What does the wisdom of the market tell us about the Fintech bubble question?


Markets going through disruption tend to be a bit manic depressive, with headlines alternating between:

“Its a bubble, the big crash is coming, sell sell sell

“Its going to the moon, load up today, buy your Lamborghini tomorrow, buy buy buy”

The Fintech bubble question has become a staple as the media chases page views with sensationalist clickbait headlines.

I want to bring some data, rather than add to the landfill of opinions. That data is lurking in the markets (both stock and cybercurrency). Investors have skin in the game. They back their opinion with cash. Investors can be wrong for a while, but in aggregate their actions usually signal something more interesting than an opinion.

In this post we seek data from the markets to answer the question whether Fintech is a disruptive force or a bubble waiting to pop.

What does the KBW Index tell us?

For example, if Fintech disruption is real, it might be reflected in Bank stocks declining in price. You can see the logic from past disruptions such as e-commerce disruption hitting retailers or social media disruption hitting publishers. In that scenario, bank stocks would be declining.

KBW created a leading index of Bank stocks with symbols BKX. There is another one with a more regional bank focus called KRX. A quick glance tells us that investors still like bank stocks.


The price action to date has nothing to do with Fintech. It is more likely simply that monetary policy in America is on a path to rising rates which benefits banks and there is an expectation that the regulatory load will be lightened under the Trump Administration. The big moves can be easily tracked to the Trump election and statements by Janet Yellen.

So, the takeaway is “Fintech is a bubble, it is having no impact on bank stocks”. Not so quick, read on.

Lets look at publicly traded Fintech stocks.

Fintech ETFs – FINX and FINQ

Daily Fintech created the first Fintech Index back in March 2015. More recently a couple of companies created tradable ETFs from the simple idea of an index – FINX and FINQ. Zacks offers a comparison

These are not as cheap as buying a Vanguard S&P fund. Both charge 68 bps.

There are some differences between weighting by big, medium and small cap and by geographic region, but they share one thing in common. The holdings are almost all “traditional Fintech”; this is Wave 1. Some are Wave 2 which is Emergent Fintech based on SMAC (Social Mobile Analytics Cloud). This is natural. To get to scale big enough to be a public stock you need to play within the current system.

(See this post for a description of the three waves of Fintech). TL:DR: Traditional Fintech Wave 1 is “we bring you lunch” (aka vendor), Emergent Fintech Wave 2 is “lets split the bill and partner” (aka B2B2C revenue share partnership) and Disruptive Fintech Wave 3 is “we eat your lunch”.

So it is natural to see these Fintech ETFs going up in tandem with KBW and the overall bank market. When the banks prosper, the vendors and partners to those banks prosper. Many of these companies are moving from a pure vendor model (here is my technology and here is the price) to a revenue sharing model (either white label or co-branding). In short, Traditional Fintech is morphing into Emergent Fintech as quick as they can; but in both models Fintech and Bank interests are aligned.

There are some great companies in these ETFs, however don’t trade it as a hedge against bank stocks. The correlation is surprisingly strong.

First we show the two Fintech ETFs together (taking a 1 year view):


They track pretty closely. FINQ seems to stop this summer and as they track closely enough I only use FINX for further analysis.

So, lets look at Bank stocks and Fintech stocks together. In a 3 month view we see some outperformance by Fintech, but on a longer term horizon we see mostly correlation:


Stop yelling, its Yellen that matters

Looking at all these ETFs, there is high correlation. Its The Macro Stupid.

So lets look at some individual stocks on opposite sides of the Fintech Bank divide and how they reacted to similar crises.

Comparing Lending Club and Wells Fargo crises

When the Lending Club CEO did something stupid, the board fired him immediately and the stock tanked. In my view, the market overreacted and LC was a bargain and I was fortunate to buy in at the all time low of 3.51 (see this post for my analysis at the time) and sold a few months later.

When Wells Fargo did something stupid my analysis was a) that this was worse than what  Lending Club had done and b) the underlying cause was probably related to Fintech disruption (a thesis I outlined in this post).

So you would think that Wells Fargo stock would have crashed like Lending Club did. A quick look at the two charts (on a two year view to get the LC crash) shows this is not true:


The takeaway, scandals are rougher on Fintech upstarts than Banks. How long this will remain true is a matter of opinion. Wells Fargo and Equifax will be stocks to watch, but also assume we will see many more blow-ups like this in the months ahead – it is Act 3: Denial in the 7 Act Creative Destruction Play.

Searching for negative correlation via Disruptive Fintech

Smart money is waiting for the OmniBubble to burst. This is bigger than all previous bubbles, whether Housing or DotCom, driven by money printing all over the world. If you see this OmniBubble, none of the normal strategies work. All the sensible assets are also over valued. You want to buy something that is anti fragile that will benefit from a crash.

There are not many tradable stocks in Disruptive Fintech category of Crypto Finance. There are lots of private companies but then you buy into the public/private valuation inversion which was the subject of no 7 of our Top 10 Fintech Predictions for 2017:

“7. Uber will not do an IPO and may do a private down round.This will signal the dramatic end of the public private valuation inversion (private higher than public valuations). This started in 2016 and will have its dramatic end in 2017.”

