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Even though I worked at a bank for years before founding Coinsetter in late 2012, it's incredible how little I ultimately knew about how banks and financial institutions work behind the scenes. Starting a bitcoin exchange has been a crash course on how banks operate that touches upon every aspect of that business – especially regulation. When I was in investment banking, my peers and I joked that we had no marketable skills outside of the bank. Times have changed, and there has never been a better time for someone in the financial services industry to become an entrepreneur. It could be you!
Okay, banker. If you got excited after that first paragraph and already started writing your next business plan, slow down for a second. Before you rush off to start your revolutionary business that will change the way people invest or transfer money in a previously unimaginable way, I thought I'd give some tips that will save you from spending that last six-figure bonus you received on stupid entrepreneurial mistakes (even though you'll probably find new ones to make on your own, anyway).
Tip 1: Don't Hold Other People's Money
In the case of Coinsetter, a global exchange for bitcoin trading, it was an obvious requirement that traders would need to make a deposit to fund their account, just as they would do with a trading account held in any other market. This meant that Coinsetter would need to accept and hold deposits to ensure accounts were sufficiently capitalized for trading. This made sense logically, but as the bitcoin industry quickly became regulated, we learned that holding customer deposits is best left to companies that are already licensed to do this.
Whether you're starting an investment company, a trading platform or a money transfer service, it's an expensive FinTech entrepreneurial mistake to hold customer funds. This activity almost always requires regulatory licensing of some sort, which can cost millions of dollars and take years to obtain. Don't do it yourself. Partner with a bank, broker-dealer, prime broker, or money transfer company that is licensed to custody funds on behalf of others. This will allow you to focus solely on technology (you're a tech company after all, right?)
Remember: Your core competency and quickest path to value creation is to build technology, not to run a regulated financial institution.
Tip 2: Make Banks Better, Don't Try To Make Them Obsolete
People hate banks. They seem expensive, untrustworthy, greed-driven, slow, clunky, invasive on our privacy and don't seem to care about customers. An entrepreneur's natural reaction may be to build a “disruptive” alternative that solves these lingering problems. Being deeply involved in the bitcoin space has led me to meet hundreds of entrepreneurs who are dedicated to making banks obsolete. While improving the financial system is a much needed endeavor, the approach most FinTech entrepreneurs take is destined to fail. Regulation works in a way such that companies that disrupt banks ultimately need to become banks themselves. It's best to realize this early, save yourself a lot of pain, and instead focus on providing technology that makes existing banks better.
The best way to build value as a FinTech company is to focus on one specific part of a bank's tech stack and improve it. For instance, instead of building the next peer-to-peer lending hub (which requires a banking license), build a company that helps regulated banks originate better loans through data analytics (unregulated for you). In another example, you could focus on making the customer online banking experience better and increase account security at the same time by focusing on multi-factor authentication, like LaunchKey does. This is a very small piece of the bank's overall tech stack, but you can still build a multi-million dollar company without requiring a $10mm+ banking license.
Remember: Build technology on top of existing banks. Don't become a highly regulated bank yourself.
Tip 3: Focus Your Product On Something Boring, Like Compliance
It’s best to focus on creating value by either increasing a bank's revenue or by cutting its costs. Most of the other inexperienced FinTech entrepreneurs pitching VCs at the same time as you are focus on changing the most superficial parts of a bank in ways that don't add real value. Be smarter than your competition. Focus on fixing boring, expensive pain points for banks rather than pursuing the obvious front end UI/UX issues. These dull problems, like regulatory compliance, are a growing cost for banks in the order of billions of dollars. There aren't as many entrepreneurs working on these less-understood, mind-numbing issues, which means there will be less competition for you too.
Remember: Your FinTech company can create more value with less competition by focusing on things that people don't understand and don't want to do.
Tip 4: Get Compliance Advice By Making New Friends Instead Of Lawyers
Even if you're building "technology" which should not require licensing, it can still be difficult to understand if your product requires it nonetheless. Enter lawyers. If you've chosen to build a regulated company, then it's even more certain that you will require legal advice. While lawyers will be necessary, you should not run up a massive legal bill early in your company's life by asking lawyers for advice. Attend a conference, make friends with compliance advisors or knowledgeable industry executives, take them out to drinks, and ask them all of your legal/compliance questions. Even though these topics seem distant to you, you will likely be asking very basic questions from their point of view. There are many people out there who will be happy to spend time explaining regulatory and legal issues to you in order to help you succeed.
Remember: Lawyers are to be used only as a last resort for legal advice.
Tip 5: Understand Why Banks Are Constructed Of Marble
Many entrepreneurs under the age of 35 are accustomed to using the trendiest tech websites with sexy UI design. If you are starting a financial services company, however, your design should not focus on incorporating the most cutting edge themes – your website’s design must more appropriately give your visitors a sense of stability and confidence in your firm. Just look at the websites of most successful financial companies out there… Their websites look like they were designed by 50 year olds using IE6. Although counterintuitive, this is partially on purpose.
