Long Take: The fundamentals of Circle's $4.5B SPAC, Robinhood's IPO, and the $30B of fintech venture capital

Hi Fintech futurists --

This week, we cover the following:

  • Thesis: Last quarter, fintech funding rose to $30 billion, the highest on record. $14 billion of SPAC capital is waiting to take these companies public. Robinhood and Circle are about to float on the public markets, via SPAC and IPO. In this analysis, we explore the fundamentals of both companies, as well as the unifying thesis that explains their growth.

  • Companies: Robinhood, Circle, Centre, USDC, USDT, Coinbase, Schwab, Moonpay, SeedInvest, Jump Trading, Citadel, Uniswap, Poloniex

  • Topics: venture capital, digital investing, crypto, blockchain, payments tech, SPACs, IPOs

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Long Take

If you’re in Fintech today and not winning (at something), you’re not playing the game right. Or maybe you are not playing the right game.

It has never, ever been easier for a Fintech company. Demand is off the charts.

That’s over $30 billion in quarterly venture funding demand - a number higher than the annual total a mere four years ago, according to CB Insights (h/t Theo Lau).

But don’t feel too bad. A lot of that funding has shifted towards later rounds, propping up extremely rich funding rounds and valuations, leading to literally unprecedented number of private company unicorns. Our prior complaints about unicorn valuations being bad for your health seem quaint and whiny in retrospect. We are all SoftBank now, as Revolut looks to raise from the Vision fund at a $30 billion valuation.

Part of what is driving the gold rush is the fast that there are exits. You are not locked into illiquid equity forever. Whether it is the $11 billion Transferwise direct listing, or the $14 billion of fintech SPAC capital, or the Robinhood IPO, there is now an off-ramp. Just to do the math, $14 billion at a $200-500 million a SPAC pop is about 40 more fintech exits.

Today, let’s look closer at Robinhood and Circle. One of our core theses for a while has been that crypto, DeFi, and Fintech are all part of the same movement: a digital distribution approach powered by a digital manufacturing transformation. Thus it makes sense to have digital investing into digital assets, rather digital investing into non-digital assets, or non-digital investing into digital assets.

Mobile neobanks and rodoadvisors have been putting scotch-tape on traditional securities for a while, layering beautiful pie charts and price lines on your phone screen. But this is like Spotify selling physical records, or Netflix mailing you video cassettes. No — what comes next is broad based distribution of regular financial use cases, powered by computational blockchain rails, to literally everyone into their phones.

Circle’s strategy and growth position

Circle has announced a transaction with Concord Acquisition, the Bob Diamond-backed SPAC, which will take the company public at a $4.5 billion valuation and 2021E revenues of around $100 million. You can see the investor presentation here.

This is a pretty dramatic turn-around for Circle, which has gone through a number of business model pivots in navigating the crypto opportunity. Its early business focused on being a crypto wallet, and supporting a variety of trading functionalities in an app called Circle Invest. There was also Circle Pay and Circle Trade.

Circle Invest has since been sold to the Canadian-listed public crypto exchange Voyager (VYGR), run by brokerage industry veterans. Based on the fact that Voyager has a marketcap of $3 billion and booked $60 million of revenue last quarter, one could have said it made sense to hang on to a trading business and its potential for 1.6 million verified accounts. It’s easy to read meaning into random number generators.

But then there is also something to say for focus and being really good at one particular thing. And it seems Circle has decided it does not want to bet on trading — in 2018 it also bought the exchange Poloniex for $400 million, and sold it off after a year to a Justin Sun-led investor group. Rather, Circle wants to do this:

The clear and present growth engine of the company is USDC, issued through Centre, an infrastructure entity and standards-body funded by both Circle and Coinbase. The stablecoin is a dollar-denominated and backed financial instrument with a market capitalization approaching $30 billion. While that is still behind USDT (Tether via Bitfinex) at $60 billion — a dominant though highly controversial onramp for the East — USDC is a strictly better product for Westerners in being transparent and well regulated. And if USDT tanks, USDC could absorb its market demand.