Uber is still making brave noises about an IPO, but it is likely that an IPO will be a massive down round. Some other overvalued private companies are “taking their lumps” now and getting the pain over. One example is the 70% valuation drop for Prosper. Their problem was that Lending Club was such an obvious comparable.

The only public stock I can see where any Josephine Q Public (aka unaccredited investor) can buy without permission into the Crypto Finance Third Wave is Overstock ($OSTK) where TZero and other Crypto Finance ventures are lurking within an e-commerce company. That is not a pure play.

That explains the hunger for ICOs. Those ICO issues are all you can buy if you think Blockchain, Bitcoin and Crypto will change the world and you don’t have access to private deals. However there is a much, much simpler investing strategy hiding in plain sight:

You could not buy The Internet in the 1990s, but you can buy Bitcoin today.

There are obvious parallels between the Dot Com bubble and today’s ICO craziness.

In the 1990s, you could not buy “The Internet” if you saw The Internet changing the world. All you could buy was lousy stocks like Pets.com. Today’s equivalent is a lousy ICO. If you see Crypto Finance changing the world and you are an unaccredited investor, all you can do is buy an ICO. Not quite true. Today you can also buy Bitcoin. If you see Crypto Finance changing the world, your actionable trade can be as simple as buying some Bitcoin. Any “dumb” retail unnaccredited investor can do that without anybody’s permission. Meanwhile the smart money buys into overvalued private deals. Err, who is the sucker at this table?

Getting back to the bubble question, one way to look at this is that we are witnessing the end of the Financialization Bubble. This has been going on for so long that it is harder to see it as a bubble. For years, the smart money has seen this and while pumping the securities bubble as much as possible, they buy gold and land as better stores of value than paper assets. More of them are now also buying Bitcoin as an alternative store of value, which explains the rise in price. Some on Wall Street trash talk Bitcoin and some buy it and some do both. All understand that Bitcoin, weird as it may sound, is the anti fragile portfolio response to decades of loose money policy.

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Bernard Lunn is a Fintech deal-maker, author, adviser and thought-leader.

Get fresh daily insights from an amazing team of Fintech thought leaders around the world. Ride the Fintech wave by reading us daily in your email.

How incumbent banks, particularly Swiss, can thrive thanks to GDPR and cybersecurity, even after PSD2, but need to embrace Bitcoin

data hackers

The usual story line goes that big old slow incumbents cannot compete with agile Neobanks with their hip UX and with their low costs that are unencumbered by branch networks.

If UX is the game, banks can at best play catch up. They can buy the hip UX ventures, only to be left in the dust as a new one emerges that is even more hip. Just when you figure out mobile apps, you have to figure out ChatBots with an AI back end. Just when you figure out ChatBots with an AI back end, you have to figure out…

Doing that with a clunky backend designed in the batch era is not just hard, it is almost impossible.

Playing catchup is a lousy game.

PSD2 made the playing field level

That was really bad news for incumbent banks. In theory, banks can win on that level playing field. In reality, if the game being played on that level playing field is how to create the best UX, banks will lose.  Agility wins that game and a Neobank is more agile than an incumbent Bank. If two teams play soccer/football on a level playing field and one has an average age 25 and one has an average age 55, I am placing my bet with confidence on who will win. If the 25 year old team has a 25 degree upward slope, the odds even up.

Consumers don’t care that much about UX

That is heresy. UX is the whole deal. That is the mantra we have all been repeating, but which I will challenge. Sure consumers care about UX. But how much do they care? How much do they care compared to things like low fees, low interest rates and that simple word – security.

Before getting onto security, look at this from the POV of those hip Neobanks. Read this post by Fred Destin of Accel, one of the best VCs, working at a top tier VC firm. The Customer Acquisition Cost (CAC) for Neobanks is a real issue. This is not like getting users to engage with a free social service. When money is at stake, people take longer to commit. Fear is part of that delay. Will the venture still be around years from now? Will they lose my money?  The fear may be irrational, but even irrational fear kills your CAC metrics.

The biggest fear is, will they lose my money? Will they lose my data? This is where banks could have an advantage – if they play their cards well.

The latest hack – Equifax – creates an inflection point in the market. It could be a disaster for banks. If they don’t take urgent and decisive action it will be. Or banks can seize the opportunity that this creates.

The Equifax inflection point

The Equifax data loss is a huge problem for institutions that live on trust from consumers. It impacts consumers in such a fundamental way, causes so much work and impacts every interaction with the banking industry. 

To anybody who understands a bit about cybersecurity, this was no surprise. Cybersecurity folks hold 3 truths to be self evident:

  1. Anything that is digital can be hacked. Nothing is secure. It does not matter whether you are a Fortune 500 company, Government, US Presidential candidate, mega Bank or payment network. You will get hacked. It is an arms race that the good guys are losing because every solution, no matter how clever and expensive, has a shelf life until the bad guys find a way around it (and the payoff for the bad guys is big enough and the Crime As A Service networks use the full power of digitization and Moore’s Law). Your identity can be stolen with ease and with a valid but stolen identity all the KYC & AML processes are useless.
  2. This is a Board level issue. Banks and other big companies are willing to spend whatever is needed because the cost of a breach is so high. This is an existential threat for the biggest companies on the planet. Attention is not the problem. Budget allocation is not the problem. A viable solution that does not create an awful onboarding UX is the problem.
  3. Eliminating static passwords is essential. With key loggers on mobile phones, everything you type on those phones is visible to criminal gangs. Which is a problem when we all live on our phones. If you drew a matrix with Great UX and Secure as the axes, it is obvious where Mobile phones sit.