To understand why larger financial institutions take this approach, it’s helpful to look back on history. One hundred years before the internet, banks were constructed of marble to make their customers feel like the assets being held inside their walls were protected in the equivalent of a fortress. Marble is also an expensive material, which indicated that the bank was sufficiently capitalized beyond its customers’ assets. Your website design in the new millennium should embrace these themes in order to successfully attract customers.
Remember: Your website design give your customers a sense of confidence in your company and not necessarily be trendy.
The financial services space can be difficult to navigate, but you’ll substantially improve your chances of success in your ambitious FinTech startup if you keep these five tips in mind. Count me in as part of your support network, and communicate with me on Twitter if you have any entrepreneurial questions at @borntobank.
The year 2014 has brought meaningful bitcoin adoption by merchants around the globe–certainly an early bullish sign for the future growth of the broader bitcoin network. Despite this early traction, though, many have commented that consumers still aren't utilizing bitcoin as much as expected. There are obvious reasons for this, all boiling down to a lack of consumer value proposition from bitcoin versus alternative payment options.
Taking a look at online payments in particular, bitcoin's most direct competition comes from credit cards. While credit card processing is, in fact, a very expensive form of paying for goods online from a high level perspective, it is only costly for merchants. For consumers, paying with credit card is a profitable proposition through the inclusion of rewards programs. The attractiveness of rewards are undeniable, and frankly, they're unlikely to go away.
When deciding to pay with bitcoin or a credit card, consumers quickly come to realize that bitcoin has a few drawbacks:
Drawbacks #2 and #3 are problems that can be solved on the application layer. However, drawback #1 is more difficult to solve. It is also the number one reason why bitcoin isn't being adopted by consumers today: bitcoin is far more expensive to use than credit cards.
Why have bitcoin users put themselves in the position of paying more for the "privilege" of paying with bitcoin? I believe this problem has sneaked its way into the purchase process without much thought. The simplest way for bitcoin payment processors to build their systems has been to dictate the exchange rate at which the consumer must pay for the item, defining how much BTC is due for the purchase. Unfortunately, dictating a merchant-favoring exchange rate has pushed the majority of costs onto the consumer. While payment processors may make the argument that consumers are receiving the same exchange rate at which they could sell their bitcoins, that still leaves consumers paying the fees and spreads associated with the transaction while the merchant removes nearly all costs on their end. Whether you side with the consumer or the merchant on the issue, the status quo leaves bitcoin noncompetitive versus credit cards if it is to be used as a behind-the-scenes payment protocol.
In order to introduce a value proposition to consumers that makes bitcoin competitive versus credit cards, we must find a way for consumers to negotiate more favorable exchange rates. The goal should be for consumers, on a $100 purchase, to have the same $100 amount pulled from their bank account from the transaction–and they preferably would still earn a 1% reward on top of it too. While some of the cost savings can come from efficiencies associated with using the bitcoin protocol, most of the difference will come from the merchants' current windfall. This should still be accepted by merchants, since they continue to see a substantial reduction in payment processing costs and remove the possibility of chargebacks.
All of this begs the question: how do consumers move to a position where hidden fees are placed back onto the merchant? Well...
Rather than accepting the current "take-it-or-leave-it" exchange rate that merchant processors offer bitcoin users today, consumer wallets should instead have the ability to dictate the same favorable "take-it-or-leave-it" rate, or potentially the ability to negotiate a rate that is fair for both parties. Said another way, for a given dollar amount, consumers are being required to send too much bitcoin to complete a purchase. We should instead find a way for merchants to accept a bitcoin amount that makes the transaction profitable for the consumer.
I see a few ways this can be solved.
Option 1: The simplest solution is for consumer wallets to send a bitcoin amount that is adjusted for a discount rate. To reduce errors on merchant processing applications, we could establish an industry standard where bitcoin payment processors require flexibility from merchants to provide a 2% discount on purchases. Merchants' unit prices theoretically already reflect a cost of at least this amount, and the discount would likely come down over time. That would make bitcoin very competitive versus credit cards, and it would shift the costs of payment processing off of the consumer.
Option 2: The next solution is for wallets and merchants to solve the issue on the B2B application layer. In this scenario, a wallet provider (i.e. Circle) would negotiate a deal with a payment processor (i.e. BitPay) whereby merchants would be required to grant a discount on purchases made by the wallet's customers. This is similar to an interchange or discount rate in credit card payments. When a payment is sent, an encrypted message could be included in the bitcoin transaction confirming that a reduced BTC amount is approved.
Option 3: The most difficult-to-implement but widely impactful solution is to solve the issue within the bitcoin protocol itself. Perhaps the method described in the second option may provide guidance on how this could be achieved. I welcome all developers with ideas on implementation to reach out to me.
The power of bitcoin as a protocol cannot be underestimated. It will be truly transformational to global finance. That said, it will take thought and action from the community to build a consumer valuation proposition that enables it to expand to mainstream usage. Solving this issue will prove to be the magic bullet that makes bitcoin valuable to consumers versus the other options currently available.