2021: A Cyber Space Odyssey

It has been fifty-three years since Stanley Kubrick’s landmark film “2001: A Space Odyssey” was first released, and exactly two decades since that particular year went from being fiction to history. While talking AIs in the form of Alexa, Siri and others have now become part of human history as well, we can all feel ever so slightly relieved that the antics of HAL 9000 still belong in the realm of fiction. 

Having said that, traveling recently on a London tube carriage with my daughter, she pointed out to me that every single passenger bar none was sitting, head bent at a forty-five degree angle, face fixated on the cool glow from their smart phones, totally lost to the outside world as the aforementioned AIs were busy stimulating the dopamine receptors in their respective brains. So while HAL 9000 may not have become reality, perhaps William Gibson’s dystopian vision from the Neuromancer trilogy very much has.     

In any case, turning back to the history and fiction of fintech, 2021 was a landmark year in many regards, and those of us who lived through it are left feeling dizzy, excited, and exhilarated. While it is hard to summarize a year in a few words, here are some of the key trends of this year.

  1. Valuations went sky high. 2021 was a year of record valuations, and records were being broken at such a rapid pace, that it was difficult to keep track of what a “market valuation” for a start up should really be. Many of us in the fintech community found themselves going back and forth between the extremes of struggling with the valuations of new deals, to celebrating the successes and progress of our portfolio companies as a result. 
  1. Invisible fintech becomes real. Embedded finance is now mainstream, and we now see more and more non-fintech businesses using embedded finance and fintech as their monetization routes. Your core business may not be fintech, but fintech increasingly became the route by which companies were looking to monetize their user bases. And we started seeing more and more proof that even the big tech giants will increasingly turn to fintech for monetization.
  1. A tale of two cities. In the rapidly evolving world of e-commerce, it was the best of times and it was the worst of times. While demand for e-commerce went through the roof, the supply side got so disrupted, it was simultaneously the best time and the worst time to be an e-commerce player. Fintechs that were funding and enabling payments for e-commerce merchants went through a similar roller coaster, and the best of them were able to capitalise on the volatility and turn it into a huge opportunity. 
  1. Everybody is now invited to the fintech party, and hedge funds were no exception. This was the year of the likes of Tiger Global and Coatue coming out in force, and becoming king makers and game changers, acting fast, decisively, and with big bazookas. Very few funding rounds went by where the stance of the big hedge funds turned growth investors were not a big topic of discussion. 
  1. Crypto goes boom. While crypto has always been a big part of fintech, this was the year where investments into crypto changed by an order of magnitude. Oh, and a sovereign country adapted bitcoin as legal tender. There was in fact a quantitative shift in the amount of money that flowed into crypto related start ups, and 
  1. Web 3.0 and Metaverse were big trends in the tech world, and their reflection in the fintech universe were NFTs that went right to the heart of this question: What does it mean to own something that only exists in the digital world? In the art world, Beeple was at the forefront of tackling this question, and profited handsomely, becoming multimillionaire overnight. In a world where so much content only exists digitally, the fintech world started tackling the questions of ownership and value attribution in earnest. One can only hope that this will continue to benefit the digital artists and creators out there. 
  1. Hiring is the ultimate competitive advantage: Forget proprietary tech or other moats around your business. Those that managed to hire top talent in this market had an edge nobody else could match. This was perhaps not surprising, since after record funding rounds, all these start ups and growth companies had to deliver on their ambitious plans, and AI or not, it turns out we all still very much need fellow humans.

So looking back at all these trends, 2021 was in many ways a year of extremes and contradictions, and this was very much reflected in our world of fintech as well. 

Next up will be predictions for 2022, so stay tuned, stay healthy, and keep your seat belts fastened!

Trusting the “Fin” versus the “Tech” in Fintech

The question of whether or not people trust Fintech has recently came up in the media.

This is indeed an interesting question to consider.