There are only two ways out of this:

Scenario 1: everything moves to decentralised self-sovereign identity stored on a blockchain. This will make banks as we know them today irrelevant. The problem for ventures pushing in this direction is “how do we get from here to there, today?” It is a grand futuristic vision, but consumers want a solution today, not at some distant time in the future. The banks also will have trouble buying this vision. Telling a Fortune 500 board that their only hope is to move off centralised data centres to a fully decentralised Blockchain based network will get you some odd looks around the boardroom table.

Scenario 2:banks get their act together. Which brings us to the wonderful world of Cold War spy stories and the one time password.

One time password is the only answer – ask John Le Carre

If you steal the the one time password, you can steal the contents of that message/payment and only that message. And you have only a short time window to do do. This makes it theoretically possible,  but economically impossible for the thieves. That is fundamentally different from stealing data that is a key that thieves can use multiple times (such as a password, social security number, credit card number),

The one time password was extensively used during World War 2 and the Cold War. John Le Carre fans will know it as a key part of “spycraft”.

One time password uses cryptography. Don’t worry, you Bitcoin fans, we will get to that other cryptography later.

That totally messes with the frictionless UX

If you live in Switzerland, you may already use a hardware device that the banks give you (a “dongle”) that uses one time password technology. Many Banks insist upon it. But each dongle is bank specific and can be rather unfriendly to use, making onboarding harder. Once you get used to it, the dongle is fine, but the onboarding experience is lousy.

This is where the opportunity lies. The onboarding pain of a one time password dongle makes consumers reluctant to switch to a new bank if they have to adopt a totally new dongle. The incumbent bank can argue “why not keep all your accounts with us, we can do all the account aggregation and reporting that you need”.

Of course a Neobank can also use a a one time password dongle. It will make them significantly less hip and mess with the lovely UX, but it will be significantly more secure. Personally that is a trade off I am able to live with. 

So how do you find early adopters to use this secure account with a harsh onboarding UX? Up to this point, incumbent banks will be doing the nodding dog act. The takeaway will be “just protect the base by being ultra secure”. 

This is where incumbent banks will start getting uncomfortable because my recommendation is that they offer a secure service to Bitcoin investors.

The newbie Bitcoin investors pain point.

The Bitcoin veterans tell newbie Bitcoin investors to have hot wallet and a cold wallet and the cold wallet needs to be on a hardware device that you put in a  safe. They look with scorn on anybody who thinks this is a pain.

If you have a lot of Bitcoin on your hardware device, put it in a bank vault rather than relying on a home safe.

Does that remind you of the gold business?

The reason I wrote “particularly Swiss” in the headline is that Bitcoin is legal in Switzerland. Sure you have to ask investors/customers for AML/KYC checks, but that is not a problem. Just don’t accept Altcoins designed for the dark web. Dark web users don’t use Bitcoin so much any more because it is trackable. With a bit of work it it is quite feasible to define a service to store Bitcoin that passes AML/KYC checks.

However, once they have done this, banks do not need to give that information to anybody who comes knocking asking for the data, which brings us to GDPR and Switzerland.

Switzerland by law is already ahead of GDPR – customers have data privacy as a right.

Bitcoin investors is a tiny market today, maybe 1% of the gold market. Read Peter Thiel’s Zero To One to see the value of starting with a tiny market that nobody else cares about that may grow in future (for example PayPal started with power sellers on eBay).

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Bernard Lunn is a Fintech deal-maker, author, investor and thought-leader.

Get fresh daily insights from an amazing team of Fintech thought leaders around the world. Ride the Fintech wave by reading us daily in your email.

The role of trust and brand in the great incumbent versus fintech showdown

There is no escaping the fact that the majority of the financial services we consume daily have become indistinguishable commodities to most of us.

In a market where everything is various flavours of the same vanilla, customers either stick with what they have, or chase bargain-bottom pricing. “Who cares if we’re boring”, financial providers say to themselves. “So is everyone else. Plus they trust us.”

These days it’s hard to go past a press article or finance blog that doesn’t mention the phrase ‘clever marketing’ – or some other thinly veiled backhanded compliment – from grey haired industry experts called upon to discuss the meteoric rise of startups in various fintech ‘hot spots’.

And while here and there you’ll find a few pearls of wisdom, what most of this commentary has amounted to is a clever (and calculated) de-positioning of the one tactical weapon traditional financial services firms don’t have – a great brand capable of being marketed successfully. Capable of winning customers hearts, then minds.

Unfortunately for incumbents, many new entrants will prove they are more than capable of playing by the same regulatory rules as their forebears – possibly even better. Which means if they can combine financial nous with brilliant creative, then the un-commodification of financial services may come a lot sooner than anticipated. Combine this with a growing realisation by many that the tactics used to make FMCGs successful can now, thanks to deregulation and increased access to technology, be applied in a similar way to finance, then you have serious disruption. In many ways, it will be through brand, that 100 years of trust will be achieved in a much shorter timeframe.

