Nov 30, 2022
Stripe’s strategy map; Key risk factors for Embedded Finance (EmFi); B2B marketplaces; Is it wrong for DeFi projects to track data?;
In this edition:
1️⃣ Neal Stephenson on the Future of the Metaverse
2️⃣ Case: Smart contract
3️⃣ Why Pricing Optimization can be a Financial Lifeline for FinTechs
4️⃣ What are the latest product trends in fintech?
5️⃣ B2B Marketplaces
6️⃣ Stripe’s strategy map
7️⃣ What Is A dApp?
8️⃣ Key risk factors for Embedded Finance (EmFi)
9️⃣ Is It Wrong for DeFi Projects to Track Data?
🔟 How crypto goes to zero. If everyone stopped using it
And many more….
***
What Is Crypto Contagion? How It’s Spreading After FTX Collapse
When a large institution like the cryptocurrency exchange FTX implodes, it drags others down with it.
That dynamic is what’s referred to in finance as contagion, or the tendency for a financial crisis to spread to other institutions, markets, and regions.
Since FTX filed for bankruptcy on November 11, there’s been a growing list of other companies that have had to disclose their “exposure” to FTX and its related companies FTX US and Alameda Research. In this case, having exposure means a company lent money to, received commitments from, invested in, or had funds deposited with FTX.
For example, Genesis Trading said on November 10 that its trading desk has $175 million in “locked funds” in its FTX trading account. The company later had to suspend withdrawals from its lending arm, citing “unprecedented market turmoil.”
On the same day, crypto exchange and stablecoin issuer Gemini announced withdrawals from its Earn product may be delayed, a knock-on effect of Genesis, the lending partner for Gemini Earn, suspending withdrawals. That was one day after Gemini initially said it had no exposure to FTX — it turned out it did have exposure to Genesis, and Genesis had exposure to FTX.
As a side effect of Gemini’s news, traders on decentralized finance lending protocol Aave were lining up to short Gemini Dollar, GUSD, in anticipation that the firm might become another victim of the FTX contagion.
Now there’s on-chain data that suggests the events leading up to FTX’s collapse were originally triggered by the Terraform Labs collapse, which happened in May 2022.
That would mean, as is often the case, that one source of financial contagion, FTX, links back to another epicenter of contagion, the algorithmic TerraUSD losing its 1:1 peg with the U.S. dollar and wiping out $40 billion in a matter of days.
After TerraUSD collapsed, the resulting contagion led to hedge fund Three Arrows Capital, lender Celsius Network, and crypto broker Voyager Digital to file for bankruptcy over the next two months.
Even before Terra and FTX, there have been other examples of contagion working its way through crypto markets.
Source Decrypt
***
Case: Smart contract
To illustrate a smart contract, let’s say Alice and Bob enter into a bet.
Alice thinks that the temperature tomorrow morning will reach 70 degrees Fahrenheit. Bob thinks that it won’t. They wager 0.01 bitcoin on the outcome. (In this example, the digital currency is bitcoin, but any other cryptocurrency could be used as well.)
If Alice and Bob don’t trust each other, they will have to use a trusted third party as an escrow agent. In other words, they will each have to give the agent that amount of money, and the agent will distribute the winnings and the amount staked to the winner.
There’s no way around the middleman in this scenario, even using a cryptocurrency like bitcoin. And the Bitcoin blockchain has no way to record this “contract.”
Ethereum, on the other hand, offers a solution. Alice and Bob could agree to use some basic code — an “if, then” contract of sorts — that pays out based on the temperature. If the temperature is higher than 70 degrees Fahrenheit, the code is programmed to pay Alice; otherwise, it pays Bob. Alice and Bob could then place their “programmed” bet on Ethereum’s blockchain. At that point, it becomes binding from a technological standpoint.
This is a “contract,” because Alice and Bob have agreed to its terms, to a degree transforming code into law. It’s “smart” and “decentralized” because all participants in the Ethereum blockchain hold a copy of this contract.
Just as all Bitcoin “nodes,” or participants in the system, know that Alice sent Bob 0.01 bitcoin, all Ethereum nodes know that Alice and Bob have entered this bet.
Let’s watch this smart contract execute in real time:
- Alice and Bob enter into a bet and place this bet on the Ethereum blockchain. All “nodes” on the Ethereum blockchain now hold a copy of this smart contract.