For the moment, let’s put aside the difficulty of defining what exactly is and is not fintech. Arguably printed fiat money is a relatively early yet very successful example of a financial technology and trust in that particular innovation has certainly ebbed and flowed over the years depending on the political and economic circumstances. So one could easily argue that “everything in finance will one day become fintech” but for our purposes here let us only refer to the new batch of tech driven startups that have been making the headlines over the last decade or so. 

In this context, one interesting thought that comes to mind is that it is very different to trust the “fin” versus the “tech” in fintech.

We can think of the fin part of fintech as all things relating to money, regulation, capital ratios, etc. and the tech part of it as relating to all things that have to do with mobile apps, APIs, data sharing – in other words all the things that have to do with the processing and sharing of information. 

What becomes clear with this framework is that different kinds of people may trust one side of this equation but not the other. 

A particular person may feel very comfortable opening up a mobile bank account, but may not entrust their whole paycheck to that new bank account, instead choosing their old and trusted bank for all major transactions. On the other hand, somebody else may trust the new bank as it is fully regulated by the PRA and their deposits are insured, but they may feel uncomfortable conducting transactions on a mobile app as it doesn’t feel natural to not be able to actually see and touch the money. 

So what are the implications of this for the founders and leaders in today’s fintechs? 

Most importantly, they must realize that they need to live up to the dual challenge of having both their fin and their tech trusted by their users. While building up the trust in tech requires things like transparent information sharing, intuitive user experiences, and an app that hopefully doesn’t crash when it is most needed, the building of trust in the fin sphere of things requires very different attributes. 

To gain users’ trust in the fin sphere, the product proposition must be fair, non exploitative, and transparent with regards to fees and charges. The company must also be solidly funded and exude the kind of fin trust that consumers have craved over the ages. It is no coincidence that bank buildings looked so secure and imposing while the bank managers had a dress code that radiated an aura of dependability. If people are to trust somebody with their financial decisions, they have certain conscious and subconscious expectations that have to be met.

It is very interesting to consider what the 21st century equivalent of a solid bank building with security guards is for today’s digitally native financial service providers. Surveying the landscape here a few commonalities stand out. For example the number (usually measured in millions) of users that already use the service in question is usually advertised prominently, and so is the various quality certifications and memberships in respected industry bodies.

Surely, this space will continue to evolve, and as today’s fintechs become more and more mainstream, we will see how they continue to build the trust of the consumers in both the realms of fin and tech.

In the end, all trust is underpinned by delivering on the brand and service promise day after day, and while building up trust can take years, if not careful, it can be torn down in an instant. Hence, the best advice for the operators out there is to be conscious about building trust and delivering on your promise, and only break that promise at your own peril. 

Good Growth and Bad Growth

If there is one metric the VC community seems obsessed about, it is probably growth. In fact, at times it seems that everything is measured with the famous “X” – 2x growth, 5x conversion, or the much coveted 10x, which is simply referred to as an “order of magnitude.” 

This is, of course, very much understandable. When you start a business with a small team and a big idea, competing against incumbents that have 100x (there we go again) your resources, it is only natural that you want to catch up as fast as possible. After all, we can think of incumbents and fintech startups as being in a race: startups are trying to get to get to scale before the incumbents figure out how to deliver digitally native, intuitive, and seamless user experiences.

But one thing that sometimes gets forgotten in this quest growth is that not all of it is created equal – there is such a thing as sustainable and unsustainable growth. In fact, nature offers us a lot of interesting parallels here given that most living things are in a life and death race for existence, and all things being equal, natural organisms, much like startups, are trying their best to grow exponentially at the early stages of their existence.

Consider for example early embryonic development. Once a zygote is formed, an eight week long embryonic development process starts, with the cells in the zygote doubling (that’s exponential growth for you), until a fetus is formed eight weeks later. If all goes well, this process then continues with the fetus developing further, until a baby human is born around 40 weeks after the zygote is first formed! The cell division that underpins this process is of course very much sustainable, according to a grand plan, and one that all of us have experienced though we certainly cannot remember it. 

