Dissecting a Bank and the Ghost of 2008

If capitalism were a religion, it would not be too far-fetched to think of banks as its temples, with the likes of Jamie Dimon, Ben Bernanke and Christine Lagarde the high priests and priestesses that guide the masses and interpret the will of the gods to deliver humanity peace and prosperity.

Thankfully, at least for now, nobody is making us go to banks on Sunday (except perhaps if you are an investment banking analyst working on Wall Street). However, banks still play a crucial role in our lives (whether we know it or not), and this makes it somewhat surprising that the average person doesn’t really have a good conception of how a bank actually works. One good example of this is that most people are blissfully unaware of the fact that the money they think the bank is safely keeping on their behalf in fact does not actually exist (more on that slightly disquieting but also amusing fact in my next blog).

Hence it is useful to provide a simple framework of how to think of a bank, and then use that to put the recent decade into context.

In its simplest form, banks exist on top of three fundamental foundations: trust and legitimacy, data and intelligence, and capital. Trust and legitimacy consists of the bank’s brand and public image (a bank must look secure and trustworthy, hence all the fancy suits and imposing buildings), and all its regulatory licenses. Data and intelligence used to be comprised of the bank’s employees and customer records, but in today’s world are rapidly being complemented (and sometimes replaced) by databases and algorithms. Finally, capital consists of all the funds that the bank is entrusted with from its customers, depositors and investors.

On top of these three foundations, banks build their products and services which they channel to their customers via a distribution network.

A simple framework to think about banks: Better frameworks exist, but this is the only one that looks like a combination of a bank and temple.

When we look at banks through this lens, we can easily see how fundamentally disruptive the events of the last decade and the crisis of 2008 has been for banks.

Let’s first consider the pillar of trust and legitimacy. With the onset of the 2008 financial crisis the trust and legitimacy pillar of the bank took a devastating one-two combo in the form of the trust and public image of banks being eroded severely as average citizens were being evicted from their homes, while the regulators also stepped in with new and restrictive regulations such as Dodd-Frank, not to mention multi-billion dollar fines.

As the pillar of trust and legitimacy was being shaken, there were meanwhile hitherto unprecedent changes taking place on the data & intelligence front. While in the past banks had relied on experienced loan officers and customer files with relatively straightforward data to make decisions, machines were increasingly stepping into the equation with powerful computers and complex algorithms creating an entirely new sort of decision science. And it was clearly not easy for banks to attract and nurture the kind of specialized talent needed to build those algorithms, especially given how scalable those technologies could be, and consequently how easy it could be to get funding from Silicon Valley for the top entrepreneurs and technologists.  

Finally, the capital pillar came under attack from multiple directions: regulatory fines, higher capital requirements, more stringent KYC (“Know Your Customer”) requirements that resulted in a ballooning back office headcount, not to mention big losses from loans underwritten prior to the financial crises all exposed considerable cracks in capital foundation of the mighty banks.

While this all sounds bad enough in its own right, 2008 also saw the advent of a development that would add to the malaise: the invention of the iPhone by Steve Jobs and the friendly folks at Apple. So while the big banking houses were having all three pillars of their core foundations shaken, the invention of the iPhone and mobile distribution saw the roof starting to leak as well. Whereas banks had relied mostly on their vast branch networks to distribute their products and services, the iPhone enabled millions of consumers to start conducting commerce on the go, all from the palm of their hand.

To illustrate the magnitude of this challenge for banks, just consider that one of the savviest and most envied tech companies of the time, Facebook, was itself caught off-guard by the advent of mobile and it took Zuckerberg & Company a year or two to fully appreciate and adapt to mobile distribution. If the folks behind the slogan “move fast and break things” took a year to get it right, just try to imagine how things looked from the perspective of a centuries old bank, in the midst of a crisis that was shaking its foundations, with regulators and media beating down its door.

A graphical illustration of a painful decade for banks

It is easy to see why the decade since the financial crisis has not been kind to banks. So, what should the banks have done? Or what can they do now? Obviously, there is a lot of firefighting happening to strengthen the foundation and fix the leaking roof, and thousands of bankers around the globe are keeping busy doing exactly that at this very moment. But to get out of the predicament banks find themselves in, there is one area that should provide a silver lining.

