A lot has changed in the fintech landscape in just the past few months, so let’s start there:
First, there’s my former employer SoFi, one of the first and most infamous SPACs. It was hyped by Chamath Palihapitiya and then by the WallStreetBets community. They pointed to the brand awareness of the newly opened SoFi Stadium and SoFi's acquisition of fintech platform Galileo as two reasons to be bullish.
Full disclosure: I’m a shareholder, so I was paying close attention when the price of its stock rose to $21 (which is when I sold about half my shares).
Now, SoFi is struggling mightily, trading near $6 as of this writing.
Other consumer fintechs going public such as Coinbase, Robinhood and Revolut have similar stories. Robinhood, which was priced at $38 during its July ‘21 IPO, is now around $9.
That’s a drop of 72% and 76% respectively. For comparison, the S&P500 is down just 13% from its high and the NASDAQ is down just 21%.
In the private markets, European financial services company Revolut has raised $1.7 billion over 17 rounds, the latest of which was in August 2021. At one point, the neobank was the most valuable fintech startup in the UK, and there are speculations about an IPO happening in the near future. And despite fintech layoffs last month, Revolut is still hiring.
So if we look at the public markets, which are arguably more efficient, the future looks glum for consumer fintech—but if you're thinking about which of these fintechs to work for, or invest in, we need to unpack consumer fintech further and understand the forces that will drive growth and defensibility.
There are four contours to this fintech landscape that most people get wrong:
First, many startups marketed as fintechs are actually financial services firms, repackaged. They aren’t technology disruptors, but instead tech-enabled alternatives of 20th century products. These types of businesses may have lower growth potential and defensibility.
Second, in financial product categories that are commoditized, businesses race to the bottom. Look for true product differentiation.
Third, if everyone is a brokerage, if everyone is a platform for buying crypto, and the distribution “rails” for financial products become commoditized, we may see the rise of DTC micro-brands in financial services.
Fourth, value any development tools or other businesses separately, and apply a discount once acquired.
Let’s discuss these points one by one.
1. People mistake financial services firms for fintech companies.
There’s this concept of tech companies vs tech-enabled companies. Tech companies offer some type of technology that creates defensibility.
Take a look at Robinhood, Revolut, SoFi, PolicyGenius, and Titan. These apps have taken an existing financial service and have merely put better packaging around it. All the products that they offer—student loans, auto loans, life insurance, brokerage accounts—have existed for decades, even hundreds of years.
Being tech-enabled can give these businesses a tailwind at the beginning - they can acquire customers more efficiently than an incumbent by streamlining the application and underwriting process online. I’ve also read plenty of investor decks and press stories from folks like Affirm saying “we’ll use data enrichment and machine learning to better predict risk and better price loans.” This can in theory help them capture borrowers who are being turned away by incumbents and grow faster, but having implemented and then ripped out Affirm at numerous businesses, so far this all seems to be more sizzle than steak.
Additionally, as upstarts in an established market, their cost of capital is often higher than incumbents, eating into margin. Unless they get creative, these businesses will eventually find themselves in a race to the bottom.
In July 2021, investment app Titan raised a $58 million Series B led by a16z. This surprised me because, to me, the concept behind Titan felt quite simple: You deposit your money into the app, select an investment strategy, and “your personal investment team” will look for opportunities and do the investing for you. How is this different from giving my money to the bloke at the corner Merrill Lynch? And what prevents that bloke from repackaging his services as an app? This is financial services repackaged. Fintech, it is not.
So what’s an example of a true fintech? Square. It started as a way for cash-based merchants like food trucks to start accepting credit cards using a cheap iPhone-card reader. As they moved upmarket, they built new technologies to drive lock-in. Next, small service providers signed up. They joined for the credit card reader, but my barber still uses square for easy appointment bookings.
Coffee shops buy sleek iPad cash registers to use Square’s functionality, but they’ve locked in thanks to the payroll system, customer loyalty program, and turnkey email and SMS marketing. Layering in these software services drives retention. Square also allows users to send invoices and manage payroll, and now it has its own lending services.
Each of these technology-powered services provides a level of value that differentiates Square from other payment solutions, including Visa and Mastercard.
2. When a product is commoditized and there is no defensive moat, the market is in a race to the bottom.
SoFi’s decline, even when the market was red-hot earlier this year, is quite telling. There are three underlying causes.
First, borrowers have not had to make any payments on their federal student loans since March 2020 thanks to a pandemic-related pause that Biden has extended several times. The benefit is set to end on August 31 but could get extended further. This has likely been tough on SoFi’s core business.