- Alice ends up being correct — the temperature is higher than 70 degrees Fahrenheit. The contract “self-executes” based on this information and sends the funds to Alice’s account.
- Since all nodes hold a copy of this smart contract, all nodes independently confirm that the contract has executed correctly. The new state of this executed smart contract (i.e., Alice as the winner of the bet) is added to the Ethereum blockchain.
- This entire process is recorded on Ethereum’s blockchain, creating a “common digital history” around this bet.
Smart contracts like these are what make Ethereum so compelling. A smart contract allowed Alice and Bob to build a very small “decentralized application” — their wager “self-executed” and paid out without using a middleman. What if we could build larger and more complex decentralized applications, i.e., souped-up smart contracts that can do complex things?
Thus, Ethereum creates a blockchain for any programmable use case — which we delve into below with dapps — whereas Bitcoin’s blockchain was pioneered exclusively as a payments application.
Source CB Insights
***
Why Pricing Optimization can be a Financial Lifeline for FinTechs
FinTech companies have experienced a boom in recent years, but the arrival of challenging conditions has added pressure to those that are yet to adopt an effective pricing strategy.
Section 1. The FinTech industry is in a rough patch
Yet many FinTech companies are very shy to adjust pricing due to several main reasons:
• Overestimated customer price sensitivity — many think “in a dog-eat-dog market if prices are raised, clients will flee”
• Lack of pricing transparency — most CEOs know their sales volumes for last month but have no clue how to measure price realization or productivity
• Technology and data limitations — tech stacks are not ready to execute personalized pricing and there is a lack of real data from past experimentation to enable risk / propensity based pricing
Section 2: Pricing is an important lever
In B2C pricing there is limited one-on-one negotiation while B2B prices are almost always negotiated, leading to all flavors of bespoke pricing and price leakage. In many cases products themselves are also customized for B2B versus mores standardization for B2C, further impacting the pricing discipline.
Section 3: Pricing frameworks & opportunities in FinTech
Achieve higher price productivity:
• Raising overall prices — based on the perceived value of your product to customers, driving up the list price
• Rationalizing discounts — especially in the B2B world
• Pricing model — changing the basis of pricing or the underlying monetization model when it works to your unique advantage
• Optimizing price discrimination — by customer segmentation, recognizing that all clients are not equal and their price elasticities vary
Deepen wallet and increase customer stickiness by selling the full franchise:
• Pricing & packaging architecture — how you modularize, tier, and bundle your offers in a way that customers perceive significantly more value from a higher bundle while the incremental cost remains low for providers
• Monetization strategy — what you choose to monetize and what you choose to give away for free to drive adoption of higher value services
Smoothen revenue profile:
• Pricing model — changing the basis of pricing from price per widget to price per subscription for example
Section 4: What it takes to capture the benefits?
• Price variability across customers — do you have customers quite similar in nature paying significantly different amounts due to contract negotiations, special discounts, sales practices, timing of customer acquisition, etc…?
• Leakage in price waterfall — what are the key sources of leakage in the price waterfall overall and by customer, are they being actively managed and minimized?
• Under-managed price ladder — is pricing appropriately tailored to align with value by segment? Is there adequate differentiation, upselling, tiers, …?
Source Boston Consulting Group (BCG)
**
What are the latest product trends in fintech?
To learn more about the ‘role of product’ in the fintech sector, Strebkov Design conducted a benchmark study in partnership with the fintech news media, Everly — challenger bank news which I also had the pleasure to contribute to!
Over 100 fellow fintech product specialists from brands like Wise, EasyPaisa Exchange, American Express, Minted, and Playter completed the survey and shared their insights on their:
- Internal product operations and structure
- Level of experience and remuneration
- Challenges and opportunities, and
- Investment plans for the future.
Research methodology:
The study was implemented over the course of three weeks in October 2022 and involved surveying 100 product-related professionals from the fintech sector. The survey was completely anonymous and included 15 questions aiming to gather some key information about the current state of product:
- Operations and structure
- Level of investments and remunerations
- Challenges and opportunities within the fintech sector
***
B2B Marketplaces
B2B Marketplace funding has remained relatively steady during market shakeups.
Compared with other industries such as Health or Transportation and consumer-focused categories, B2B marketplaces have not had such a reduction in inward investment in 2022.