Banks need to get back to the core of why they exist, and that is to provide products and services to their customers. Products like credit cards were invented in a world where the nuclear families of the fifties and sixties were driving their ’57 Chevy to the newly built shopping mall to buy new and exciting consumer products such as washing machines. But the world has moved on since then. New problems exist, and new products need to be invented to solve these problems. Banks would be the obvious players to invent these products, and if they want to thrive in the aftermath of the perfect storm of 2008, this is undoubtedly what they should focus on.

The other risk is that, if banks do not create these products, somebody else will. Looking at some of the most exciting new companies in London, one can see new products being developed at a formidable speed. Income streaming (helping workers access their earned wages real-time, and thus avoiding predatory lenders – e.g. Wagestream), income sharing agreements (enabling people to borrow for school or vocational training, and only pay back if they get a bigger salary and better job which incentivizes universities to offer more relevant and employment-friendly degrees), companies that give consumers power over their data while enabling them to monetize this data (e.g. Fidel API), and companies that solve the problems faced by the elderly in a world where many people may spend more time in retirement than working (e.g. Rest Less) are just some examples.

In summary, the conclusion is simple: innovate, or find yourself relegated to history. Now is the perfect time!

Data Privacy and the Meaning of the Universe

In The Hitchhiker’s Guide to the Galaxy, Deep Thought, the second greatest computer in the Universe of Time and Space is asked to answer The Ultimate Question of Life, the Universe and Everything. In the improbable event that you have not read the book, I will not give away the answer here. But it does turn out (as is usually the case), that the question is actually more important than the answer: once people receive the answer (which takes Deep Thought 7.5 million years to calculate) they are unable to make any sense of it. Hence a new computer, which would be the only computer in the Universe more powerful than Deep Thought has to be built to tell people what the Ultimate Question of Life, the Universe and Everything actually is. That computer needs an additional 10 million years to calculate the question, but in an act of supreme irony it is destroyed by an intergalactic bureaucratic species called the Vogons five minutes before it is about to reveal the Ultimate Question.

Since the Many-Worlds Interpretation of quantum mechanics postulates the existence of myriads of parallel universes, I like to imagine that in one version of this same story, Deep Thought actually calculates the answer, but rather than revealing it, tells people that it is not able to share it because it would be in violation of the privacy laws of the Vogonian Union. After all, to calculate the answer, Deep Thought would need to be able to have access to all the personal data in the universe.

The Hitchhiker’s Guide to the Galaxy by Douglas Adams, Volume One in a Trilogy of Five

Interestingly, this is not too far from the situation we find ourselves in today. The vast amount of data currently in existence is being regulated by laws such as the EU General Data Protection Regulation (GDPR) which states that private data may not be shared without user consent, and the Payment Services Directive 2 (PSD2) which states that consumers can demand their data be shared with whomever they want. Bureaucracy can be confusing, (and in the case of the Vogons, quite lethal) and it is easy to see how one could easily think that GDPR and PSD2 very much contradict one another.

Being a humble, (and in the grander scheme of things quite insignificant) member of the body called the EU, I actually do not see a contradiction between GDPR and PSD2. On the contrary, I see intelligent design at work. The way to resolve the contradiction between GDPR (a law that prohibits companies to share personal data without user consent) and PSD2 (a law that forces companies to share personal data if people demand it) is quite simple. The data belongs to the people that generate it. If they want to keep it secret, they can, or if they want to share it, they can also do that. Data is the cyber-gold of our times, and it belongs to we the people!

So far, so good, and this is all quite empowering and exciting. However, there is a small catch: the amounts of data being generated is growing exponentially! According to one recent estimate, over 2.5 quintillion bytes of data are created every single day, and by 2020 it is estimated that 1.7MB of data will be created every second for every person on earth. And now the EU is saying that all 7 billion of us on this planet (or at least the half billion living in the EU) will be controlling the 1.7MB of incremental data that is being generated for each of us every second. Sounds great, but how exactly do we do that?

Well, for starters, I see two options. Either we sign away the right given to us by the government by blindly clicking the “I accept” button every time we land on a new page on the internet, implicitly accepting the implications of being too busy to read five pages of small print. Or, perhaps somebody, (a fintech superhero?) comes along that has managed to standardize and productize the way in which we can share and control our data. Thanks to the API-fication of data I have written about before, the standardization element has become orders of magnitude easier, where vast amounts of data can be shared and controlled via a standardized protocol.