Second, and more importantly: The core products are, in a lot of ways, a commoditized business. It’s very difficult to differentiate a lending product along any dimension besides interest rates—that was one of the first things that we learned when SoFi was in its early stages. Back then, the federal direct student loan was 6.80%. The Federal Plus was 7.9%, and we were refinancing it to around 5.99%. So our rates were just a little bit cheaper, and we found that’s all that really mattered: it didn’t bother folks that we’ve only been in business a few years or that a lot of our processes were still quite manual.
SoFi, as well as similar companies like Revolut, had tried to position itself as a “super-app” for the financial category.
In China, WeChat has become a super-app in social media and payments. There’s a network effect to both of these use-cases: A social media app is only useful if a critical mass of my friends use it. In the same vein, a payments app is only useful if a critical mass of both consumers and merchants accept it. That network effect gives the super-app defensibility.
The problem with SoFi and Revolut’s argument is that in the highly commoditized product lines like lending and brokerage accounts, there’s no network effect and low switching costs. If a competitor’s interest rate is even a few basis points better, there’s little incentive to stay loyal.
A mortgage broker in New Jersey, whom I’d never met, gave me a better rate than SoFi, Wells Fargo, and my credit union, so I went with him. The relationship didn’t matter.
When I was comparing high-interest saving accounts, I saw that SoFi's had a much lower rate of return than Vio—so logically, I chose Vio. Even the terribly-clunky website didn’t deter me.
3. If everyone’s a platform, expect further unbundling and the rise of financial services micro-brands.
“For many, relying on a single bank or credit union for all of their financial services used to be the norm. But as users have become more comfortable with fintech, they’ve begun to “unbundle” their financial tools, choosing the best app for each function.” - Zach Perret, CEO of Plaid
Robinhood offers no competitive differentiation because the brokerage product is commoditized. SoFi has a brokerage product too. So do Schwabb, Fidelity, and Vanguard. As a result, the rails themselves are being commoditized: Every financial services firm and fintech can give you access. But look one layer deeper, and you’ll find that individual stocks, ETFs, and cryptocurrencies are beginning to forge a direct relationship with the investors.
The platforms themselves may become interchangeable, and the value will shift to the securities being purchased. The future may be bright—we’re perhaps at the brink of a Cambrian explosion. In the same way that online platforms like Facebook Ads, Shopify, and Amazon Marketplace democratized distribution, enabling a generation of DTC CPG brands, I predict we’re on the cusp of a new DTC explosion in financial service brands.
Imagine a future where niche ETFs and crypto assets go directly to consumers, build a brand and a community, and can be bought and sold on any platform. Kathy Wood is a brand. Warren Buffett is a brand. When people buy ARKK and BRKA, they’re doing so because of a belief in a brand. We’ll see this accelerate.
4. Developer tools and platforms should be valued at a much higher multiple than consumer businesses.
SoFi, Revolut, and Robinhood are tech-enabled financial services firms. The multiples on these businesses could be high, assuming they can find a product differentiation.
Square, Recurly, and Marqueta are platforms (picks-and-shovels businesses). They deserve a higher multiple, and I think we’ll see more of them. Stripe, meanwhile, is a developer-first pick-and-shovel business. The multiples on these types of businesses should be highest.
Companies like Square and Stripe have such high valuations because they are tools that enable hundreds of thousands of businesses to thrive on top of them.
SoFi acquired payment software company Galileo, giving them a developer-focused product for the B2B market. I’d value their B2C and B2B offerings differently—I would value the direct-to-consumer business at a lower multiple.
So what is the future of fintech?
Thanks to so many fintech tools businesses like Plaid, Stripe, and Marqeta that make it easier to create consumer-facing financial services, we’ll likely see a proliferation of even more financial services firms.
To find a defensible position, I expect to see more startups niche-down. For example, I spoke with a business offering a tax solution targeted to bitcoin millionaires—that’s actually a decent market size now. In the same way, I’m expecting to see credit cards for single fathers or checking accounts for South Asians.
One trend I’m definitely seeing is the unbundling or re-bundling of wealth management. 20 years ago, you’d go to Merrill Lynch, where a financial advisor would take you to golf, set up a brokerage account, mutual funds, and take a fee. In the last 10 years, more and more people have turned to digital tools such as Wealthfront, Fidelity, and Vanguard to manage their money themselves, bypassing the service fees of wealth managers.
I’ve talked to a couple of startups that are exploring this wealth management space—they’re offering a vertically integrated solution that delivers both wealth management and cryptocurrency, or a wealth management solution that’s digitally native (think Redfin for wealth management). This blended technology-and-services model seems promising, and we might see a lot of growth there.
The SoFis and Revoluts of the world, who want to be everything to everyone, will have to dig in and find competitive differentiation at the product layer to succeed. Meanwhile, like in any gold rush, it’ll be the people selling the spades and shovels, such as Plaid and Stripe, who will capture most of the value.