In a glimmer of hope for existing incumbents, the famous Edelman Trust Barometer has indicated trust in traditional FIs is on the upswing. But there is still baggage. Fintech startups on the other hand who are ‘entering the conversation with authenticity’, are, according to Edelman, garnering high trust readings off the bat, of 64 to 72 percent in areas involving mobile applications and blockchain.

There are a lot of people and businesses who have become incredibly wealthy off opaque and vanilla financial services businesses that require them to do very little in the way of trying to keep their customers happy, off the back of a trust bank created over generations. But something in the wind tells me that is changing, and that established players who choose to underestimate the power of brand versus baked in trust will do so at their peril.

Daily Fintech Advisers provides strategic consulting to organizations with business and investment interests in Fintech. Jessica Ellerm is a thought leader specializing in Small Business.

Why the KIK ICO is the one to watch


NagarjunaSagarDamThe Filecoin ICO is chewing up a lot of bandwidth this week, but I think that KIK is the one to watch.

Starting with Filecoin, there is lots to like – great team, ambitious tech goal, key protocol for decentralised Internet, but I would not bet on it for these reasons:

  • lower cost digital storage is not high on most people’s worry list.
  • Jeff Bezos (AWS) is a fierce competitor who wins price wars and takes on Walmart and China. He coined the line – “your fat margin is my opportunity” – and he has not left any fat margin to exploit.
  • the Filecoin tech is unproven and the marketing challenge (needing to scale to billions to be meaningful) is horrible
  • there are other viable vendors in the beat AWS by going P2P game such as Storj.

I hope Filecoin make it but the odds look lousy.

KIK is interesting because it has nothing to do with blockchain or decentralisation. It is one of many viable companies that would like IPO as an alternative to trade sale, but that are dammed up in front of a wall that excludes all but the most massive companies. KIK did a Pre ICO round that looks a lot like a Pre IPO round in ye olden days. This is a sign of ICO transitioning to mainstream – real securities sold to real investors in a legal framework. Whether it is a good deal and a great business is another matter. The key is that ICO is replacing IPO as a viable exit and competing with M&A and PE. That is a mega trend shift. Traditional exchanges and all who work in that ecosystem are facing disruption.

Will be watching this one with keen interest.

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Bernard Lunn is a Fintech deal-maker, author, investor and thought-leader.

Get fresh daily insights from an amazing team of Fintech thought leaders around the world. Ride the Fintech wave by reading us daily in your email.






After the ICO gold rush, it is time for Innovation Capital to change the world through Digital Cooperatives


During the August holidays I spent some time in a lake house in the Rocky Mountains where the history of Native Americans, Homesteaders, Miners and Moonshiners was much in evidence. It seems quaint in hindsight because we know what came after (big cities, mechanised farming, massive wealth creation). It was not quaint at the time. It was rough and tough, just like the ICO gold rush of 2017.

The Ethereum releases of Frontier, Homestead, Metropolis and Serenity track this same trajectory. Ethereum is currently somewhere between Homestead and Metropolis. Ditto the disruption to Innovation Capital that the ICO gold rush of 2017 is signalling. We are in the homestead/gold rush/moonshine era and will be moving into the big city/mechanised farming era.

That trajectory implies a few big company winners.Our thesis is that the disruption to the Innovation Capital business that the ICO gold rush of 2017 is signalling heralds something much more interesting, which is a more sustainable version of capitalism that will benefit the many not just the few. This mega trend shift is what we call Digital Cooperatives.

The ICO disruption to the Innovation Capital business. 

Disruption has winners and losers. The winners in this case is everybody – the 99% if you like. The losers will be the few firms who currently control the spigots of the Innovation Capital business.

I don’t use the term Venture Capital because that term now denotes one business model for Innovation Capital – the 2 and 20 compensation model for VC firms, mostly clustered around Sand Hill Road in Silicon Valley. I refer to that now as Wall Street West, which works closely with the firms across the country in Wall Street East that do the big money transactions (IPOs, big M&A, Bond Markets). In the founding days of VC and Silicon Valley, it was utterly different from Wall Street. As VC grew in economic importance, the bonds between the two tightened, with talent and deals moving easily between the two worlds. This wealth creation mostly bye-passed Main Street. The future of Digital Cooperatives will be about the Main Street real economy. It will be exciting for the 99% and boring or even disturbing for the 1%.

Software is eating the world. Software drives the economy and is disrupting every market. This means that software is now too important to be left to a few firms on Sand Hill Road and Wall Street.

The job of Innovation Capital is to fund innovation that changes the world. The VC to IPO model did that brilliantly for a long time, but it is increasingly broken (see this post for more) and has been ripe for disruption for some time. The ICO is the first step in that direction. Like all disruptive innovation it arrives first with a lot of sketchy characters. The ICO gold rush of 2017 makes The Wolf Of Wall Street seem tame and that is hard bar to vault over!

Like all disruption, the ICO appears wild and chaotic and filled with sketchy characters, with ventures that are totally unregulated and often skirting the law. In short, we are in the Napster era. What comes after will be more like iTunes and Spotify, not free but much cheaper and more convenient and totally legal. When was the last time you saw a retail store selling CDs? Who mentions Napster other than as a historical footnote?

I see three fundamental drivers of change from the ICO disruption:

  • A better way to manage early stage technical and market risk.

  • A shorter path from garage to liquidity.

  • The enabling innovation coming from the protocol layer.

