The Year in Four FIN Posts

Number of the Week: $2 billion (explanation below)

The Year in Four FIN Posts

Barring some breaking news, this is the final FIN installment of 2021, the first full calendar year that FIN published. Fintech has grown at a neck-snapping speed: some $100 billion in private investment gushed into the sector this year, and there were huge new entrants into the public markets, including Affirm, Marqeta, Nubank, Robinhood, and SoFi. The growth was so feverish that it’s hard to imagine 2022 repeating it; there are several signs indicating a slowdown, such as the likelihood that the stock prices of Square (now Block) and PayPal will close the year well below where they opened it.

Moreover, the growth has created a lot of friction within the industry and in broader society. As millions more consumers adopt fintech-enabled products and services, the end results aren’t always ideal (as discussed below). In the US, Biden-appointed regulators and increasingly sophisticated Congressional staffers have changed the environment. 2021 was a useful reminder that unprecedented growth can’t solve all of an industry’s problems, and often helps create some new ones. Here are excerpts from four FIN posts that defined the year.

Buy Now, Pay…Never? (February 7)

A dog is for life, not just for Christmas.

If you are from the United Kingdom, that pithy adage needs no explanation. For everyone else: in 1978, the charity then known as the National Canine Defence League issued a television ad that went viral, in whatever way that happened pre-Internet, and became an international cause….The now-iconic campaign was intended to reduce the number of dogs bought impulsively in pet shops as holiday gifts, and then returned to overwhelmed charity pounds. But it also suggested a Fezziwig capacity for Brits (and of course others) to splurge during the Christmas season and later regret.

That holiday spendthrift tendency reared its red-inked head this week. The British comparison shopping site Compare The Market released survey data showing that 44 percent of British adults who used Buy Now, Pay Later (BNPL) plans for Christmas shopping now fear that they can’t pay their debts without borrowing more money. The survey coincided with the release of a BNPL report from the Financial Conduct Authority (FCA), and increasing public concern that BNPL can get consumers into trouble; Labour MP Stella Creasy has recently labeled BNPL “a financial scandal waiting to happen,” and called for stricter regulation of the growing sector (more on this below).

BNPL, for those unfamiliar, is essentially an installment plan; instead of paying $150 for a jacket all at once, the customer is given the option of making, say, four payments of $37.50. As long as the money is paid back on time, the service is usually free.

BNPL is one more example of fintech’s “COVID accelerant” documented in the first installment of FIN—indeed, it might be the biggest. “The use of BNPL products nearly quadrupled in 2020 and is now at £2.7 billion (about $3.7 billion), with 5 million people using these products since the beginning of the coronavirus pandemic,” the FCA report said. The entire population of the UK is about 67 million, and presumably children aren’t using BNPL, so we’re talking about a large chunk of the British population. Some UK surveys put the number at 37%, with even higher usage among Generation Z (50%) and millennials (54%). A study found that the average 18-to-24-year-old in the UK owes almost £247 (about $340) to BNPL companies, significantly more than older shoppers. On the whole, these younger consumers tend to have fewer savings than those in Generation X and older, and so their inability to pay Christmas bills could have serious consequences….

Robinhood, Binance, and the Culture of Contempt (July 4)

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….

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.

The SoFi Battle That Won’t Go Away (August 8)

A long-simmering conflict over the ownership of fintech superstar SoFi got a fresh boost of energy this week when US Representative Brad Sherman (D-CA) sent a letter to Securities and Exchange Committee (SEC) chairman Gary Gensler, calling SoFi’s recent entry into the stock market “alarming” and “troubling.” Sherman, a California Democrat who ranks high on the House Financial Services Committee and positions himself as a kind of fintech expert, appeared to rely on a still-pending 2018 case in the New York court system, which alleges that onetime SoFi board member Joseph Chen massively defrauded investors in his once-powerful Chinese social media company Renren, which took a large ownership stake in SoFi soon after the firm’s 2011 launch.

The rise and fall of Renren is a fascinating, somewhat sketchy tale. When the Chinese government began blocking Facebook access in 2009, Renren positioned itself as the “Chinese Facebook” and by the end of 2010 claimed 100 million registered users (although there is ample reason to believe that those numbers were inflated). Renren’s 2011 IPO on the New York Stock Exchange was robustly successful, raising nearly $750 million and enjoying a 29% bounce on its first day of trading, creating a market capitalization of $8 billion….

As competitors likes TenCent’s WeChat began to grow, Renren faded, and the company began bleeding losses. A 2014 Bloomberg story carried the devastating headline “The Facebook of China Suddenly Has a Myspace Feel To It.” To salvage the company, CEO Chen and his board turned Renren into a kind of venture capital firm, using the IPO cash to invest in outside companies. One of its earliest investments was a 2012 stake in SoFi; eventually it acquired nearly 15% of the company. Chen had already personally invested $4 million in SoFi in 2011; his LinkedIn profile indicates that he still sits on SoFi’s board of directors, although SoFi’s Web site does not currently list him as a director. (On Monday August 9, SoFi confirmed to FIN that Chen is no longer on the board.)

In 2018, after failed attempts to take Renren private or buy out shareholders, nearly all of Renren’s investment portfolio was spun off into a company called Oak Pacific Investment (OPI), controlled by Chen and his associates. A group of Renren shareholders revolted, charging that the assets were dramatically undervalued. The SoFi shares, for example, were ostensibly worth more than half a billion dollars, but were sold for about half that amount.