We think of stablecoins as money market product sitting in cash-sweep accounts. If you want to park cash in a brokerage account, you don’t send it to a bank account, which is a different underlying regulatory entity and technology stack. Instead, you put it into a cash-equivalent, with a small interest yield. The “you” in this case can be a retail investor, or a gigantic institutional allocator. And that’s why there is $5 trillion in net assets for these funds. This is the crypto stablecoin opportunity.

Circle is parking itself on the cash allocation revenue pool, right between payments and savings. The target clients are banks, financial institutions, crypto traders, and commerce platforms. If you revisit our embedded finance thesis, highlighting the shape of Affirm and Stripe customers, this will feel familiar. Rather than trying to accumulate individuals buying crypto assets, Circle is aggregating all the places where institutions onramp into crypto payments rails, and need those rails to be regulated.

Monetization comes from interest-rate arbitrage. If you have $30 billion of cash on your balance sheet (i.e., money at rest), there are lots of things you can do — including putting it into a bank account and earning an interest rate. On money in motion, i.e., any technology rails you provide for currency conversion or payment volume, you can earn FX-like fees or something that looks like interchange. See for comparison our conversation with Moonpay. You can do this best when you hold the requisite regulatory licenses.

All this to say, there’s a good economic engine with upside that the company has landed on, and it is differentiated from just pursuing a retail footprint. The last bit of remaining business with SeedInvest and equity crowdfunding is more of a mystery to us. The original thesis for p2p lending and investing failed out. The crypto bull market re-invigorated some issuer platforms like Coinlist, and potentially the venture funding figures we cited at the beginning of this analysis are tipping the scales in the positive direction for this business model. But more likely, having a broker/dealer and the ability to plug in USDC into brokerage rails is a useful hedge for (1) the bear market, and (2) if digital securities end up taking off in a long tail probability event. It doesn’t hurt that SeedInvest has a 500,000 user list.

So let’s get to revenue.

Focusing on just 2021E, we see $65 million of transaction and treasury services revenue, $40 million of USDC interest income, and $10 million of SeedInvest revenue, for a total of $115 million. Out of that, about $20 million gets paid out as transaction costs and revenue share. So, let’s say there’s about $100 million of net revenue supporting a valuation of $4.5 billion. That’s a 47x multiple — definitely on the high end of the spectrum for paytech, fintech, and crypto.

Assuming USDC average balances of $20 billion on the year, we get pricing of around 50 basis points on assets. To get to the 2023E of $800 million of payments-related revenue, USDC needs to be at $160 billion in assets. It’s certainly possible, but hard. If we look a bit closer at Circle clients and what the firm has really booked, things get a tad less comfortable.

There are 1,000 Circle B2B accounts, projected to triple at year end. [Note — in the email version of this analysis, we incorrectly suggested there were 1 million accounts. The language here has been corrected to reflect the change.] And booked revenue sits at a run-rate of $60 million rather than $115 million. Applying these haircuts, it is starting to look like a 90x multiple price point. On a per-client basis, let’s divide the $4.5 billion valuation by 1,500 accounts, which yields a $3 million enterprise value per account — that’s a lot for each institutional relationship.

We are fans of Circle, and the industrial logic of the USDC-powered mega payment rail checks out for us. But this is definitely a premium price point, and we would be positively surprised if the revenues landed as such.

Robinhood’s democratization

As the Robinhood S-1 became available, so did a number of high quality takes on the topic. We don’t want to add any filler content, and recommend you check out the following.

Rex Salisbury has an epic tweet summarizing the entire revenue flow of the company in the last quarter. $520 million in revenue splits out into $200 million from Options, $130 million from Equities, $90 million from Crypto, $65 million from net interest, and $40 million from subscriptions and the like. YOLO to the max.

Tanay Jaipuria does a fantastic detailed tear-down, looking across comps, including traditional brokers like Schwab and Fidelity, as well as crypto brokers like Coinbase. Our main takeaway is that Robinhood has a lot more trading and smaller accounts than other digital investing apps, but also is showing improving marketing economics and returns to scale. Revenue is outpacing cost growth, with profitability coming around. Further, users are getting richer and therefore are doing more on the platform (Tanay’s graphic from the analysis below).

This last point is key, and is sustained by the endless fiscal and monetary programs of the United States government. Thanks Uncle Sam for minting billionaires!