So, the technology to standardize the data that is now being created at a rate of 1.7MB per second per person has been solved by APIs yet creating a framework that lets people easily decide what to do with their own data remains the bigger challenge. The pipes for exchanging, controlling, and sharing the data is there with APIs, but how do I as a simple consumer decide which data I share versus keep private? This is where productization, and companies like QED’s recent investment Fidel API, come into the picture.

Fidel API founders Dev Subrata and Andre Elias: Helping people control their data

Fidel API enables consumers (we the people who like to buy things like a cup of tea) to share our data with organizations such as merchants and shopping malls (that sell us the tea) by connecting with payment networks and card issuers (the friendly folks that enable us to pay for said tea using a piece of plastic). Fidel enables these connections via its API, and the end result is that the millions of bytes of data per second that I generate is only shared if it is in my interest as a consumer. If the fact that I bought a sandwich at Heathrow Airport is going to trigger a discount at a tea shop in the same airport, only then is my data shared, and I instantly get a free cup of tea. And if you’re not giving me a free cup of tea with my sandwich, you are not getting my data. It’s all automatic, all programmatic, and all controlled by an API that follows my directions. After all, in a big and lonely universe, a nice cup of tea can be worth its weight in cyber-gold.

Dumb Pipes, Smart Plumbers and API-fication of data

Speaking to my friends that work for some of the big multinational banks, a comment that I have heard on more than one occasion is that they do not want to become the “dumb pipes” on which the financial system runs. For those of you outside of fintech and banking circles, the argument goes something like this: “Banks are getting bigger and increasingly more regulated, open banking is yet another regulation that forces us to give access to our customer data, enabling others to build products on top of our infrastructure while we become the pipes of the financial system, leaving banks to do the plumbing while fintechs steal our customers and capture all the riches and glory.”

While I cannot speak on behalf of big banks, looking back at history I am not sure that being the piping is such a bad thing. In fact, going back no further than the start of the last century, we can see that just like today’s headlines are dominated by the monopolistic power of big tech, the most pressing business issues in the early 1900s were around the dominance of the big “robber barons” that literally controlled the rails and piping of the emerging modern economy.

The first example that comes to mind is usually John D. Rockefeller, widely regarded as the wealthiest American of all time, (and possibly the richest person in human history) with his wealth worth nearly 2% of the US GDP at its peak. And while controlling 90% of the US oil and kerosene market in one of the most infamous monopolies of history was the key in paving his way to such riches, Rockefeller was equally focused on controlling the pipes through which this oil would flow. The first pipeline to carry oil was pioneered in 1863 by Samuel Van Sycle (the importance of this quickly became apparent to the Teamsters union who proceeded to try and destroy the pipeline which would take away their jobs) and it was not long after that in 1872 that Rockefeller had already bought United Pipe Lines, and by 1876 Rockefeller already controlled half of all the pipelines in the United States.

John D. Rockefeller: A smart plumber with a smart moustache.

So Rockefeller certainly did not think of pipes as being “dumb” and neither did some of the other robber barons of the gilded age. In fact, when Rockefeller moved to New York in 1884, his 54th street residence was next to the mansion of William Henry Vanderbilt, whose father Cornelius had built up a vast family fortune with their railroad empire (not quite at 2% of GDP, but close).  

There are clearly analogies here for our data driven economy almost two centuries later, and I am not just talking about the odd similarity between the oversized moustaches sported by the robber barons and Super Mario, the smart plumber of the digital age.  The twenty-first century economy runs on data, and those who control the rails and pipes on which data flows can exert huge profits and influence. Whereas oil was referred to as the “black gold” of the gilded age, data is now the “cyber gold” of the information age. The importance of this is very clear in everything from Angela Merkel’s focus on how Europe is lagging behind the US and China on data platforms, to the fact that Mark Zuckerberg is making increasingly frequent trips to Capitol Hill. It is worth noting that over the last couple of centuries Zuck seems to have replaced the moustache with a hoodie, but the lack of gender diversity has not changed as dramatically as fashion has in the top billionaire ranks.

So how does this relate to the world of fintech and banking? For one thing, if I were a bank, I would be much more worried about not being the pipes versus vice versa. And rather than worrying about customers controlling (and being able to grant access to) their bank data with fintechs building new and innovative products using that access, I would worry about big tech companies such as Google or Tencent becoming the new pipes that power financial transactions.

