How Fintech, Banking, and Blockchain Intersect in Europe

Earlybird’s newest Partner, Tim Rehder, offers an overview of the European Fintech ecosystem

Blockchain was the number one breakthrough tech in 2008-2009 across the financial markets — but where did it land? Which companies are using the cryptographic technology today and in what ways? In what direction did blockchain develop in the financial sector?

To answer these questions, Tim Rehder, new Partner at Earlybird, shares his perspective. With a focus on early-stage companies in the blockchain space, Tim joined Earlybird in January 2018 and has successfully expanded our Digital West Fund’s footprint in the Fintech sector. Prior to Earlybird, Tim founded one of the earliest European-based crypto exchanges and successfully led the company as the CEO. Combined with his VC experience, Tim knows first-hand what’s needed to build and run a company.

We asked Tim for an overview of the ecosystem and believe you’ll benefit. Feel free to let us know in the comments.

1. For a few years now, blockchain technology has been perceived as one of the next big things in the startup scene. You’re one of the German pioneers. When, and in which sector, do you expect the first real breakthroughs?

TR: We’ve already seen some significant breakthroughs in recent years. The trading of digital assets and cryptocurrencies, for example, run on top of blockchain technology. Companies like Coinbase, Kraken or Binance are some examples of having turned the idea of an alternative asset exchange (and store of value) into a multi-billion-dollar opportunity.

Blockchain democratizes access to financial products as it creates fully-digital financial markets that are purely controlled and governed by lines of code…

But, you’re right. Blockchain can do much more: It democratizes access to financial products as it creates fully-digital financial markets that are purely controlled and governed by lines of code, sitting atop the Ethereum blockchain for instance, also known as “smart contracts.” In this way, the governance of financial markets becomes fully automated and trustless, while being available on a 24-hour-a-day, 365-days-a-year basis. Most of these products and services run on top of the Ethereum blockchain and are now classified as Decentralized Finance (“DeFi” in short).

Today, we look at over $ 9 billion in locked-up value in DeFi protocols and this market is a fast-growing sector (approx. 13x since Jan’20, reference: Defipulse), while still offering tremendous room to innovate. As Money Markets (Lending/Borrowing) remain the largest use-cases, we see clear (though still early) signs of broader consumer adoption emerging.

2. Where do you see some exciting blockchain companies developing?

TR: MakerDAO and Compound are definitely two of the most promising and best-known startups in the area of DeFi. MakerDAO has over $ 1 billion in total value locked up, or 36% of all funds invested into DeFi (see Defipulse). Both companies are US-based and are backed by Andreesen Horowitz. MakerDAO runs their own interest-bearing stablecoin (backed against the US dollar) and allows users to pledge their own cryptocurrency and to borrow a certain ratio in the form of a collateralized debt position (CDP) against it.

Blockchain applications and the tokenization of financial assets provide huge innovation into this space, as even illiquid assets or securities become divisible into many small pieces and globally tradable.

Another company operating in this space is called Upvest. The company is building a full-stack backend infrastructure for securities — taking over the whole lifecycle of tokenizing traditional assets, such as real estate, to also store securities over their own custodial wallet. Blockchain applications and the tokenization of financial assets provide huge innovation into this space, as even illiquid assets or securities become divisible into many small pieces and globally tradable.

In a next step, Upvest builds a brokerage platform for those securities, by connecting large incumbent asset managers to Fintechs as distribution channels. Upvest allows asset managers, who search for innovative distribution channels, to tokenize any asset, transform it into securities and offer those to end users via a simple API on modern Fintech platforms, such as digital banks or investment platforms. The company is backed by HV Holtzbrinck and Notion Capital and currently services clients such as Exporo, the digital real estate crowdfunding platform out of Germany.

3. Which of Earlybird’s portfolio companies could become tomorrow’s rising stars in the blockchain world?

TR: Another leader, or one to watch in the blockchain space is Bitwala, which is an active portfolio company of Earlybird. The company developed a classical neobank, with embedded functionalities like their own credit card with 0% fees, or a fully functional mobile banking app. However, in contrast to other challenger banks like N26 or Revolut, the company has integrated a blockchain wallet infrastructure into their core banking system, enabling their customers to instantly buy and sell cryptocurrencies like Bitcoin or Ethereum out of their own bank account.

On top of that, Bitwala started to integrate a few of the Ethereum-based Defi protocols, in order to offer their customers easy and frictionless access to the benefits of the decentralized finance world (i.e. annual interest rates of 5% on deposits). In contrast to the decentralized nature of blockchain-based financial services, this company operates under a full German banking license and hence provides a centralized structure when dealing with these new and sophisticated financial products. Bitwala is positioned as a real enabler for mass adoption of cryptocurrencies and DeFi products, showing consistently strong growth since our initial investment.

4. What’s likely to be the “next big thing” within the Fintech sector?

TR: Although there are many exciting industry developments, I’ll outline a few sectors we find particularly interesting:

First, after a wave of challenger banks, mainly retail banks in Europe, there is a next wave of B2B banks entering the European market. Qonto from France is just one example of a B2B neobank trying to re-think the journey of opening and transacting with a traditional SME bank account. With new B2B banks, SME credit players have positioned themselves as fully automizing and accelerating the credit process over a data-enabled approach. In that instance, different startups have entered the market, either vertically focused on specific sources of financing (i.e. factoring or cash-flow based), or platform approaches that provide all sorts of financing solutions.