Now consider a much less pleasant topic, and hopefully one that nobody reading this will ever have to experience – malign growth of tumors. In the early stages of tumor growth, cells also divide exponentially, creating two daughter cells each time. This, however, is very much an unsustainable form of growth, which if left untreated leads to the collapse and breakdown of its host environment, the human body. 

The analogy for startups is that you certainly want to make sure that your growth is of the sustainable kind, and one which will result in a fully developed and independent organism at the end of the journey, and not one that is at odds with the environment in which you exist.

The key to achieving this is complex, and involves several aspects, from human resources to finance, and from product to technology. We will touch upon two particularly crucial ones here, sustainable unit economics and the right human resource infrastructure. 

First, let us consider the business model and finance side. If your growth is not underpinned by solid unit economics, you can grow, but will forever be at the mercy of what can be very fickle capital markets. Yes, funds may want to come and invest in you in one round after the other as long as you are delivering your “X”s, but if you cannot manage to solve the simple equation of “revenues minus costs is greater than zero” eventually, you will never be able to control your own destiny.

In fact, back in the early days of scaling Capital One, we used to say one sometimes has to “go slow to go fast.” This referred to the fact that we would conduct tests on certain segments of the population, and then wait for as long as twelve to eighteen months for that data vintage to mature so we could get an accurate read of the risk characteristics of that segment. However, once a particular segment was proven, we would go from a test on two thousand customers to a full roll out on millions of customers overnight. That was going slow so that we could later go fast, and it was all about having a plan and about sustainability.

In fact, many of our UK investments have also utilized this very framework: ClearScore spent its very early days perfecting its model and assumptions, and once the team saw the path to sustainable unit economics, they scaled from a standing start to ten million customers in little over a couple of years. Similarly, Capitalise who is positioned as the super platform in the SME space, first fine-tuned its unit economic model, which then enabled it to not only survive the shock and dislocation of Covid in the SME space, but in fact come out of it stronger, with more customers and exponential growth in revenues. 

The second and equally important element of sustainable growth is on the human resource side of the equation. Setting up the infrastructure for hiring the right kind of people is of paramount importance, and never as easy as it looks from the outside. To use one last saying from the early Capital One days, we were “not in the consumer finance business, but in the people hiring business.” The whole organization at Capital One, from the first year analyst to the division VP, all spent a very significant part of their time recruiting, scouring college campuses for talent. 

And hiring is not just an exercise in throwing bodies at a new opportunity – it has to be done in a very deliberate and thoughtful manner, making sure the right people get allocated the right roles. Diversity is of paramount importance here, and as I touched upon in a prior blog, more diverse organizations also make for more resilient organizations. Sometimes surviving an unexpected but existential crisis is even more important than growth, and the kinds of organizations that have been able to cultivate an environment where people from very different backgrounds can flourish are much more likely to demonstrate such resilience. 

Growth is essential, but it has to be balanced with a solid master plan and a sustainable model for it to fulfill its true purpose: creating new businesses and industries that exist in balance with their environment. 

Digitization, Automation, and the Hierarchy of Human Needs

Real estate is one of those unique asset classes that has various forms of appeal to almost everybody. When you get right down to it, real estate appeals to our deepest rooted instincts of shelter, security and community. In an evolutionary sense, it even transcends our mammalian roots and gets deep down into our reptilian brain. 

It is no coincidence that Abraham Harold Maslow (20th century American psychologist famous for framing a hierarchy of needs for psychological health predicated on fulfilling innate human desires) put shelter right at the bottom of his pyramid, right above fundamental physiological needs such as breathing, water, food and sex. 

Abraham Harold Maslow, 1908–1970, American psychologist best known for modeling a hierarchy of human needs

While real estate has such fundamental appeal to humans, real estate investing takes this desire for safety and builds on it with complicated terms like gross yield, net yield, return on investment, and leverage to name just a bit of the jargon that usually goes along with real estate investing. So yes, as we start investing in real estate we transcend the reptilian brain, and start engaging our frontal lobe with cash flow projections and predictions around which country or which city will see rental incomes rise.  