The other lesson that banks today can glean from Rockefeller’s playbook was that in addition to his focus on using the pipes to gain a competitive advantage, one of his other business strategies was to standardise the kerosene and oil that he sold. (He did not name his company Standard Oil for nothing!) In fact, the combination of owning the pipes and gaining huge economies of scale resulted in the price of kerosene dropping by nearly 80% over the life of his company, while the standardisation resulted in improving the quality of the kerosene.  

Standardisation has huge benefits, and just like the advent of containerisation dropped costs in logistics (moving the same amount of break-bulk freight in a container is about 20 times less expensive than conventional means), the advent of APIs today enables data to connect faster and orders of magnitude cheaper. In fact this sort of API-fication of data transmission is a leading driver of newly emerging fintech businesses such as Railsbank and Fidel API, both innovative companies founded in London with a global reach, and both very much happy to be the pipes that drive the innovation of other fintechs.

Bringing together banking and pipes in a final anecdote, I’d like to share a story that used to circulate in New York some years ago. In this story, a wealthy banker from Manhattan is organising a big party in his Hamptons weekend house, and hours before the guests are due to arrive, the plumbing in the house breaks down, flooding all the bathrooms. Desperate to get it fixed quickly, the banker calls a plumber who shows up immediately but gives him an astronomical quote to fix the pipes in short order. Shocked, the banker tells the plumber, “I am a banker and even I don’t make this kind of money!” To which the plumber replies, “I know, I used to work on Wall Street as well, but I decided to become a plumber.”  

Accountants vs. Robots: Fintech superheroes to the rescue

One does not have to browse for too long in today’s news headlines before encountering a story about how machines are replacing a lot of the jobs that used to be done by humans. These stories usually come with dramatic headlines, and for an avid reader of science fiction such as myself, it feels like the next step may actually be Isaac Asimov’s vision of humans starting to develop romantic relationships with robots, or robots taking over the task of raising and nurturing our children (arguably some parents have already started taking this leap with iPads).

While it is hard to predict when the first romantic relationship between a human being and a machine may occur (for the record, in a story that he wrote in 1953 Asimov predicted that the first self-driving car would be created in 2015, and romantic relationships were just a few decades behind – so watch out!) it is clear that machines have already started to take over a lot of the jobs that people took for granted, and this has clearly caused a profound level of stress in people that are being replaced by efficient (and more effective!) machines.

As an investor in technology driven companies, I have to admit that this triggers two conflicting emotions in me: On the one hand, it is impossible not to worry about all the disruption that society will be going through with this tsunami of technological change, while on the other hand one gets quite excited about all the new possibilities that the new technology enables.

So, will we ever be able to constructively deal with our own creations becoming better than us at what we do? In an attempt to gain some insight, I decided to read a book that I thought would be relevant in this context: “Deep Thinking” by Garry Kasparov, which is a first-hand account of how the then reigning world chess champion Kasparov came to terms with being beaten by a chess playing. With the whole world watching intently, Kasparov was decisively crushed by IBM’s Deep Blue in 1997, and thus became one of the most well documented case studies of machines trumping humans.

Based on Kasparov’s public statements after the match, as well as the general media coverage back then, it would be all too easy to conclude that Kasparov did not take the defeat very well!

Kasparov on losing to Deep Blue: “I was really angry and I couldn’t help comparing [a particular move in game 2] with Maradona’s Hand of God”

However, with the benefit of twenty-two years of hindsight, it is amazing to see how Kasparov has come to terms with his loss. Everybody should certainly read his book to find out for themselves, but one key insight that stands out is that humans can actually partner with machines to beat computers at their own game. In his book, Kasparov has some rare tidbits, one of which includes Kasparov’s Rule: Weak Human + Computer + Strong Process is better than Strong Human + Computer + Weak Process. In other words, we as humans can beat just about anyone as long as we know how to employ data crunching computers on the one hand and smartly designed processes on the other hand.

So how does this all relate to the world of finance and fintech? While Kasparov was a very publicized example, it turns out he was merely the canary in the coal mine, as what happened to him soon started happening to others. Brokers, traders, accountants and all sorts of finance professionals started being impacted, not to mention other industries such as travel agencies and organized retailers. The accounting example in particular is interesting for us at QED, since we believe that there is great opportunity in the midst of all this disruption in an area we know particularly well: small business lending.