Consumer Goods, Logistics & Lending are the highest valued segments in B2B Marketplaces.
By addressing complex value chain challenges, Logistics & Lending have joined Consumer Goods as the highest valued segments.
B2B Marketplaces have immense potential for growth.
VC funding has grown significantly in B2B marketplaces in the last 5 years, but funding levels are still only 19% of that of their B2C counterparts.
**
Stripe’s strategy map
Payments company Stripe is the second most valuable private company in the world. Over the last 2 years, Stripe has forged dozens of strategic business partnerships, invested in almost 20 different companies, and even made a handful of acquisitions.
Many of these relationships extend beyond Stripe’s core offering of e-commerce payments processing. Late last year, Stripe announced partnerships with Barclays, Citi, and Goldman Sachs to provide business banking-as-a-service.
In February 2021, Stripe partnered with Afterpay to expand its merchant offerings to include buy now, pay later checkout. And in August 2021, Stripe made its second investment in the same year into B2B payments platform Balance.
Source CB Insights
***
How the FTX Collapse Is Impacting Fintech
JPMorgan Chase & Co. Payments Global Head of FinTech and Partnerships Jason Tiede and Trovata Founder and CEO Brett Turner join Caroline Hyde to discuss the impact of the FTX collapse on the fintech industry, and how banks and fintechs are working together to boost adoption.
Source Bloomberg
***
What Is A dApp?
A decentralized application (dApp) is a digital platform that operates and runs on a blockchain — or some other peer-to-peer network of computers. These applications run outside the control of a single authority, and their operations run primarily automatically.
Although most dApps are built on the Ethereum blockchain, several other blockchains have also emerged as formidable competitors and are now homes to their own dApp ecosystems. And today, some dApps serve multiple functionalities — from finance and investment to gaming, social media, and more.
dApps gained prominence thanks in no small part of the growth of decentralized finance (DeFi). Many of these protocols operate without any central authority, connecting parties in a transaction for the purpose of exchanging data and resources.
How A dApp Works
To get a clear understanding of how Apps work, consider traditional apps like Twitter or Lyft. These apps run on computer systems that are owned and operated by single organizations — in these cases, Twitter inc. and Lyft Inc. With these apps, upgrades and decisions on product direction are determined by the founding companies — they control the apps and their workings, so they decide how the product works.
While there could be multiple users on one side, the organization controls the app and its backend.
dApps operate much differently. They work on blockchain networks, and they are built in a way that doesn’t require control by a single entity or organization. For instance, a developer could build a Facebook-like social media dApp and put it on a blockchain for users to engage and share content. Once the app has been put on the blockchain, it can’t be deleted. The app also operates independently of the developer’s control.
dApps are open-source, meaning that any changes made to them will need to be decided by a consensus of users. This consensus is usually reached via decentralized autonomous organizations (DAOs) — organizations that are controlled by platform users, who vote on changes and proposals.
Much like other apps, dApps require front-end codes to create things like webpages and feature sets. However, the back-end codes that they use are much different because they depend on decentralized, peer-to-peer networks to operate. These back-end codes are why dApps aren’t controlled by a single entity.
Another peculiarity of dApps is that they are supported by smart contracts. These smart contracts are responsible for enforcing the rules that govern the dApps themselves — if a condition is met, then an action is taken. The smart contracts themselves are stored on blockchains, so they are immutable and permanent.
Source Arf
***
Key risk factors for Embedded Finance (EmFi)
Embedded finance is not without its challenges. Key challenges that could hinder the evolution and uptake of embedded finance in the future include:
Evolving regulatory landscape:
The financial services sector is highly regulated in most jurisdictions around the world. Even within a given jurisdiction, the presence of multiple regulatory authorities is not uncommon. The regulatory landscape for embedded finance is not as structured as for the financial services sector as a whole. In the future, embedded finance will likely come under increasing scrutiny from regulators, which could create complexities in terms of licensing, compliance, and the overall development of the embedded finance ecosystem and specific solutions.
Managing cybersecurity and data privacy risks:
Given that the internet and digital infrastructure are the building blocks of embedded finance ecosystems, exposure to cybersecurity risk is inevitable. Embedded finance players are also vulnerable to data privacy risks as they collect and share sensitive consumer data in return for enabling a seamless customer experience. As integration of APIs across multiple partners becomes more common, and the volume of transfers of complex and confidential data rises, businesses need to ensure that their systems and data are secure and that information privacy is maintained.