Last, there’s the always-thoughtful take from Marc Rubinstein, asking “What is Robinhood?” And the answer is that Robinhood shares more DNA with gambling, betting and contracts-for-difference CFD companies like Plus500 than is comfortable, amplified by meme of “democratization of financial services” that has led everyone to become an investor. As a fun side note, CFD trading is banned in the US, and payments-for-order-flow is strongly limited in Europe. Yet Robinhood sneaks through. Further, Marc has two fantastic charts about trading frenzies — showing a spike in trading activity per account of 500% (from 3 to 15) at the end of 2020, and a similar increase and then 50% collapse following the Internet bubble of 2001. Maybe someday we, or the Fed, will learn.

So here’s the spin we will add on the topic. Just as the story of Facebook is really a story of the advertising industry, so the story of Robinhood is the story of market making and institutional capital markets.

In any platform business matching buyers and sellers, or let’s euphemistically say “market participants”, one side is likely to (1) have more pricing power, and (2) be more valuable to the commercial logic of the platform.

Advertisers and other attention buyers (e.g., propaganda engines) ended up designing the market mechanisms for our current version of the Internet — hyped up on a machine-fabricated cocktail of dopamine and adrenaline, we yell profanities into the abyss of each other’s Newsfeed. Meanwhile, the machine does as the attention buyers want, collecting maximal data from each of us in order to more precisely trick us into a purchasing decision. These are straightforward incentives that are only now becoming obvious and (hopefully) disentangled.

Similarly, Robinhood presents this product to the manufacturers of the trading of financial instruments. Its 12 million customers are brokered and ready to play, and Citadel Securities, Susquehanna, Wolverine, and other market makers are ready to buy. On the mechanics and economics of how this works, see our discussion with Alphacution. For every USD Robinhood makes, the market maker will make 5 to 10 times more.

Looking back at the fundamentals, 12 million people generated about $1 billion of revenue for the company last year, and will probably print $2-3 billion in 2021. That’s $80 to $250 in revenue per user on average assets of $4,500 per account. Given the high turnover driven by gamification and behavioral addiction, each account is generating 200 to 500 bps of revenue. If the Robinhood IPO hits at $40 billion as intended, that would imply $3,333 per user — a number that looks a lot like Circle on user valuation, but “only” 20-40x in revenue multiple.

This is the price of top shelf Fintech for you.

Lastly, almost 10 million Robinhood users traded almost $90 billion of crypto volume on Robinhood in Q1 2021. For comparison, Uniswap moves about $50 billion per month between 400,000 onchain addresses.

For Robinhood, crypto trading is just like traditional trading. They broker and route it to a third party for execution:

“RHC engages with third-party market makers to provide liquidity for customer crypto trading and all orders placed on RHC are routed to market makers for execution. Specifically, when an RHC customer places an order to purchase cryptocurrency, the customer authorizes the transfer of funds from their RHF brokerage account to an RHC-owned account at RHS, RHS takes the customer's instructions and causes the customer's cash funds to be transferred to the RHC-owned account at RHS, and RHC relies on this cash transfer to place the cryptocurrency trade with a third-party market maker.”

The third party is Tai Mo Shan Limited, part of Jump Trading Group.

None of this stuff should be all that controversial — it’s just a really well-executed distribution model that outsources the plumbing to those that want to do it. And the best way to sell something to someone is by appearing to be giving it away as a gift.

Key Takeaways

Given that crypto revenues are nearly 20% of Robinhood’s P&L in the last quarter, we think they will be giving away a lot more crypto as a “gift” to their users. If we were in their shoes, all of DeFi would be plugged into some custodian footprint, which was then intermediated into the trading memes on the platform. The success of Coinbase — a nemesis with deeper vertical integration into blockchain technology, staking, and Web3 wallets — would be intolerable.

In the likely case, more people will own crypto assets.

When we look at Circle, we see an effective onramp for ecosystems, banks, and eCommerce platforms into onchain economies while remaining regulated. Given the incentives around issuing USDC, it is possible we will see many more members sprout up as the company starts to tell its public story more effectively. What Libra/Diem had tried to accomplish may instead come from running a collateralized money market fund throwing off hundreds of millions of interest payments.

In the likely case, there will be more onchain crypto dollars.

The vector of change is accelerating, at a rate of $30 billion of funding per quarter.

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