Robinhood, Binance, and the Culture of Contempt

Plus, an in-depth conversation with BTIG's Mark Palmer.

Number of the Week: $6-7 billion (explanation below)

Robinhood, Binance, and the Culture of Contempt

It was inevitable that the damning Financial Industry Regulatory Authority (FINRA) action and $70 million fine against Robinhood would be eclipsed within 24 hours by the company’s S-1 filing to go public. It’s also unfortunate, because the depth and repetition of Robinhood’s malfeasance documented in the FINRA letter can scarcely be exaggerated.

Ever since the GameStop Götterdämerung, the public has arguably become accustomed to the fact that Robinhood gives false and misleading information to its customers. But the degree of the company’s lies and missteps is staggering: for years, according to FINRA, even basic market information such as stock splits and dividends were misrepresented on Robinhood’s platform, meaning that on a daily basis, Robinhood gave millions of customers inaccurate assessments of their account balances. It gets worse; FINRA charged Robinhood with:

• No oversight on who is allowed to trade options. FINRA notes that a teenager can open a Robinhood account, claim 3 years of investing experience, and be allowed to make the riskiest options investments—even if, moments before, the same teenager had said she had no investing experience.

• Lax maintenance of critical technology. The infamous Robinhood outage earlier this year was hardly the first. Indeed, Robinhood executives identified a December 2018 outage as a “watershed incident.” Even so, and despite warnings that it was not in compliance with FINRA rules, Robinhood failed to supervise the maintenance of its Web site and app.

• Lack of a viable backup plan. According to FINRA, Robinhood’s “business continuity plan” in case its system went down was to take customer orders by phone. The problem with this plan is that there was no phone number for customers to call.

• Failure to report customer complaints. No one who’s ever dealt with Robinhood’s Sisyphean customer service will be surprised to learn that between January 2018 and December 2020, the company neglected to report to FINRA tens of thousands of customer complaints.

• Shoddy customer identification. Fake Social Security number? No problem: “Robinhood approved more than 90,000 accounts from June 2016 to November 2018 that had been flagged for potential fraud without further manual review.”

Robinhood’s transgressions make a mockery of the idea that companies always act in their own self-interest; almost all of these actions pose an existential risk. Moreover, you’d have to expel all logic and common sense to think that a company this dysfunctional can quickly change its behavior and culture in response to even record-setting fines and the coming scrutiny of the public market. It’s not as if the people running Robinhood don’t know the rules; one thing we learned from the Robinhood S-1 filing is that the company’s highest compensated employee is chief legal officer Daniel Gallagher, a former Obama-appointed commissioner on the Securities and Exchange Commission. One can only conclude that Robinhood doesn’t care about rules and laws, or else has built a culture so reckless that it can’t follow them.

As for Binance, it has not been formally fined or accused of wrongdoing on a scale anywhere near Robinhood’s. Still, the world’s largest cryptocurrency exchange’s encounters with global regulators this year have been breathtaking—and it’s hard to see how Binance is going to be able to stay in business without significant downscaling. On June 26, Britain’s Financial Control Authority issued a statement saying “Binance Markets Limited is not permitted to undertake any regulated activity in the UK.” While Britons are not strictly prohibited from buying and selling cryptocurrencies via Binance, they can’t put in or take out their investments in pounds sterling, which makes it hard for Binance to do business in one of the world’s largest crypto markets. Six days later, Thailand’s main financial watchdog filed a criminal complaint asserting that Binance was operating a digital asset business without a license. The Thai commission says that it had warned Binance about this in April but received no response; this could end up with a jail sentence. One begins to see a pattern:

• Also in late June, Japan’s market regulator said that Binance was illegally operating in the country.

• Binance stopped doing business in Canada’s largest province (Ontario), after its financial regulators cracked down on Bybit and other crypto trading rivals.

• In March, Bloomberg reported that the Commodity Futures Trading Commission was investigating whether US citizens had illegally bought and sold derivatives over the exchange.

• In May, Bloomberg reported that the US Justice Department and Internal Revenue Service were investigating alleged money laundering via Binance.

