The neobank business model: Too dependent on interchange?

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A warm hello and welcome to Protocol Fintech. This Wednesday: Neobanks profit problem, Kraken sanctions investigation and layoffs at Shopify.

out of the chain

What happens when unstoppable domains meet an unshakable force? The crypto domain company just raised $65 million for a $1 billion valuation for “blockchain domains.” These are not regular web domains and require special software to access them. ICANN, which oversees domain names, has warned against so-called alt-root domains. If that sounds like a recipe for chaos, it’s: Unstoppable is suing competitor Handshake over the .wallet top-level domain.

—Owen Thomas (E-mail | Twitter)

Bet on interchange

Recent layoffs at Varo are just the latest sign of the crunch neobanks are feeling. Last week, Varo cut 75 jobs, or 10% of its staff, a move CEO Colin Walsh said was necessary to ensure the digital bank has “sufficient capital to execute our strategy and our path to the profitability”.

Making money has proven to be an elusive goal for neobanks. Only 5% of the roughly 400 global neobanks identified by research firm Simon-Kucher and Partners have broken even, according to a May report.

  • That didn’t matter as much when venture capitalists poured money into fintechs in 2021. But the market cooling has clearly squeezed some startups.
  • Fintech companies raised $20.4 billion in the second quarter of 2022, down about half from the same period in 2021, according to CB Insights. Banking-focused fintech startups raised $1.9 billion in the quarter, down nearly 80% year-over-year.

Most neobanks targeted the underbanked. The term is most often used to describe technology-focused startups that offer some form of banking service, such as online checking accounts.

  • Neobanks such as Varo and its competitors Current and Chime have raised billions from investors and built up bases of millions of customers. They offer free bank accounts to low- and middle-income consumers, whose incomes could make them vulnerable to overdraft fees and maintenance fees at traditional banks. Most business revenue comes from collecting card interchange fees.
  • Varo in 2020 became the first US neobank to receive a national banking charter. The process took three years and cost $100 million. The charter allows the company to hold and lend directly from customer deposits – a bread-and-butter breadwinner for traditional banks.
  • But, as fintech analyst Jason Mikula detailed in a recent newsletter, Varo has yet to set up a significant loan operation. About 98% of its revenue still comes from interchange fees in the first quarter, as well as fees from ATM withdrawals and a cash advance program. “No US neobank has built a significant lending business,” Mikula said.
  • First-quarter regulatory filings showed Varo was burning through cash so quickly it could run out of cash before the end of the year, as Mikula wrote in May, despite lifting a $510 million Series E round in September 2021. At the time, Walsh told Banking Dive that Varo had “enough capital to achieve profitability.”

The slowdown could reshape the digital banking sector. Ron Shevlin, director of research at Cornerstone Advisors, recently said in a Forbes column that the “end of the era of neobanks” has arrived.

  • “The days when fintech startups preyed on middle to low income consumers in the name of inclusion is very noble and selfless, but it hasn’t yet built a sustainable business,” Shevlin said. to Protocol.
  • Walsh’s blog post hinted at a new strategy for Varo when announcing the layoffs. He wrote that the company is creating a new business unit called Varo Tech to “bring together technology, design, data and product functions under one umbrella.”

David Becker, CEO of Indiana-chartered First Internet Bank, noted that there have already been shake-ups in the industry. His bank, founded in 1997, is one of the few survivors of a group of dozens of online-only banks that emerged during the dot-com boom of the late 1990s. continues, he said, there is a lesson to be learned from companies that have survived. “You really have to offer the full suite of services because customers don’t want to bank in six different places,” Becker said. “You have to offer the full suite or customers will find someone else who can.”

Read the full story on the protocol here.

—Ryan Defenbaugh (E-mail | Twitter)

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on the money

Kraken is facing a sanctions investigation. The Treasury Department is reportedly investigating whether the crypto exchange allows users in Iran to buy and sell digital tokens.

On protocol: The SEC is investigating whether Coinbase illegally authorized trading in unregistered securities. The regulator listed nine tokens it believed to be securities in an insider trading case it filed against a Coinbase employee last week, though the investigations appear to be separate.

Shopify will lay off 10% of its staff. CEO Tobias Lütke said the company had recruited staff in the bet the pandemic had permanently accelerated demand for e-commerce. “It is now clear that the bet did not pay off,” he wrote in a note to staff.

Gen Z doesn’t care. According to a new study from BlackRock, Gen Z workers – aged 18 to 25 – are saving an average of 14% of their income for their golden years, ahead of their older counterparts in the workforce.

Another Senate bill would make certain crypto transactions tax-exempt. A new bill of the senses. Pat Toomey and Kyrsten Sinema would exempt any crypto transaction under $50 from capital gains tax reporting. The Lummis-Gillibrand bill contains similar provisions to exempt small transactions.

Understood

Pat Toomey also beats the drum of “regulation by enforcement”. In a letter to SECOND Chair Gary Genslerthe senator blasted the agency “categorical refusal to provide regulatory clarity” to the crypto industry, instead pursuing a “A capricious and ineffective approach to consumer protection known as regulation by enforcement.”

Just a question for
Emmalyn Shaw, Managing Partner, Flourish Ventures

Throughout his career, Shaw has had a particular interest in financial health. Prior to joining Flourish, she co-led the financial inclusion team at Omidyar Network.

What’s your take on crypto and Web3 investing?

We know that, despite the most recent collapse, Web3 will be highly integrated into our world. We’re going to operate in a world where we’re paying our mortgage maybe through our traditional bank account, but we’re going to return capital using a crypto, decentralized structure. We will be able to buy our coffee in exchange. But when you think of the United States…many of the people who lost capital in this last crisis were the most vulnerable financially. There is this opaque nature in crypto that has made us reluctant to play it. Thinking about the level of impact, we know there’s money to be made, but that wasn’t the question. The point is the impact on consumers and where we want to play in that regard.

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Thanks for reading – see you tomorrow!

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