In this context, it is no surprise that real estate is the single biggest asset class in the world. Just to take the UK as an example (otherwise the numbers simply get too big!) UK residential real estate is an asset class of GBP 7.4 trillion. Buy to let investing (where landlords buy property for renting, also knows as BTL) equates to a “small” subset of GBP 1.4 trillion. Just to put this in context, the FTSE all-share index (in effect the value of all publicly traded companies in UK, many of which are international and operate globally) is GBP 2.4 trillion and the value of all loans outstanding to UK SMEs (Small and Medium Sized Enterprises) is about GBP 0.18 trillion, or 180 billion.

But while real estate is big, and appeals to both our analytic and primal instincts, it is one of the least liquid asset classes out there. One can trade shares on the FTSE in a a matter of milliseconds, exchanging ownership in AstraZeneca with ownership in Unilever in an instant. Business loans can be traded in a matter of hours. However, trading real estate can take months in the UK. So ironically, the biggest asset class is also the one that is least liquid.

This is exactly where GetGround and companies like them operating at the intersection of Fintech and Proptech come into the picture. There is no intrinsic reason why trading real estate should take months – in fact, many of the constraints that slow down this process, which at times can be outright frustrating, can be solved with technology. And this is exactly what GetGround does: turning the currently slow and arduous process of owning and investing in real estate into one that is smooth, simple, and secure.

At its core, GetGround enables its customers to buy, incorporate, bank, fund, and manage their property with just a few clicks of their mouse. Let’s now examine each of these five steps in more detail, and why each one is so important.

First and foremost, the process of buying property involves tons of documents, legal agreements, searches, negotiations, etc. We will examine what GetGround does in more detail on the buying side in a future blog, but suffice it to say that the process just asks for standardization, and with its technology driven approach GetGround can standardize all these documents giving confidence to all parties that are involved in the transaction. More importantly, as GetGround is positioned in the centre of the ecosystem, there are tons of so called network effects where GetGround can leverage its central position to help its customers buy their desired property.

Buildings may change, but the human desire for real estate and shelter does not

Secondly, and this is one of the platform’s core features, GetGround helps landlords incorporate a company that holds their property. Many of us take companies for granted as something that has always been part of human life, but as Yuval Noah Harari states so elegantly in his book Sapiens, companies are nothing more than a shared fiction that humans all subscribe to. But while companies may be nothing more than a creation of our collective imagination, they have very real financial benefits in real life. When applied to properties, these benefits include more efficient tax structures, better inheritance planning, better governance, and more standardized and easily exchangeable ownership structures to name just a few. Hence, GetGround has built a product (including direct API connections to the UK Companies House) that enables their customers to incorporate a company with a few clicks, and put their property into this company, all with automatically generated, customized, and standardized legal documents. 

The third benefit follows logically from the first two: Once a landlord has bought a property and put it inside their newly incorporated company, it only makes sense to open a bank or e-money account dedicated to that company and property for collecting all the rental income into one dedicated place. This makes it very easy for the landlord to track all their rental payments affiliated with one company in one place, which in turn makes things like tax filing and expense tracking much easier.  

Funding the property is then the fourth area where GetGround helps, and it does so by connecting its landlords to all the various banks and lenders that are looking to deploy their balance sheets to fund these properties with specialized BTL mortgages. BTL mortgages are one of the fastest growing segments in the UK mortgage market, and GetGround creates the ideal platform where lenders and landlords can meet. From the landlord’s perspective, they have just acquired a property and they appreciate the introduction to lenders, whereas from the bank’s perspective, the standardized documents and e-money account GetGround provides makes everything more standardized and secure, all accessible in one centralized platform. 

Finally, in terms of managing the property, there are tons of needs ranging from furniture removal to renovation that need to take place, along with financial management needs such as tax filing. GetGround is in an ideal position to connect its customers to the experts that are needed in each different situation. 