• In late April, Germany’s regulator BaFin issued a statement saying that Binance’s recently launched “shares tokens”—essentially a coin derivative pegged to a stock like Tesla or Apple—violated European rules that require a public prospectus for any security being sold.

• Surely unrelated to all of this activity is the sudden departure, revealed in early June, of Binance’s chief financial officer.

It’s worth underscoring here: These are not fringe players caught cutting corners—these are the global market leaders in their respective spaces, and rule violations appear to be at the very heart of their business. FIN is the first to agree that in many areas around fintech and cryptocurrency, laws and regulations can be vague, out of date, or worse. But a fintech movement that wraps itself in the “democratization of finance” ought to understand that with democracy comes responsibility: to customers, to stakeholders, and to society. To date, both companies have treated their responsibilities with contempt.

(Photo by Executium on Unsplash)

An Exclusive Interview with BTIG’s Mark Palmer

BTIG’s Mark Palmer

Given the meteoric rise of fintech stocks in recent years, it’s striking that there isn’t a household-name stock analyst who dominates the space, the way that Mary Meeker or Henry Blodget did in the late ‘90s dot-com boom. This is probably a good thing, but at the same time, as more fintech companies go public, the role of a reliable sherpa is more important than ever. FIN admires BTIG’s managing director and fintech analyst Mark Palmer, both because he is not afraid of taking bold stances, but also because he does not sugarcoat or bullshit the sector. Thus, we were thrilled to nail down an in-depth interview, in what is turning out to be a critical year in fintech.

FIN: The first half of the year is over. For the companies that you cover, what do you consider to be the most important events of the first two quarters? And what do you think has been driving performance?

Mark Palmer: The digital asset space has seen immense volatility during the first half of 2021. There was a great deal of enthusiasm, initially, driven by reports of institutions getting into the space, ranging from insurance companies to large mutual funds and hedge funds. That had not been the case historically with regard to crypto. I think that to a certain extent was self-reinforcing: you saw institutions get in and that caused the other institutions to become more interested and they would get in, and so forth. That was one of the things we saw during the earlier part of the year, leading up to the Coinbase IPO, which was really a watershed moment for the digital asset space.

Since then, volatility has only picked up; we've seen a weakness in crypto prices. More recently, a lot of the focus has been on China banning Bitcoin mining. It definitely caused a swinging sentiment that was felt throughout the entire ecosystem. From our perspective, the transition of 60% of the world's hashrate from China to elsewhere creates uncertainty and volatility. That said, one of the biggest overhangs of the crypto space for some time has been the concern that a majority of Bitcoin mining was in China and that the Chinese government at some point could crack down on—well, we have now seen that occur.

So in a way, the realization of that fear has removed it, and now it's just a question of where that 65% of the world’s Bitcoin mining base is going to ultimately end up. We're seeing it distributed to various places already, ranging from Texas to Iceland to elsewhere. What's important is that when Bitcoin mining was still in China there was very little the rest of the world could to influence the Chinese government as it pertained to the use more environmentally friendly energy sources to drive Bitcoin mining. Now that is moving to the rest of the world, there's more of an opportunity to increase the focus on environmentally friendly sources which, if successful, will help to address some of the concerns among ESG-focused investors.

FIN: It's interesting: You cover these big payments companies like PayPal and Square, but the response to my question went immediately to crypto! I wonder: a year and a half ago, two years ago, did you even think of yourself as being in the crypto space?

Palmer: We formally launched in the crypto space in the November timeframe. One of the catalysts was PayPal, in the third week of October, formally announcing its crypto initiative, in my view a game changer. If you look at any of the major crypto data providers, they will point to that time period in October and November of 2020 as the time when institutions began to get involved in crypto in earnest. The other aspect of it was really macroeconomic: the 2020 presidential election, which then caused the belief that we would see significant fiscal stimulus, not only in the US but abroad, which could lead to inflationary pressures. Bitcoin is viewed by many as being a hedge against inflation for value. As much as that drew attention specifically to Bitcoin, frankly, I think it brought attention to the entire crypto ecosystem.