These three fundamental drivers of change will enable a more sustainable version of capitalism via Digital Cooperatives. First lets look more closely at those three fundamental drivers of change.

A better way to manage technical and market risk

VC Funds manage risk. Like any investor, they like the upside potential and want to minimise downside risk. VC want to invest when as much of the risk as possible has been eliminated. This is what the LPs pay the GPs to do.

VCs have to time that entry carefully. As one VC put it to me “we want to come in just before an entrepreneur can get a bank loan”. The boom in mega PE/VC funds is partly explained by bankers reluctance to lend post GFC. If you have to wait longer for a bank loan, that mega equity round may look more attractive – even if the preferential equity terms give founders some agita.

Preferential/Convertible Equity is a hybrid Debt/Equity instrument for a good reason. Debt makes risk management easier for passive investors (even if it wipes out common equity owned by founders and management in the process).

Risk management is what LPs expect from GPs. They want the massive upside without the massive risk. That makes sense as long as entrepreneurs have no other option. Thanks to ICO,  entrepreneurs do now have another option.

This focus on risk management means VC GPs work hard to avoid two types of risk. You can look at the ICO market through the prism of these two types of risk: Technical Risk & Market Risk.

Technical Risk.

If you invent a cure for cancer (or longer lasting/cheaper/safer batteries or other change-the-world technology), the market is huge and ready. There is lots of technical risk, but there is no market risk.

Professional investors have had a “run, don’t walk” attitude to technical risk. Imagine Vitalik Buterin pitching a Sand Hill Road VC for Ethereum in 2014. Would they have seen a future Bill Gates? Probably not; the first filter of technical risk would have killed the deal. Bill Gates did not raise money until Microsoft was already profitable. In contrast look at the individuals who bet early on Ether in 2014; they had some ability to assess the technical risk of building a decentralised computer, because they were developers first and investors second.

Now imagine a Biotech or Cleantech venture with a massive market but lots of technical risk. Biotech or Cleantech scientists who can assess that technical risk can use ICO mechanisms to vote with their wallets by buying in early. Those scientists will be the technical smart money voting on Technical Risk. Professional investors will follow that technical smart money.

Market Risk.

Most ventures funded by VC have zero technical risk. Look at ventures such as Facebook, Twitter, Uber and AirBnB; the early technology was trivial.

When it comes to market risk, that risk gets taken by founders, friends and families and the occasional Angel; they have to get the venture to Product Market Fit before VC will invest. If you build an app and find a market, VC cash will help you scale; VC today is growth equity after market risk has been eliminated. The problem occurs when everybody wants to fund after market risk has been eliminated; that will cause the innovation funnel to dry up.

Fortunately the ICO model also helps manage market risk, because the early visionary users are also the investors.

Again Ethereum is a useful case study. Ethereum’s early visionary users/investors also built the early DAPPs; they had the tech chops to do so, as well as the financial motivation because they owned some ETH. In contrast, in some 2017 ICOs, the early investors are speculators who don’t use the product. They speculate based on some hype in a YouTube video; these ventures will probably fail. A promising sign is when, like Ethereum, the early investors also build stuff with the new technology coming from the ICO; that is when passion, expertise and capital are aligned.

The progression from the Napster era to the iTunes/Spotify era means coming to terms with the complex legal, technical, tax, organisational and marketing issues related to launching something like an ICO that includes a beneficial interest in the venture that means that a) it is a better deal for investors b) it is definitely a security and will be regulated as such. The companies that lead this next wave of innovation will not shy away from securities regulation; they will embrace it. This won’t be easy but the prize is a big one.

Although the legal, technical, tax, organisational and marketing issues related to an ICO that is legally a security are complex, they will be fixed because the prize is so big. The reason is that the next phase of the ICO market does not simply change the early stage. More critically also the next phase of the ICO market also changes the late stage. In the late stage one word matters most – liquidity.

A shorter path from garage to liquidity

The future of ICO is more than crowdfunding.

The simple reason is liquidity. If you invest in a private company via crowdfunding, you are locked in until there is an exit or until you do some complex bilateral negotiation where you will tend to be at an informational disadvantage. There have been some opaque grey markets in private shares but they are nothing like public equities in terms of transparency, price discovery and liquidity. In contrast, you can trade ICOs almost like you can trade public equities; you have to learn a few new techniques, but it is possible. The ICO market has price discovery, shorting and all the other market mechanisms that enable liquidity.

Liquidity is a game-changer. It is why the O in ICO is like the O in IPO. The difference is time and statistical probability. The journey from garage to IPO is at least 10 years vs instant liquidity for an ICO. The statistical probability of an early stage venture getting to liquidity is less than  1% in IPO vs 100% for ICO. Ventures can languish in small cap hell on both markets but that means below $2bn in IPO world and below $200m in ICO world.

Liquidity has measurable value as shown by the liquidity discount given by the tax man.

Liquidity is a game-changer because it makes early stage so much more accessible to Josephine Q Public. A Fund or a Professional Angel can live with illiquid investments. Everybody else wants something like the stock market where they can check price and sell if needed without getting anybody’s permission; whether they choose to be active traders or buy and hold investors is a choice they can make.