Forging the right partnerships:
The use of embedded finance is often dependent on partnerships and collaborations between different parties (e.g., banks, retailers, API or platform providers). This makes identifying the right partner(s) — with compatible technologies and capabilities — critical to the successful development and delivery of embedded finance solutions. Working with partners that may have different technologies or processes in place lead to operational complexities and risks if not considered in advance.
Lack of end-user knowledge:
While the concept of embedded finance has gained traction on the supply side (e.g., e-commerce players, merchants, payment providers, financial institutions), there is still limited awareness on the demand side (e.g., from consumers). This lack of awareness and understanding of embedded finance and its related concepts (e.g., open banking, data sharing, app permissions) could act as a major barrier to adoption and uptake. Regulators are also constantly looking at the approach to selling of these products where financial literacy is low, this could lead to potential adverse use of credit for customers in the short or long term.
Source KPMG Singapore
***
Is It Wrong for DeFi Projects to Track Data?
With MetaMask and Uniswap revealing the extent to which they track their users, many in the community have pushed back. Are they right?
As if there weren’t enough misery in the crypto markets at the moment, DeFi enthusiasts are now in an uproar over revelations that Uniswap, the popular decentralized exchange (DEX), tracks public user data.
True, the exchange doesn’t track personal, private data like names or IP addresses, but according to newly-uploaded terms and conditions documents, pretty much anything publicly viewable online is aggregated and harvested. And it’s not alone; earlier this week, Metamask, the popular Ethereum wallet, fessed up to tracking users’ IP addresses.
Among the many trivia collected by Uniswap, according to its privacy policy, are public blockchain data, user preferences, mobile and browser metadata, biographic data included in customer surveys (which, confusingly, includes names), and customer service communications, along with information from third-party service providers concerning “illicit or other fraudulent activities.”
That user data, it says, is gathered in order to “improve the user experience” of the DEX.
And to whom does it supply this data?
Only service providers, law enforcement, courts (in compliance with a warrant), brokerages, and M&A lawyers, to name a few entities. Basically, anyone and everyone who might be in any way tangentially involved with Uniswap Labs, the legal entity behind the exchange.
To many in DeFi, Uniswap’s T&Cs are an unwelcome introduction into DeFi of data-harvesting, Web2 sensibilities.
The user data in question is tracked via the Uniswap website, whose back end is closed to the public and is administered by a small group of developers working for Uniswap Labs, the company which develops the exchange — that is, the underlying protocol that exists on the blockchain.
This group, which was awarded 40% of the proceeds of Uniswap’s original token mint, will, after a four-year vesting period, have increased influence over the governance mechanism of the exchange.
There is, maybe, some legal justification. We’re now in a brave new world where crypto developers can be detained at the whim of governments, as happened to a developer of the privacy platform Tornado Cash in the Netherlands.
Uniswap Labs didn’t confirm or deny whether the recent arrests in the Defi world spurred its decision to publicize the data policy. However, Dan Finlay, a developer at Metamask, which has a similar data policy, told me that it was motivated by both the EU’s general data protection regulations and the hiring of a new data protection officer. But the decision was “not driven by any increase in data analysis,” he said.
Source Decrypt
***
How crypto goes to zero. If everyone stopped using it
That, in five words, is how crypto would go to zero. Still, the journey is more interesting than the destination. What would have to happen for everyone to give up?
To take out crypto entirely would require killing the underlying blockchain layers. They could either give way first, kicking the stool out from underneath everything else. Or the industry could unravel from the top down, layer by layer like a knitted scarf.
Knocking the stool out is extraordinarily hard, and the current high value of bitcoin and ether makes it even harder. To attack a blockchain and shut it down requires gaining 51% control of the computational power or value of tokens staked to verify transactions. The more valuable the tokens, the more energy it takes to attack a proof-of-work chain, like Bitcoin, and the more money to attack a proof-of-stake chain, like Ethereum. The security of these chains — as measured by the amount someone would have to spend to attack them — is now in the region of $10bn to $15bn.