When all is said and done, step by step and click by click, GetGround is digitizing and simplifying the process of owning property, taking us all closer to that utopia where we can buy and sell property in a matter of minutes and hours instead of weeks and months. This is the power of technology and data connectivity applied to one of the oldest and most primal industries known to humans, and it is a real privilege to be part of this epic transformation. 

Numerical Context on the Proposed Fiscal Stimulus

In my last blog I wrote about the immediate need for helicopter money and coordinated fiscal stimulus from governments around the world. Since then the US administration announced a $850bn stimulus package. I would like to share some numbers to put the figures being proposed by US political leaders into context.

The GDP of the United States was $21.4 trillion in 2019. This means that on average, the US produced a GDP of $1.8 trillion/month in 2019. Obviously, even with all the measures put in place in response to the coronavirus, we are very far from having shutdown the entire economy. But what percent of the economic output has been impacted by the partial shutdown and economic disruption?

To give us an idea, we can actually use the latest economic data shared by China yesterday. According to the National Bureau of Statistics, industrial output in China tumbled by 13.5% in the first two months of the year. As per the Financial Times, the same data also showed that retail sales plummeted 20.5 per cent year on year in January and February, and fixed asset investment fell 24.5 per cent. Services production also declined by 13 per cent in the first two months, and coupled with the industrial production figure, Capital Economics estimates that Chinese GDP contracted by 13 per cent during the first two months of the year. (Source: Financial Times, Chinese economy suffers record blow from coronavirus.)

However, while the data above suggests a 13 per cent drop over two months, it is important to note that China only went into full lockdown on January 23rd. Considering that February is a shorter month, the contraction primarily corresponds to a period of thirty-seven days. Putting this into monthly terms, a reasonable assumption is that China’s economy contracted by 10.5 per cent on a monthly basis during the lockdown period.

Taking this 10.5 per cent number and applying it to the US monthly GDP of 1.8 trillion, we see that the GDP impact of going into shutdown for one full month is about 190 billion dollars, or close to one percentage point of annual GDP each month the shutdown is in place. This sort of math is of course way too simplified, but it helps give a directional understanding, and it seems to imply that by proposing a $850bn stimulus package the current US administration is looking to make up for about three to four months of lost output from slowing down economic activity in response to the coronavirus.

What the numbers do not take into account is follow on disruptions that may be caused as people lose their jobs or companies have to go out of business permanently. It also does not take into account any disruptions from stress building up in the financial system such as the repo or commercial paper markets. Nonetheless, one can only hope that it will inject markets and people with a sense of stability. The delivery mechanisms will also be key, as the stimulus needs to reach the people and businesses that need it most in an expedient manner.

The most important thing to note here however is that the US is far from the only country impacted by the coronavirus. The GDP of the EU is close to $20 trillion, and their economic output have certainly been exposed to the same sorts of unprecedented shocks. Hence, it will be very important that other governments continue to take similar fiscal measures in the coming days, and do so in a coordinated manner.

It Is Time for Helicopter Money

We are living through unprecedented times. Never before has the global economy been this interconnected, and never before have the seven billion plus souls that inhibit this planet changed their collective behavior so suddenly and so dramatically.

The global wave of fear that the COVID-19 virus and the associated media coverage has unleashed has created a tsunami of reactions, with borders closing, factories shutting down, and both the demand and supply side of the economy going into what can best be described as shock.

The health and safety of the world’s citizens should be priority number one, and I would first and foremost like to express my eternal gratitude to the nurses, doctors and medical workers who are working on the frontlines of this pandemic to the point of utter exhaustion, putting their lives at risk on a daily basis to save ours. We are deeply grateful, and words are not enough to express the importance of the work that they do for all of our collective safety.

As for the global political response, I am neither a scientist nor an epidemiologist, so I will not get into the controversial topic of whether the response from the various national governments of the world has been an overreaction or an underreaction.  I would however like to point out that in times of crisis, coordination and solidarity is paramount, as is staying calm and levelheaded. Politicians globally face no easy choices in the coming weeks. It is the job of our leaders to make these incredibly difficult choices, always putting the good of society and the health of all the world’s citizens as the top priority. Sometimes the right choice might not be the most popular one, and it is the job of the leader to make that right choice in light of scientific knowledge and the long-term welfare of society. Open and honest communication that also prioritizes keeping the population as calm as possible will be key.