Sorry, I would like to make you rich but the SEC won’t allow me to do that

The ICO market of 2017 has been like the Casablanca scene – “I am shocked, shocked, to learn that investing has been going on here”. The ICO issuer has to pretend that a Coin has no beneficial interest that makes it even remotely like a security. That pretence makes it totally legal, indeed sensible and respectable, to offer worthless Coins to unaccredited investors (Josephine Q Public) while offering equity and other security like beneficial interest to accredited insiders (aka Funds and Professional Angels).

The SEC has been fighting the last war. Rather then bemoan that fact and call for the SEC to change (and grow old waiting), entrepreneurs will figure out how to legally offer security like beneficial interest with all the low cost/convenience of the ICO model. Steve Jobs did not tell consumers to stop downloading free music or tell music labels to stop suing customers; Jobs offered a cheap/convenient and legal service called iTunes.

Some commercial ventures simply need a better funding model. Some ventures also need a different operating model, which brings us to impact investing and digital cooperatives.

First, lets look at the last of the three big drivers of change – the enabling innovation coming from the protocol layer.

The enabling innovation coming from the protocol layer.

The current phase of the ICO phase of is based on one picture (which comes from Fred Wilson of Union Square Ventures):

fat app layer

fat protocol layer

There are two possibilities here:

One: this theory is wrong. The big value creation in the Decentralised Internet will be at the App level of the stack, just like it was in the Centralised Internet era.

Two: this theory is correct and there is some massive opportunity at the protocol layer.

My thesis is that there is no value capture at the bottom of the stack, but a lot in the middle and that the value creation at the top of the stack will be done through Digital Cooperatives (which we will come onto later in this post).

First, why do I believe there will be no value creation at the bottom of the stack? This is what I call the commercial TCP/IP layer mirage.

The commercial TCP/IP layer mirage.

TCP/IP is often used as an example to describe the protocol layer opportunity in the ICO market. What if you could invest in a commercial equivalent to TCP/IP for the decentralised Internet?

TCP/IP obviously enabled massive value creation – at the app layer. You could say “value creation was at the protocol layer but value capture was at the app layer”.

The reason that the commercial TCP/IP layer investment thesis is a mirage is simple. Internet protocols such as TCP/IP, SMTP or HTTP would not have got the same traction if some commercial entity controlled them and was extracting a fee.

Ethereum is the closest thing we have to a protocol layer for decentralised Internet. The Ethereum founders debated vigorously what model to follow. They opted for a non-profit Foundation model. I doubt it would have got the same traction if it had been a commercial venture at its core.

Wintel was a different era that won’t be repeated. Nobody will ever repeat the level of dominance that Microsoft and Intel had at the bottom of the stack. Chasing that dream is a recipe for burning  capital.

However, just up a notch from the bottom of the stack is the middleware layer. This is where a lot of enabling innovation is happening.

The middleware layer of the Decentralised Internet

During similarly early days of the Centralised Internet, in the mid to late 1990s, we had a market that generically was called middleware (between the app layer at the top and the OS/DB at the bottom). If you can remember things like Web Application Servers you have carbon-dated yourself.

The Decentralised Internet era has a similar middleware layer emerging. This time the services relate to things such as Identity, Provenance, Data Validation, Exchange and Payment that a) all apps need and b) will be done quite differently in the Decentralised Internet era.

The App Layer benefits massively from using these middleware services. The mantra is “write less code”.

The App Layer will be great for the world, less so for VCs, because so much of it will be non-profit or owned by cooperatives. For the kind of value capture that VCs like, the middleware stack will be great. The App Layer will have a bigger impact but will not primarily be funded by VC. The App Layer will have a lot of what we associate today with  Impact Investing, but even this will be changed by Blockchain.

Impact Investing

Family Offices (Single and Multi) usually have a big Impact Investing focus. The idea is to “do well by doing good”, by investing in ventures that will generate a reasonable economic return while also changing the world for the better. Impact investing makes sense for them because Family Offices are investing for multiple generations and they want to leave their future generations with a better world, not just with money.

Whatever the social mission (saving the environment or financial inclusion or reducing inequality through economic empowerment or better health or eduction or…), impact investing is about getting the balance right between profit and social good. Impact ventures are for profit in the sense that they generate profits by selling goods and services for more than they cost; they are not dependant on philanthropy to sustain themselves. They pay employees and contractors through this profit. They may also distribute some profits to shareholders who funded the early stage, but this is not the shareholder primacy world of the past. That is why impact ventures are often and incorrectly labelled non-profit. They are for profit; it is just that producers (employees and contractors) and customers are as important as investors.

Technology and ICOs are impacting this by bringing the idea of Digital Cooperatives into focus as a way to a more sustainable version of capitalism.

Capitalism in Crisis

Capitalism as we know it today is in crisis. Communism failed visibly after the collapse of the Soviet Union. It is clearly a failed system/ideology. Sadly, when Capitalism lost it’s natural enemy, after the collapse of the Soviet Union, Capitalism also started to fail. During the Cold War, the West had to convince people in both the developed and developing world that their system was better for the people by spreading wealth broadly. After the Berlin Wall collapsed, wealth went to a smaller and smaller group of people. Without a stake in the capitalist system, people moved to populism of both the left and the right and this came to a head in 2016 with Brexit and then the resurgence of the left wing of the Labor Party in the UK and the election of Donald Trump in America. Populism of left and right could destroy capitalism, which will be a disaster because the alternative (communism) has already been proven to fail.

