingly dragged into SVB’s orbit.
In the end, SVB’s management team was so incestuously tied to Silicon Valley’s biggest players that it’s clear many never bothered to examine the bank’s books. Had they done so periodically, they would have likely noticed that the bank’s financial condition was deteriorating. By the time the bank announced its intention to take balance sheet actions that included a capital raise of $1.75 billion of common equity in addition to mandatorily convertible preferred stock, among other things, panic set in.
Where Things Stand: On March 12, regulators closed Signature Bank, which lost 20% of its total deposits in a few hours on the same day that SVB failed (it was snapped up by Flagstar Bank, a subsidiary of New York Community Bancorp later that month). In late March, First Citizens Bank bought the deposits and loans of SVB, including roughly $72 billion of assets at a discount of $16.5 billion, from the Federal Deposit Insurance Corporation (FDIC); SVB now operates as a division of First Citizens and serves the same profile of investor and startup clients. Since the SVB deal, First Citizens’ share price has skyrocketed, up 79% for the year. In the wake of SVB’s collapse, all depositors were made whole, even those whose deposits were greater than the $250,000 limit insured by the FDIC; the estimated cost of the SVB failure to the Deposit Insurance Fund is about $20 billion, $18 billion of which was to cover uninsured deposits. Gregory Becker, who was fired as SVB’s CEO after the bank collapsed, faced blistering criticism in a Senate Banking Committee hearing in May, including this observation from Senator John Kennedy, Republican of Louisiana: “It was bone-deep, down-to-the-marrow stupidity.” As for things in the venture capital world, 2024 is going to start just as this year is ending: with a lot of belt-tightening. —Holly Sraeel
SBF Dominated Crypto Until He Got Busted. His Trial Was An Even Bigger Story.
This year’s poster child for bad behavior—hands down—is Sam Bankman-Fried, the now-convicted felon who founded the crypto exchange FTX. Everyone fell for SBF’s geeky founder allure: the boyish charm, tousled hair, shitty T-shirts and baggy shorts, riveting innovation, and excessive generosity in the name of altruism (and politics, for that matter).
It was all nonsense. After CoinDesk broke the story that FTX and Alameda Research were illegally using customers’ accounts to trade, the King of Crypto’s $32 billion empire came crashing down in spectacular fashion. Prosecutors wasted no time indicting the former CEO, who was accustomed to sucking up most of the media oxygen, albeit for entirely different reasons than standing trial on multiple charges of fraud, conspiracy and money laundering.
His odds of not seeing prison time? Slim to none, as prosecutors moved aggressively and persuasively in the early days of the trial. The mountain of evidence and testimony from some of SBF’s top lieutenants was damning, and as Michael Lewis, author of Going Infinite, noted in his book about SBF, “less than one-half of one percent of those charged with federal crimes in 2022 were acquitted.” And if prosecutors can prove financial harm, those prison odds increase. Prosecutors got an assist on that front from Paradigm managing partner Matt Huang, who testified that the $278 million his investment firm put into FTX has been marked to zero. Asked if Paradigm would have invested in FTX if it knew that FTX was using its customers’ deposits to trade through sister company Alameda Research, Huang said “likely not.”
Testimony from FTX developer Adam Yedidia, who was also SBF’s roommate at MIT, only compounded SBF’s legal predicament. Yedidia testified that he confronted his boss about a large discrepancy in Alameda’s accounts. SBF nervously responded: “We were bulletproof last year, but we’re not bulletproof this year.” When he asked when the company would be bulletproof again, SBF said between six months and three years. Yedidia said he left the company after learning that Alameda was trading with FTX customers’ accounts, telling the court: “I was concerned that as a developer at FTX, I may have unwittingly written code that contributed to the commission of a crime.”
But it was FTX cofounder Gary Wang that helped prosecutors early in their efforts to indict and prosecute SBF. Wang agreed to cooperate with prosecutors in his first meeting with them, six days after FTX declared bankruptcy. (He and Caroline Ellison, SBF’s onetime girlfriend and CEO of Alameda, pled guilty to wire, securities and commodities fraud and took plea agreements.) “I thought I was likely to be charged, and I wanted to get a shorter prison sentence,” Wang told the court. During his explosive testimony, Wang testified that FTX’s biggest sin began at its origin, with him writing FTX’s computer code granting Alameda special privileges, at SBF’s direction, starting in 2019, according to The New York Times summary of Wang’s testimony. That effectively allowed the trading platform to make unlimited withdrawals from the exchange, Wang said, none of which was disclosed to customers, investors or lenders to the firms.
As FIN pointed out during the trial, a conviction of SBF would “likely help the crypto industry purge itself of a pariah.”
Where Things Stand: On November 2, 2023, exactly one year to the day after CoinDesk broke the FTX story, Sam Bankman-Fried, 31, was found guilty on seven counts, including wire fraud, wire fraud conspiracy and other conspiracy charges. He is scheduled to be sentenced on March 28, 2024, and faces a maximum sentence of 110 years. (SBF will be spared a second trial for charges including conspiracy to make unlawful campaign contributions, conspiracy to bribe foreign officials and two other conspiracy counts.) Caroline Ellison, Gary Wang and Nishad Singh, also a former FTX employee who pled guilty, could still see prison time, even though they testified against SBF. There are roughly $15 billion in customer claims against FTX; some estimates suggest that they will recover 80%-90% of their money. The only real winner in this mess? Bloomberg investigative reporter and author Zeke Faux, whose recent book, Number Go Up, was repeatedly referenced during the trial, undoubtedly driving up sales. —Holly Sraeel
FIN wishes you a Happy New Year and asks that you forward this newsletter to anyone you think might appreciate it. Stay tuned for the fast forward on fintech from us in 2024.