While nothing can be more important than preserving people’s physical health and wellbeing, I would like to focus here on the economic consequences of what we are going through. I will not go into the numbers here, but the analogy with regards to the global economy that comes to mind is a big airliner that has shut its engines in midflight. We now need to restart the engines and land the plane safely.

The Fed has announced that it has cut its rates to zero percent, so it is fair to say monetary policy is stretched to its maximum. However, while this will undoubtedly help, it will likely not be enough.

Given that the global economy faces an unprecedented challenge, global policy makers now need to focus on unprecedented economic responses. Given that the shock is driven by both the supply side (factories shutting down, supply chains breaking down) and demand side (consumers not spending money and postponing most purchase decisions), governments will have to take swift steps to address both sides.

The term helicopter money is derived from a thought experiment by Milton Friedman

One such step would be what is known as “helicopter money” a term attributed to a thought experiment performed by Milton Friedman, where a helicopter drops money that is directly picked up by the people. One key condition of his thought experiment is that everyone is convinced that this is a unique event that will never be repeated. This thought experiment has since been picked up by economists as an alternative (or supplement) to monetary policy including quantitative easing. Its proponents argue that it can be a very efficient way to increase aggregate demand, especially in what is known as the liquidity trap – or central banks reaching the zero lower bound on interest rates.

The proponents of this tool include Ben Bernanke, who has in the past stated that helicopter money should be on the table as an alternative of last resort.

In practice, there are clearly many ways in which helicopter money can be implemented. The spectrum can range from tax credits to individuals and small businesses (the mildest form) to actually transferring money directly into their bank accounts (basically a sort of temporary Universal Basic Income for the duration of this crisis).

Given the severity of our current crisis, I think policy makers need to immediately start assessing the various delivery mechanisms and preparing an action plan as soon as possible. The best option in today’s circumstances is likely to be one where small businesses and consumers get money put directly into their bank account. While the cost of this will undoubtedly be high (using a simple example, giving forty million people GBP 1,000 per month equates to a cost of forty billion pounds for each month that the policy is in place).

However, if the benefit is to prevent a total breakdown of the economy, the cost may be very worthwhile indeed. The delivery mechanisms will also be key, and alternatives that help small businesses stay solvent also need to be considered. This can take many forms including a forcing mechanism to direct the helicopter money to be spent immediately, or other direct assistance to small businesses, including payroll support where the money in effect gets delivered via business payroll. One big benefit of this would also be to give consumers one less thing to worry about. Everybody is clearly very worried about their physical health and wellbeing, and adding financial worries on top of this only increases the level of stress.

Finally, it is also important to point out that one big benefit of helicopter money is that it would create less inequality and would thus help maintain social stability and cohesion in trying times. Quantitative easing primarily gets delivered via the banking system and tends to flow towards house prices and stock prices, which then tend to leave behind people that cannot afford to own a home or buy stocks.

We need to remember that (God willing) this too shall pass, and once it does, we want to wake up to societies that have made it through these troubling times with their heads held high, in solidarity with their fellow people and neighbors, and without sacrificing the fundamental values on which we have built our civilization.

Your Money Does Not Exist (and Why Your Bank Needs a Babysitter)

In my last blog, I mentioned the slightly disquieting and amusing fact that your money does not exist. People usually have one of two reactions to this statement. If they are an economist or a student of the modern banking system, they say “Yes, so what?” whereas if they are part of the remaining of 99.9% of the population the reaction is usually a mixture of “What have you been smoking?” and general disbelief.

The easiest way to prove the point is to use a simple example, and here it goes. To illustrate that this is not directly related to the digitalization of money which is a separate issue (i.e. paper vs. digital money), let’s consider a bank in an economy that only uses paper banknotes.