The best hope for a revised and sustainable version of Capitalism comes from the concept of a digital cooperative where producers, customers and owners are aligned. We can see the early signs of this in some of the best ICOs. The ICO model is ideally suited as the funding and governance mechanism for Digital Cooperatives.

Digital Cooperatives

The idea of Cooperatives is not new. It works in many markets; think of Community Banks and Coop grocery stores for example. These are Customer Cooperatives; the shareholders are customers.

One example of a Customer Cooperative is Vanguard. The customer in this case is a shareholder of the funds. There are no outside investors. This structure allows Vanguard to charge very low expenses and this is what Efi Pylarinou on Daily Fintech dubbed the Vanguard effect. It makes Vanguard the real disrupter in the Wealthtech segment of Fintech. When they started in 1975, their average expense ratio was 0.89%. By 2014 this had dropped to 0.18%. Given their scale, network effects and customer ownership structure, nobody can undercut Vanguard on price and in a commodity such as ETF, price is the deciding factor. The growth numbers (tell the story:

  • 32 years to reach $1 trillion in assets
  • 8 years to get to $2 trillion
  • 3 years to get to $3 trillion.

At the top of the WealthTech stack are the Single (SFO) and Multi Family Offices (MFO) where the shareholders are the owners. Intermediaries to SFO and MFO still get paid if these intermediaries deliver value, but they do not control the game in the same way that intermediaries serving the less wealthy control the game.

In short, ownership matters.

In the analog era there were many Worker Cooperative experiments. They mostly failed due to a simple alignment of interest issue. If employees are owners it is too simple to get employees to vote for a pay increase that will make the business unprofitable; it is a tragedy of the commons. The resurgence of left wing populism is bringing back these ideas, but they are likely to fail for the same reasons.

A Producer Cooperative aligns better with the reality of the Gig Economy (which is the norm in the Rest of the world). The Producer Cooperative is based on free agents such as doctors or drivers. We have profiled some examples on Daily Fintech (such as a Dentist Cooperative). The idea of a Producer Cooperative is simply that the ownership of these gig economy networks remains primarily with those who provide the services in those networks. These free agent entrepreneurs will be much more thoughtful about when and how to raise prices than a salaried employee might.

There are also User Cooperatives.

Imagine if Mark Zuckerberg’s next door neighbour at Harvard had the same simple brilliant idea for a social network and built a good enough product, but decided to offer the first few thousand users a big % of the equity. He or she would be very wealthy (albeit not as wealthy as Mark Zuckerberg) and few thousand people who made it happen would have had their lives changed.

In the case of social networks, the User is also the Producer; they produce for free in return for getting a free service. They are also the Product being sold to advertisers. So a User Cooperative is slightly different from a Producer Cooperative.

A Digital Cooperative (whether Customer or Producer owned or some combo) applies digital efficiency to the simple idea that ownership should be shared among those who create the value.

A well designed ICO enables a Digital Cooperative. Again the Ethereum ICO is an example. The early Ethereum investors were also the  early producers and the early customers building the DAPPS. Through this simple alignment of interest, Ethereum overcame both technical and market risk.

In many cooperatives, the ownership is incidental. You care about the good prices at a Community Bank/Vanguard/Coop Grocery; your ownership stake is incidental. The ICO with its liquidity makes that ownership more valuable but it is still not the primary consideration. The ICO with its liquidity will enable many more Digital Cooperatives to thrive. It may become the primary form of company in the future.

The ICO disruption took everybody by surprise.

That is why they call it disruption. If a lot of people forecast a trend, it is less likely to be disruptive.

Many people wrote about how the VC to IPO innovation capital business was broken; but although the problem was obvious, no real change happened for decades and the status quo seemed locked in forever. Many people wrote about how Ethereum would enable new crypto economic markets and governance structures, but that seemed highly theoretical and geeky. Many people wrote about how real time settlement using blockchain would change how the capital markets operated, but that seemed limited to the B2B realm. Nobody connected all three dots to show how a completely new permissionless network would emerge so rapidly in 2017 offering:

  • A better way to manage technical and market risk for investing in early stage ventures.
  • A shorter path from garage to liquidity to enable ventures, both for profit and non-profit, that would never have seen the light of day in the old model.
  • The enabling innovation from the middleware layer of the protocol stack that reduced the time/cost to create the world-changing applications of the Decentralised.
  • A new form of impact venture, the Digital Cooperative, that promises an inclusive, sustainable model for the future of capitalism.

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Bernard Lunn is a Fintech deal-maker, author, investor and thought-leader.

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Why the Third Wave of Fintech is fundamentally different

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My career began in the middle of Wave 1. It is hard to see this as exciting and disruptive today, but it was at the time. We were replacing paper process with computerised processes and the payoff was huge. The business model was KISS – develop software and license it to banks. All the risk/reward went to banks. There was not much VC in those days, so we bootstrapped from customer revenues.

Wave 2 is what we have been calling Emergent Fintech(vs Traditional Fintech = Wave 1). Wave 2 leveraged the SMAC technologies (Social Mobile Analytics Cloud) that had reached mainstream adoption. Startups beat incumbents by creating better User Experience (UX). It was only a question of time before incumbents caught up by creating better UX. During the time when incumbents were playing catchup, some Fintech startups got to critical mass and network effects and so become long term winners. However, many Emergent Fintech startups do not have any major moat against incumbents.