Just as Kasparov was able to see the silver lining for the world of chess in his defeat, cloud accounting software and bookkeeping automation has opened up new horizons for the accountants of the world. Rather than seeing a job being taken away, they can now see it as an opportunity to start focusing on how to devote their energies on advising their business clients on other important finance related questions beyond just balancing the books. Obviously, the most important such question is to how to grow their business, which in many cases relates to funding, something that is not always easily accessible for a small business.

Capitalise cofounders Paul Surtees and Ollie Maitland: Turning accountants into fintech superheroes.

One of our investments in particular, a London based fintech startup called Capitalise, has tackled this opportunity head-on, by creating a platform that connects the hundred thousand plus accountants in the UK with finance providers, hence enabling these accountants to do what community bank branch managers used to do fifty years ago – advise entrepreneurs how to fund and grow their business. And the timing could not have been better! As bookkeeping was being automated, thousands of bank branches were shutting down, leaving their small and medium sized business clients with nobody to talk to on important questions like what kind of funding solution to use to finance the future growth of their business.

Hence Capitalise takes the challenge created by what seems like a disruption and turns it into a win-win-win solution: Accountants can focus on providing higher value-added corporate finance advisory solutions while machines do the bookkeeping, the small businesses that had nobody to talk to about growth & funding (with neighborhood bank branches closing down) can now talk face to face with their trusted accountants, and all the alternative finance providers and banks that have less branches or a reduced physical presence can now access thousands of small businesses via trusted accountants that help create positively selected loans (i.e. much less risky loans – it turns out Capitalise accountants consistently create loans with much better credit quality). And while doing all this, Capitalise is certainly adhering to Kasparov’s Rule, utilizing smarter processes as mentioned above.

So here is yet another example of how one technology platform can help mitigate some of the disruption that other technologies are creating. While an automated bookkeeping software can only tell you how much money you spent exactly last month, a human accountant, supported by Capitalise’s platform, can actually help a business owner ask the right question: What kind of financing is right for my business?

To take a quote from Pablo Picasso that Kasparov also references in his book: “Computers are useless. They can only give you answers.” Only truly empathetic and intelligent beings know which ones are the right questions to ask.

Why QED Chose to Invest in London

This summer marked the second anniversary since I joined QED Investors to open up our London office. In those two years we have already created or invested in six UK companies that are all growing rapidly. Those of you on top of current events will have noticed that our decision must have been made after the by now infamous 2016 Brexit vote (and, yes, I was able to hold on until the third sentence of this article to mention the B-word).

So why did one of the leading fintech funds in the US and Lat Am, having invested in six out of the top ten fintech unicorns in America, choose to open an office in the UK in the midst of all the Brexit noise and drama? While answers to questions such as this are always subjective and open to interpretation, as the head of our UK office, my view is that there is a set of obvious answers to this question that are underpinned by more fundamental reasons.

In terms of the more obvious answers, first and foremost, London is geographically connected to the rest of the world in a unique manner. Sitting in London, one is simultaneously a manageable flight away from Mumbai, San Francisco, and Sao Paolo. More importantly, it is possible to have a video conference call with any of the aforementioned cities within the span of the same business day. This is the classic time zone advantage that is often attributed to London.

Moreover, London is also culturally connected: From sports (think football or tennis) to literature (Shakespeare!), the UK is connected to the rest of the world in a number of complex and subtle manners. One just has to walk the streets of Soho, Piccadilly, or Mayfair to witness this. On any given street corner, you can find people from Argentina to Zimbabwe talking to each other about and exchanging ideas in English, the Lingua Franca of the modern world.

Secondly, from a VC perspective, the crucial ingredients that a venture capital ecosystem needs are all present in London in spades: Access to ideas, capital, talent, and markets are all available more so than any other European capital. All these classic reasons that make London a natural destination is also supported by economic facts. More venture capital was deployed in the UK than in any other European country in 2018, London is the largest foreign exchange trading market in the world, etc.

However, beyond these more traditional answers there are more fundamental reasons that have catapulted London to the position it occupies today. After all, from the perspective of Marcus Aurelius close to two millennia ago, London would hardly have seemed a central and connected place as he was travelling from Rome to Cairo to meet Cleopatra. So, what are the reasons that made London so central to the modern world over the subsequent centuries, and how do they relate to venture capital?