Unravelling is therefore the more conceivable path. The events of this year have revealed just how prone to this sort of thing crypto is. The implosion that seems to have set the chaos in motion was that of Terra-Luna, a decentralised stablecoin system, worth around $40bn at its peak. It collapsed in May, wiping $200bn off the market capitalisation of crypto. That led a few weeks later to the demise of several lending platforms and a hedge fund, events which wiped another $200bn off the market cap. When ftx failed, it wiped another $200bn off crypto’s market cap. Now other exchanges and lending platforms look to be in trouble.
Beady-eyed readers will note that most of this stuff, apart from Terra-Luna, is in the “on top of” category and not actually on-chain tech. DeFi exchanges and lending protocols have continued to whirr even as the enterprises more akin to normal businesses have imploded one by one. But the collapse of these enterprises could imperil the underlying tech by taking out chunks of its value, making the chains more exposed to would-be attackers and pushing miners or stakers to switch off their machines. The value of on-chain activity and tokens is self-reinforcing. The more people that use DeFi, the more valuable Ethereum becomes. The higher the price of ether, the higher the hurdle to attack the blockchain and the more confidence people will have that blockchains will endure. This also works in reverse.
The total market cap of cryptocurrencies is currently $820bn. That is 70% below the peak a year ago, but still high compared with most of crypto’s history. Crypto’s reputation has been undermined before. Although fewer people will use crypto as a result of the ftx collapse, it is very hard to imagine the number will be small enough to take its value to zero.
Source The Economist
***
Open source could transform the financial industry in four critical ways
Drive standards and increase reliability
Standards exist in payments, but they are old and tedious to build to. Last year, $55 trillion moved via ACH (a format created in 1970), for instance, and 1.3 billion trade lines were reported every month to the credit bureaus via Metro2 files (a format created in 1997). Open source libraries would not only save developers the hassle of building such standards from scratch, but would also create modern reference points.
Payments have thousands of edge cases, too many for even sizable teams to keep up with. Modern open source libraries are made more robust by the many contributors who run payments through them, fixing edge cases along the way.
Open connectivity
From the U.K. to Brazil, many countries are driving open banking regulation, in which banks are required to create and maintain APIs that enable consumers to give third-party applications access to their banking data.
Developers at banks around the world are developing similar infrastructure (connections into legacy core systems, APIs to expose data) to comply with these open banking regulations. This is a repetitive process across banks and countries — where banks would benefit from open source libraries as a starting point.
Tap global networks
Two trillion dollars are laundered every year globally, often financing drug trafficking and terrorist activities. In 2019, banks spent $30 billion to combat money laundering; their efforts were effective at stopping just 3 % of such crime. That same year, banks paid $10 billion for non-compliance with federal authorities, despite software systems that continuously alerted compliance teams of potential issues. (95 % of those alerts turned out to be false positives.)
With open source libraries, banks could contribute their hard-won algorithmic intelligence to benefit the system as a whole. When one bank gets smarter at solving a particular pain point — say, entity matching — it would contribute to the collective good. We’re starting to see some movement in this direction, such as early projects that allow for intelligent search across sanctions lists. Similarly, Red Hat has open sourced rules to identify risky transactions and improve entity matching.
Increase access and reduce costs
There are three billion unbanked or underbanked people worldwide. Why don’t banks around the world serve lower-income customers? One reason is that they are making too much money. Latin American banks, for example, have some of the highest ROE (return on equity) in the world. Another factor, however, is banks’ underlying cost structure: If it costs $20 per month in software fees to keep an account open, the economics simply don’t work for account holders with low balances who will never take out a profitable lending product.
Source Andreessen Horowitz
***
Neal Stephenson on the Future of the Metaverse
When Neal Stephenson coined “the metaverse” three decades ago, his book Snow Crash was found on the shelves of “science fiction”. While the book remains in that category, many of its concepts are now found in reality…
Fast forward to 2022, where numerous companies are now building toward their version of the metaverse, including Neal himself, working on his latest venture Lamina1, drawing on his experience as a builder at MagicLeap, Blue Origin, and more.
While the present metaverses don’t perfectly mimic that from Stephenson’s early imagination, we get the unique opportunity to discuss the various design decisions that he’s making, but also the intersection between the metaverse and gaming, the involvement that AR/VR might play, the evolving role of IP, how artificial intelligence fits in, what he’s building and why, and where he gets all of his ideas from.
Source Andreessen Horowitz