I use 2014 as the watershed year as a) 2014 was the year of the Lending Club IPO which was high water mark of Wave 2 and b) 2014 was when Ethereum was born, and Ethereum is a big enabler of Wave 3.

Wave 2 could be easily coopted by incumbents. It was an era of pugnacious public talk, but with private negotiations around partnership and collaboration. Banks needed startups and vice versa. Wave 3 is harder for incumbents to control. It is not being financed by incumbent VCs and this wave of ventures need less capital, because they  don’t need to buy giant server farms in order to scale (the user’s machines are the servers).  There is still a lot of opportunity for incumbents to add value, but they do not control the pace of change.

A lot of the activity around “enterprise blockchain” is an attempt by incumbents to get back to the “good old days” of Wave 1 when they controlled the pace of change. As Andreas Antonopolous points out, the conversation with Banks starts with “we are not interested in Bitcoin, more in the underlying Blockchain technology”. Then when Blockchain technology becomes divided into permissioned and permissionless, the conversation shifts to ““we are not interested in Blockchain, more in the underlying Distributed Ledger Technology (DLT)”. At that point they take a call from their favoured enterprise software vendor about their latest version with its DLT features. This would be like Kodak upgrading their ERP system to deal with the disruption from digital photography.

The ICO innovation was to raise money without selling securities. You get customers to buy your coins which they can use to buy your products. That is a “back to the future” world. It is like Wave 1 when we financed from customer revenue. This puts entrepreneurs fully in control. The incumbent can no longer call a VC and say “we would like to buy Company X in your portfolio”.


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Bernard Lunn is a Fintech deal-maker, author, investor and thought-leader. 

Get fresh daily insights from an amazing team of Fintech thought leaders around the world. Ride the Fintech wave by reading us daily in your email.


Michelle Moffatt – the agile fintech auditor

Regulatory pressure, new regulatory models, cyber security, big data, small data, new payments platforms and standards, digital identity – there is no question the risk landscape is increasingly mottled with potholes for both traditional financial institutions and fintech startups. Potholes big enough to cause a business a serious flat tire, or at least make the ride somewhat uncomfortable.

This week I spoke at the International Auditors Conference in Sydney, Australia, sharing the stage with a friend and ex-colleague of mine, Michelle Moffatt. We took attendees on a mobile payments discovery journey – from where we are today to the new emerging voice activated platforms and forays into virtual reality payments. The message we had for the audience was simple. To effectively audit these sorts of innovations you have to be across the fundamentals of the technology and be part of the product journey – from inception to launch.

Michelle previously headed up the internal audit function at Tyro – an SME neobank/challenger bank in Australia, Michelle now holds the title of Chief Risk Officer at a fintech startup Spaceship.

Michelle has long been a practitioner and advocate of ‘agile auditing’. She, like a growing number of auditors in the fintech space, is acutely aware of the rapidly changing risk landscape, not to mention the increasing pace of change.

There is nothing worse for an organization when one agile arm (often the development side of the house) comes up against a non-agile one. This has huge implications on the traditional internal auditors role – a function which historically is only introduced at the end of the project.

However there is a growing need for more auditors like Michelle in the space. Auditors that are willing to come on the journey with the team, yet retain their independence. While this type of cultural shift will be notoriously difficult for an incumbent, there is no reason why a startup can’t adopt this approach with their internal audit function from day one. This is one more way the incumbents’ benefit of scale can be eroded by smart technology and alternative cultural thinking.

After the conference I asked Michelle for some feedback on a number of themes that cropped up throughout her presentation. Here are her high level take-away’s.

Audit processes must mirror startup processes – so agile is key

Starts ups are moving quickly so to keep pace internal audit has to mirror the way they work. Agile audit allows you to give feedback early in the product creation piece so that what matters most is taken into account.

Audit culture in startup land verses big financial institutions has fundamental differences

Starts ups are generally more nimble, flexible and have a greater need for pragmatism and commerciality. They are typically flatter structures, and easy access to key decision makers ensures audit feedback & findings are implemented faster.

On the flipside, larger organizations have the corporate support and access to resources that startups typically don’t have.

Both cultures can learn from one another, or find leverage.

Adopting a learning mindset to emerging technologies is critical to the risk and audit function in fintech

Apart from key technical skills and a base level of proficiency yourself, whatever niche you operate in, you can’t afford to sit back and not engage or understand the technologies you are auditing. This includes potential competitive technologies.

Aside from emerging technologies, you need to understand the emerging micro-cultures of the teams you are auditing. I strongly suggest internal auditors attend meet-ups in their space and network internally. It’s a constant education process with the subject matter experts. What is great about this is it builds your own sphere of influence.

What advice would you give to other auditors working at challengers/neobanks, given your time working at Tyro?

1) Don’t freak out, figure it out.

2) Have an open learning mindset

3) Go back to basics – auditing 101

4) Apply common sense, be part of the solution and trust your gut.

What is the internal auditor doing differently 5 or 10 years from now?

Much of the routine work is already being replaced by scripts, with auditors providing the valuable analysis of the results in a commercial solutions orientated way. All internal auditors will have both commercial and technology as technical skills and will be able to plug and play into any audit, any time anywhere with the freelance model on the rise.