Fintechs are re-thinking their customer value proposition and trying to make use of the more extensive data-sets and direct connection into the banks “core”.

Second, since PSD II came into force, various Fintechs are re-thinking their customer value proposition and trying to make use of the more extensive data-sets and direct connection into the banks “core”. With that, new payment institutions are entering the market and aiming to facilitate instant payments, cutting out middlemen and going after the dominant payment schemes, especially on the card transaction side. While the UK already has a faster payment network and the Nordics have consumer payment methods such as “Swish”, we see similar direct bank-to-bank payment service companies arising in Germany and throughout Europe.

Third, we also see an increasing number of “deep tech Fintechs” all over Europe, especially on the compliance and “Know-your-customer”-side. These companies collect and analyze big data-sets from their customers and use machine learning applications in order to disrupt manually driven in-house solutions. One example would be our portfolio company Fraugster, who has invented an AI technology that combines human-like accuracy with machine scalability.

Fourth, a next wave of mobile, zero-commission stock brokers have also arrived in Europe: TradeRepublic in Germany, Bux in the Benelux or FreeTrade in the UK. Security trading faces various complexities when it comes to its underlying depot infrastructure or tax implications. We are very curious how this space will further develop.

Lastly, a big trend in Fintech is the embedded finance space, i.e. the transformation of any non-financial company into a Fintech by integrating innovative financial services into their end user experience — such as payment, debit or credit, insurance and even investment products. Those services are key drivers for user monetization and customer loyalty, while for example, existing customer data are used for efficient underwriting of credit products.

We see a big potential in “banking-as-a-service” companies enabling this transformation of non-financial companies.

For instance, ride sharing platforms like Uber and Lyft retain their drivers by offering financial services to them. We see a big potential in “banking-as-a-service” companies enabling this transformation of non-financial companies. Over the last couple of months, we could observe multiple financing rounds in the embedded finance space in the US and believe this trend is soon going to be established in Europe as well.

5. Do you see Fintech companies more as partners or challengers of banks?

TR: In general both can work, though the level of upside potential may differ. An example from our Earlybird portfolio would be the retail bank N26, who always aimed at entirely rethinking banking and building a mobile bank from scratch, purely designed for the day-to-day interaction of the private individual. As investors of N26 since the very beginning of 2014, we always believed in the potential of disrupting the retail banking space, which is still dominated by large institutions who usually lack significant innovation for decades. Those challengers could create a lean and more efficient software infrastructure, without relying on legacy IT systems, in order to build the most intuitive user journey and an unparalleled user experience for their customers.

(B2B Fintechs) address a real market need, since incumbents are increasingly aware of customers leaving to challenger banks, but also try to keep their costs low and processes efficient.

At the same time, I see a great potential for specialized B2B Fintechs who become partners of established financial institutions. Those companies help incumbents to modernize certain processes or parts of their banking infrastructure. They address a real market need, since incumbents are increasingly aware of customers leaving to challenger banks, but also try to keep their costs low and processes efficient. In some cases, those specialized companies may even help Fintechs and incumbents alike. Take for example, core banking providers like Mambu out of Berlin, who enable banks to transform to pure cloud-based banking infrastructure layers that allow them to scale efficiently.

6. Lastly, the European Fintech sector has created notable unicorns. What makes the European Fintech sector so successful?

TR: One factor for the tremendous success of European Fintechs in the retail space, including companies like Transferwise or Klarna, is the high level of trust European users have in the regulatory environment, ultimately triggering faster user adoption. This is coupled with regulatory bodies willing to support innovative Fintechs and consistently shaping the regulatory environment according to new technologies built. For instance, the UK Financial Conduct Authority (FCA) launched a sandbox program for Fintechs to test their products and services in a live environment with regulatory oversight. The program helps Fintechs identify regulatory bottlenecks early on, while dramatically decreasing their time to market, and gives them regulatory certainty that seems crucial for fundraising activities.

The fragmented European market across its 27 member states (and its 24 spoken languages!) forces European-origin tech startups to think and also expand internationally very early on.

As compared to the US, where different Fintech models require various levels of regulation, Europe is much more streamlined and allows for so-called passporting of licenses across countries. Moreover, the fragmented European market across its 27 member states (and its 24 spoken languages!) forces European-origin tech startups to think and also expand internationally very early on. They usually develop a strategy on how to enter a second or third European market and how to manage international teams, directly after their Series A fundraising. Ultimately however, the US market provides the highest upside potential for European companies — with 300 million in potential customers, the US has a single scale. We therefore actively support our European portfolio companies in entering the US market early on.

Thank you for these insights, Tim! We look forward to sharing further developments in this space.

*All stats and references updated at the time of original publishing.

Are you a founder, industry expert, VC, or researcher interested in the fields of Fintech, neobanking or blockchain, then we’d be more than happy to learn about your work. Feel free to reach out via tech@earlybird.com.

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