In this paper money based economy, imagine Customer #1, who now goes to a bank to deposit her $1,000 in banknotes. The bank happily accepts her money and gives her a little paper ledger that shows an account balance of $1,000 (effectively the bank now owes her $1,000). Our trusting Customer #1 may be thinking of her banknotes living a comfortable existence deep down in a secure bank vault, the equivalent of money heaven.

However, in reality, the bank is much more than a simple safe or a vault for locking up banknotes. The bank needs to make money as well, and to do so, it takes the vast portion (let’s use 90% for illustrative purposes) of Customer #1’s money and lends it out to Customer #2.

Now, Customer #2, who we can imagine to be a bread maker, takes the $900 the bank lent him, and sets out to use his $900 to buy himself a new bread oven for his soon to be opened bakery. Hence, Customer #2 goes to Customer #3 (who happens to be a bread oven maker) and gives him the $900 in exchange for the latest model bread oven.

Customer #3 who sells bread ovens has no interest in putting his money under his pillow either. Hence, he takes his new $900 and goes back to the bank and deposits it. The bank gladly accepts the money and gives Customer #3 another paper ledger that shows his account balance with the $900 on it (so the bank now owes him $900).

Let’s take a little break here and consider how the situation and all the various ledgers look. The bank only has $1,000 in its safe, but Customer #1 has a ledger that tells her the bank owes her $1,000 while Customer #3 has a ledger that tells him the banks owes him $900. If they both were to go to the bank to withdraw all their funds (a total of $1,900) the bank would have to tell them that all the money is not there.

So what gives – where is the money? Of course, the short answer is that the bank has $1,000 in cash, while Customer #2 (the bread baker who took out a loan), owes the bank an additional $900 that he will pay back with the profits from his soon to be opened bakery shop.

Of course it does not stop there. Once Customer #3 (the guy who sold the bread maker the oven) puts his $900 into the bank, the bank once again lends out a big portion (let’s again use 90% as an example). Hence the bank takes $810 and lends it out to Customer #4 who uses the money to buy bricks to build herself a new house, etc.

I’ll spare you the math and the repetitive examples, but when all is said and done, the bank is left with $1,000 in capital (cash in the vault), while the sum total of all the money in the customer’s ledgers is actually $10,000. In other words, Customer #1, Customer #2, Customer #3, etc. all collectively think they have $10,000 of cash in the bank, whereas the bank in reality only has $1,000. Hence, the bank has created $9,000 of “imaginary cash” that does not exist, except as a collective belief. (My math here is only directionally correct, as the real-life computations are complicated by centuries of banking and accounting regulations and customs.)

A bank run from the 1930s

One implication of this this is that banks are vulnerable to “bank runs” that occur when people for whatever reason believe a bank is no longer trustworthy (this kind of panic can occur for any reason but usually involve rumors about the bank’s viability). This creates a self-reinforcing herd behavior where all the customers go to the bank to get their money out simultaneously. As even the healthiest of banks would not actually have all this money as we saw above, long ques form up in front of the bank which make the bank run worse, resulting in a vicious cycle that ends with the bank going bust, and the depositors losing their money.

Times may change, but bank runs don’t

It is for this reason that government support and the associated regulation is crucial for banks. To prevent bank runs (which otherwise would occur quite regularly), the government steps in and informs everybody that they guarantee everybody’s money up to a certain amount (the money still does not exist by the way, but the government has the power to print new money if push came to shove – this of course would create inflation but that is a whole other story). But at least the government guarantee inspires confidence and makes bank runs less likely.

So what is the relevance of all this for entrepreneurs and operators in the fintech space? One big implication, especially for those longing to one day become regulated banks, is to realize that they cannot become one without accepting the protective embrace of their respective governments and bank regulators. And that protective embrace can easily turn into a smoldering bear hug if the regulators think the bank is not being run as it should be. Hence, while becoming a bank may sound tempting, know that it comes with the full weight of history and banking regulation behind it.

After all, everything, even creating imaginary money, comes at a cost.

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.