That’s where the lawsuit came in; in July 2018, a group of Renren investors sued Chen and his associate David Chao in New York State Supreme Court. The suit has thus far withstood attempts to dismiss it on jurisdictional grounds….

In May of this year, a New York court ordered $560 million in assets controlled by Chen and OPI to be frozen, just ahead of SoFi’s going public via SPAC through one of the vehicles of SPAC master Chamath Palihapitiya. (Disclosure: for research purposes, FIN purchased prior to the June 1 SPAC acquisition—and still holds—a small number of SoFi shares.) A New York judge appeared to endorse the charge at the lawsuit’s core. He asserted that the fact “that the SoFi shares were sold so soon after the spin-off to OPI and for the defendants’ benefit” rather than for the benefit of all Renren stockholders suggested “that these assets were spun off without legitimate corporate purpose.”

In Sherman’s SEC letter this week, he links Chen’s role between Renren and SoFi: “Given Chen’s troubling track record as the steward of a public company, his involvement in a SPAC transaction whereby SoFi has become publicly traded is genuinely concerning.” It’s not clear what, if any, recent event promoted Sherman to write to the SEC; Sherman’s office did not respond to a FIN interview request.

In the meantime, Renren as a company, stripped of its investments in SoFi and other startups, has limped forward, relying for a time on Kaixin, a used car dealership in China, as its primary source of revenue. It sold its interest in that company at the end of 2020; oddly, the obscure, midsized company was the most actively traded and biggest gaining stock on a major US exchange on Friday.

Sherman’s letter raises tough and legitimate questions for the SEC and for SoFi’s leadership:

Given the public allegations regarding Mr. Chen and his role as a SoFi insider, what plans, if any, does the SEC have to review the SoFi SPAC transaction?

Given that the process by which SoFi went public was a SPAC transaction, does the SEC have the tools it requires to pursue its investor protection mandate in a situation like this?

Will Sherman’s letter force Gensler to act? Responding to a FIN inquiry, a SEC spokesperson declined to comment on Sherman’s letter….Arguably, Sherman has teed up an issue that would simultaneously allow Gensler to win favor with important Congressional allies, and to make a firm statement about the SPAC boom which, while down from its frenzied highs, will nonetheless largely define 2021 for investors. At the same time, it’s not hard to imagine Gensler sitting on his hands until the New York court case reaches some kind of resolution.

The Year of Fintech Failure (November 21)

OK, the headline is deliberately provocative: obviously by many yardsticks fintech is continuing to explode like no other business in the world. Yet there’s a strong case to frame 2021 as the year that very dominant companies failed to realize their grandest fintech dreams. It’s theoretically possible, for example, that the Facebook-led Diem currency will see daylight before the end of 2021, but given a cryptocurrency market valued at over $3 trillion it’s harder with every passing day to find anyone who thinks Diem will have any impact. Robinhood and Binance, both of which are leaders in their spaces, were beset this year by repeated technical glitches (and in Binance’s case, very serious regulatory reprimands across the globe). Spain’s giant Banco Santander shut down its ambitious crossborder transfer platform PagoFX, and of course Google abandoned its expansive plans for Plex.

Now comes news that N26, the fast-growing Berlin-based neobank, is abandoning its operations in the United States. Anyone outside of the company would have perceived that N26, which launched its first product in 2015, was taking over the world. (The name N26 derives from the number of smaller cubes in a Rubik’s cube.) The app allows customers to open a genuine bank account, complete with a debit card, from their phones. N26 claims 7 million clients across 25 countries. In October, N26 raised a stunning $900 million Series E round, valuing it at $9 billion….

Behind the press releases, however, N26 was practically stagnant. (FIN requested an interview with N26, but received no reply.) Unquestionably, the COVID pandemic and associated lockdowns created a growth revolution for digital banking. In the beginning of 2020, for example, 4% of Gen Z and millennial Americans considered a digital bank to be their primary bank; by the end of 2020, that number was 15%. Even if N26 ever had 500,000 active US customers—which is highly doubtful—it got buried in 2020 by domestic giants Chime (which currently boasts some 12 million US customers) and Varo (close to 3 million)….

Of course, one factor that makes fintech so fascinating and powerful is that is entirely possible for a company to become a global force without being either created in, or especially focused on, the United States; Brazil’s Nubank and, perhaps more debatably, several companies in China are strong examples. Regardless, N26’s US retreat is a strong reminder that even the most successful companies have trouble executing on ambitious plans. Maybe it’s a timing coincidence, but it really does seem that 2021 has served up a disproportionate number of such examples, suggesting that global fintech has bumped up against some real-world walls.

FINvestments

🦈This week the Vietnamese startup MoMo announced a fresh funding round of $200 million that values the company at $2 billion. MoMo is a kind of financial superapp focused on Vietnam’s 53 million online consumers.

🦈Earlier this month, a huge group of top-tier investors, led by KKR, put $350 million into a Series D round for Anchorage Digital, a cryptonative asset platform aimed at institutions, valuing the company at $3 billion. It’s worth speculating how much smaller those numbers might be if Anchorage had not secured one of the very few digital-asset federal banking charters from the Office of the Comptroller of the Currency.