While I am no historian, I did receive a masters degree from the University of Chicago, and in my own humble view, the first fundamental factor that set (and continues to set) the UK apart is the value it places on individual freedom and enterprise. This has resulted in a legal and regulatory system that is market friendly, while valuing intellectual property and innovation as well as free speech and thought. It is also closely intertwined with a long history of stability: The United Kingdom is one of the few countries in the world that have had continuous democratic governance over several centuries. 

The second, and equally important reason is tolerance. This is in part driven by the centuries of experience the UK has in successfully integrating diverse cultures and has yielded big dividends today in terms of diversity and a society that values mutual respect. While I have witnessed successful and well-educated expat friends of mine living in other European capitals facing difficulties renting accommodation on account of what appears to have been nothing other than their names (incidentally Shakespeare’s Juliet has an appropriate quote about this), the tolerance and acceptance of London has stood out in contrast. And tolerance in the UK extends to everyone, including the non-digitally native workers that feel frustrated at having been left behind a rapidly evolving world. The UK clearly realizes that to have a well-functioning society, the needs and constraints of everybody have to be represented and balanced, which is a complex and ongoing process.

Pictures from QED’s recent reception that took place in Soho, London

The third fundamental reason is that, the combination of tolerance and individual freedom has consequently resulted in the UK being able to attract and nurture creative communities in areas as diverse as technology, art, science, and media. Balancing creativity in areas as diverse as arts and Artificial Intelligence is not easy. And of course, it is this creativity that makes London and the UK fundamentally attractive for venture capital. It attracts the right kind of people and capital from across the globe, resulting a vibrant ecosystem.

While those are the reasons that have made London an attractive destination, last but certainly not least, one should also mention that the founder of QED, Nigel Morris is a Londoner (I know, I probably should have mentioned this at the beginning). While he moved to the US thirty-five years ago and co-founded Capital One which is now a top-ten publicly listed US bank, he still maintains a pied-a-terre in London as well as season tickets to Tottenham Hotspur (and he was willing to share said tickets with yours truly until I professed my support for a rival club in SW6). So I suppose in the end, determining why QED came to London is a classic example of historical analysis: big historical forces juxtaposed with the vision and values of individual actors. All I can say is that I am happy to be where I am, and excited about the future, both for London and the community of creators that call it home.   

Technology and financial inclusion: Wagestream as a case study

Being a venture capital investor in the fintech space, I see amazing ideas and innovations on what feels like a daily basis. As these ideas gain traction and mature, the successful ones make it into the mainstream, enabling the wider society to experience the power of this innovation, albeit probably not at a pace that feels like the world of finance is changing on a daily basis (which, incidentally, it is).

While the pace of innovation and change is only getting faster, it is important to take a moment to slow down to think about our values, and how they impact the change that is happening around us. Our values as investors, entrepreneurs, consumers, and citizens will clearly impact the world we leave behind for our children, and some of the value judgments we have to make often involve difficult tradeoffs. I will explore some of the more difficult choices in future blog posts, but today I wanted to start somewhere easy, in a place where I hope we can all agree: More financial inclusion is better.

Neither finance nor new technologies are necessarily inclusive or exclusive by design. Rather, it is how we use them as a society that determines the ultimate utility of a technology. A brick can be used to build an exclusive wall, but it can also be used to build an inclusive plaza that is open to all, or a brick road that connects people.

Today, lots of people are excluded from the immense wealth and prosperity that is being created in the world. And the list of people impacted is vast: Women, minorities, the elderly, the financially disadvantaged, immigrants, members of certain religions, nationalities or racial backgrounds have all been excluded from access to wealth and prosperity during the course of history, and still find themselves in this position today.

No one person or organization can solve all the problems in the world. However, they can tackle one problem at a time, gradually improving the world for the better. In this spirit, today I want to highlight one specific example that I happen to know very well: Wagestream.

As QED we were in a unique (and very fortunate) position with Wagestream in that not only were we the first backers of its cofounders Peter Briffett and Portman Wills, but given our unique hands-on and entrepreneur first investment style, we were also effectively a cofounder with them, helping them build the vision and the business from day one.

The initial Wagestream proposition was simple. If somebody is working hard, has earned their pay, but have not yet been paid, that person should not have to go to a payday lender to meet an unexpected expense – they should be able to access their already earned wages! And just after a year since inception, that is what Wagestream has become today – a way for workers to access their already earned wages.

Now this does not mean that lending is bad, or that Wagestream can solve all the problems of the world. For example, if the unexpected cash need the person has come up against is greater than their disposable income, or the money they have earned in that month is not enough to cover their needs, they may need a lending solution. And in those cases, responsible lenders are needed (more on that in a future blog post).