In the first few months of the year, a lot of people expressed the opinion that fintech valuations were getting very frothy. We've seen a little bit of reversal of that in May and June, but I wonder what you think in general about the valuation of fintech companies—do you think they've been justified and where do you see them going?

I think that they have been justified because we have seen a sea change in the adoption of digital payments. Many of the fintech platforms that previously had been more niche focused really are seeing broad-based applications. And of course, you know, the primary catalyst for that was the COVID-19 pandemic. As an example, Square got a significant boost for Cash App during the pandemic. The pandemic put a spotlight on the fact that Square is providing through Cash App a bank account substitute for those who don't have such an account and in the United States, that's approximately 80 million people, right?

Cash App enabled those without a bank account to receive their stimulus payments, in a matter of days, rather than waiting for a check to come in the mail, which could take weeks. When we look at Square and the solution that it provides to the unbanked in the US, it's immediately apparent that that solution is applicable to the unbanked well beyond the borders of the US. Only about 11% of Square's revenues are generated internationally. We think that there's a big opportunity for Square to tap into the unbanked, in Europe and beyond, where you see well over a billion unbanked consumers. PayPal, for example, is already in many countries; we think that international represents a big opportunity for Square going forward.

On that note, it looks like the Facebook-led stablecoin that's currently called Diem will make its US debut sometime between now and the end of the year. I'm curious what kind of impact you think that will have in the payment space? The rollout initially with Diem is in the U S but I think down the road, they are looking at international use of the currency. I'm curious if you think that'll have any impact in companies like Square and PayPal and the related companies that you cover?

What is likely is that we are going to see a convergence between the digital asset space and fintech world that has been established. That's why, for example, the initiative announced by PayPal back in October of last year was so important. It demonstrated that one of the leaders in the space was taking a big step in that direction, but we anticipate that you are going to see many of the elements of the digital asset ecosystem and even decentralized finance, so-called DeFi, working their way into much of fintech. That convergence is just beginning, but we anticipate that it's going to accelerate.

So the concept of stablecoins we believe holds a lot of promise. Clearly, the Chinese have embraced this idea with their central bank digital currency. The fact that China banned Bitcoin mining was seen by some as indicative of their desire to focus on their central bank digital currency. There are reasons why it would be beneficial for the Chinese government to see a central bank digital currency do well—not least of which is that it can be used to more closely track the financial behavior of its citizens. Bitcoin could do the opposite. It could be used to fund all sorts of activities that the Chinese government may not be looking to promote.

As far as the United States and Europe, the jury's really out. We continue to hear rumblings about a central bank, digital currency, in the US and Europe. Um, and we'll see where that comes from. What is likely to occur is that the adoption of stablecoins is likely to be led first b the financial sector and as they become more popular, the various governments are going to have to pay attention and respond. We've already heard the president of the Boston Fed come out and point to stablecoin as a potential threat to short term liquidity in the markets and specifically call out Tether as a potential source of concern.

The upshot is that stablecoins are very much on the Federal Reserve’s radar screen. The Boston Fed president showed a slide indicating that the market capitalization of stablecoins, had grown to be about 22% of the short term money markets; with that kind of a percentage, it’s pretty clear why they are paying attention to this. I think it's likely that the financial community's embrace of stablecoins is going to force the issue.

One topic that you've written a little bit about is the quest to build a super app. I'm curious: first how, how you define a super app? Second, you how do you expect it to come about in US? Do you think that one company like PayPal will become a clear market leader and it'll take other companies years to catch up, or that maybe a non fintech company like Google will develop it before the fintech companies do?

One way to think about it is that any consumer on their phone right now could have a couple of dozen different apps that serve different purposes in their financial life. And the idea of a superapp is to collect all of those into a single app which serves all of those purposes and represents, for a provider, an opportunity to cross sell numerous different services to increase the average revenue per user accordingly. What we have seen is that a couple of firms in the US, including PayPal and Square, have a definitive head start in this regard; they have collected a significant functionality, which would be otherwise dispersed through multiple apps. And their user metrics have reflected the attractiveness of that approach.

We've already seen this work extremely well in China, with the Alipay model. We think that there is certainly room for multiple superapps. There may be a few different particular functions that appeal to one consumer more than another. But we also believe that it's not going to be a huge number. I think this is a situation where there's going to be a handful of superapps, simply because they're only a few firms that have demonstrated the wherewithal to do this.

Now, if Google decided tomorrow that they were going to do this in earnest, we would certainly pay attention. What we have seen historically, though, is that many of the initiatives from the big tech companies, as it pertains to functions that would make up a superapp, were pursued and then quickly dropped. This is really a “show me” area. We need to actually see followthrough before we believe that there's going to be any sort of a competitive offering.

When Coinbase became a public company this spring, a lot of people said that this was a relatively low risk way for investors to get in on Bitcoin and cryptocurrency as a kind of proxy investment. But of course, if you live by the price of Bitcoin, you may also die by the price of Bitcoin and Coinbase is worth a lot less now than it was in April. Do you think investors will ever see Coinbase value beyond the price or the popularity of Bitcoin?

There are a couple elements. One is that we do believe that the emergence of many proof of stake cryptocurrencies, and the embrace of projects being built on the these proof of stake blockchains, that Bitcoin is likely to become less dominant over time. We believe that Bitcoin certainly has its place as a store of value. But we're seeing a great deal of enthusiasm for the ecosystem that's being built on blockchains. And that really comes down to where the developers are focusing.

As it pertains to Coinbase, one of the big keys is the company continuing to develop institutional platforms. Right now, over 90% of the company's revenues are generated by transactions, which are obviously subject to significant volatility. And as much as volumes have been extraordinarily high, the price of the stock has not reflected the enthusiasm seen by crypto traders—in large part because there's an understanding that it can be fleeting. If Coinbase follows up its enormous first quarter volumes with even bigger volumes from the second quarter, the immediate reaction will be “that could reverse in the third quarter and beyond.” These are the primary concerns that are leading to the stock trading sideways for the most part, and significantly down from where it was on its first day of trading.

We believe that, as more institutions flow into the space, which we are certainly seeing, and Coinbase develops its institutional platform—it is developing a comprehensive prime brokerage offering that includes, custody, over-the-counter trading, lending, banking—that that will provide more fee-based income, which should give investors more comfort that the company's financial performance will be more stable over time and not as dependent on transactions. And that should, in our view, translate into a fuller valuation for the stock.

I'm curious to get your take on the SPAC phenomenon; as you know, there's been a lot more companies going public by SPAC this year than by traditional IPOs. Do you expect that trend to continue, or do you see some speed bumps for SPACs on the horizon, whether it's from regulators or investor fatigue or some other source?

I think we've already seen something of a slowdown along those lines. What's important, though, from our perspective is to focus not only on the structure, but on the company that is being offered via SPAC. I think what we have seen already in several cases is companies that are strong fundamentally in the fintech space that because they came public via SPAC are trading at levels that don't reflect their fundamental performance or prospects. An example of that is Paya. It is one of the companies that we cover, which has not been trading well. The company's performance has been very strong and we think that it's got a very strong outlook, but it is suffering from the fact that it was brought to the public markets via SPAC.

We have been covering public companies that came to market via SPAC for quite some time; they typically do underperform over the first few quarters that they are public. That's due to a few different factors. Investors struggle to understand the company's real share count in many cases, there might be some outstanding warrants that need to be addressed, things of that nature, which are really more technical. But once they are addressed, then the fundamental performance begins to drive valuation to a much greater extent.

FINvestments

🦈Number of the Week: The UK-based payments app Wise (formerly TransferWise) is scheduled to go public on July 7, through a direct listing on the London Stock Exchange. Its expected market value is between $6 and $7 billion, which will make it one of the biggest public fintech companies outside the US.

🦈Two former Zillow executives raised $70 million to fund their fledgling mortgage tech company called Tomo—this is apparently the largest seed round ever raised by a real estate company, and the third-largest seed round of any kind.