But if the money that the person needs is less than their disposable income, and if they have already earned that money, they clearly should not go to a payday lender that will charge them more than 10x.

When you consider that close to 60% of workers in the UK (and the ratio is similar in the US) cannot meet an unexpected expense of GBP 200 before their paycheck, one clearly sees how something that at first may seem like a niche actually becomes a very big opportunity for a better solution that impacts the majority of the working people in the UK.

But why did this solution not exist before? And why are the other alternatives so expensive? The answer lies in how the founders leveraged new technologies and a superior product structure that is fully integrated with employers. We will examine each one in more detail below, as this is indeed a great case study in how technology can create more financial inclusion.

First and foremost, Wagestream used both new and existing technologies to create cost efficiencies and product differentiation in a number of different ways. One element of this was new payments technologies such as virtual bank ledgers and API banking, which is an area we had been watching closely as QED for some time. As a result, we were able to help the founders design and connect to a back-end banking infrastructure that leveraged some of the fastest, cheapest, and most secure solutions in the market. Whereas before there would have been a cumbersome process, requiring customers to actually switch their bank accounts, or Wagestream requiring access to existing accounts, using virtual ledgers and API banking we were able to create a cheaper and frictionless solution.

The Wagestream team celebrating a recent funding round

It also really helped that we launched the product in the UK, which is very much on the cutting edge of payments innovation, with new products such as faster payments readily available. Faster payments is not only fast (effectively instant) as the name implies, it is also much cheaper to its predecessor products in the payments space.

The end result was a state of the art back end technology, which when combined with the automation of most operational processes, resulted in Wagestream being able to operate faster and cheaper than any similar company that had ever come before it.

These dynamics make Wagestream’s income streaming categorically different from payday lenders who have to work in an entirely different manner – they have to process each payday loan separately, onboard each customer separately, and in many cases with less automation. In addition to this cost disadvantage, a payday loan is indeed a loan, which means in addition to having to charge a high rate because of its cost disadvantage, payday lenders actually go after customers that do not pay them back, whereas Wagestream is 100% non-recourse – but that leads us to the product structure, and more on that below.

The second element that differentiates Wagestream is indeed its innovative product structure. The key differentiators here lay in the tight integration with the employers and the fact that Wagestream is fundamentally a payments product as opposed to a credit product.

With regards to the employers, Wagestream is able to achieve a very high level of integration with both the time keeping (rota) and payroll systems. Going back to the point on technological shifts, this is also made much easier with the rapid spread of cloud accounting, which is driving a lot of change in the world of fintech. As a result, Wagestream is able to see exactly the moment at which a worker has completed a shift. Combining this with its automated back end infrastructure described above, Wagestream is able to help the employer stream a pre-determined portion of that wage to the worker that completed his or her shift, who thus gets access to that portion of their earnings instantly. Whereas previously it would have been very difficult (and expensive) for an employer to process a portion of the payroll for a subset of the workers, Wagestream has effectively automated the entire process, and it all happens at the click of a button.

And with regards to the payments vs. credit nature of the product, the main thing to note is that since Wagestream is designed more as a payments product, there is no credit risk (the employee has already earned the money), and hence also no recourse whatsoever to the worker that is using the product. The only risk that Wagestream really takes is either one of payments or payroll fraud (which, given the tight employer integration is difficult), or a counterparty risk that the employer will not be able to process payroll at the end of the month. And given that even companies that enter insolvency make their payroll as a first order priority, this risk, while real, is very low.

Moreover, when compared to a product such as payday loans which in fact have very significant credit losses, the benefits of being more on the payments side become clear. Just consider that in any lending product there is an inherent level of cross-subsidization: The people that pay back their loan have to “subsidize” the lender for the losses incurred by those that did not pay back their loan. This simply does not exist with Wagestream where the concept of consumer credit risk has been eliminated.

Most importantly though, the great thing about this product design is that it is inclusive to the maximum. There is no credit underwriting of the employee, or in other words no workers that fail to get access to this because they may have a bad credit score or have had difficulties in the past. As long as their employer is a Wagestream partner they can use the product, and when that unexpected cash need arises they can access their already earned wages instead of going to a payday lender. So here it is then, technology enabling better financial inclusion – Quod Erat Demonstrandum.