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😱 A FinTech horror story - why are $250M+ in bank deposits locked up?

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Hi there,

Vieje back here after some much needed time off. My wife and I went to Maine for a family reunion. After living off lobster for a few days, we popped over to Spain for a week. If you haven’t been, I’d highly recommend getting to San Sebastian at some point. Besides the gorgeous beaches, the main activity there is to hop around the old town from bar to bar eating pintxos which is effectively Basque tapas. Needless to say, my stomach has been happy recently. I’m feeling refreshed and I’m glad to be back.

Today, I wanted to write about a topic that I feel should be getting more national attention. It’s unfortunately not a feel good story, but the fallout will have ripple effects throughout FinTech.

There’s currently more than 100,000 Americans (yes, retail customers) with over $250M in deposits in neobanks currently locked out of their accounts and unable to access their funds. This is due to a mess caused by the bankruptcy of a Banking-as-a-Service (BaaS) startup called Synapse.

Customers at some popular neobank fintechs such as Yotta deposited their cash with the promise of FDIC backing, but their funds are currently locked and potentially at risk.

So what is actually happening and why can’t customers get their cash? First, we’ll have to jump into how neobanks are built.

🏧 How do neobanks work?

First, it’s important to understand that neobanks are not actual banks. Almost all neobank startups are built as customer acquisition companies on top of established and chartered banks. Obtaining a banking charter is difficult, so it’s much easier for a startup to partner with an established bank.

Traditionally, neobank startups act as acquisition engines for their partner banks, and the banks, which are FDIC insured, actually hold the customer deposits. It’s a good partnership for the banks and the startups. The banks don’t have to do customer acquisition and marketing. And the neobanks focus on their customer acquisition strength through better technology and unique offers such as better interest rates or perks.

The banks are FDIC insured so when you open an account at a neobank, your money is deposited with the neobank’s chartered banking partner and therefore your money is FDIC insured. The idea here is that if the neobank goes bankrupt, your funds are still held at the bank and FDIC insured.

Customers created “bank” accounts at neobanks like Yotta which partnered with banks like Evolve Bank & Trust which was FDIC insured. So why are over 100,000 customers unable to withdraw their funds from the neobank?

🖇️ Synapse was the BaaS startup connecting the neobanks to the banks

In recent years, many Banking-as-a-Service (BaaS) startups raised a lot of money from venture capital funds. These startups made it easier for companies to become FinTech companies. Instead of building their own infrastructure, companies could add on banking products and generate additional revenue through partnering with these BaaS startups.

BaaS made it much easier for companies to do things like issue credit or debit cards or effectively offer banking and other financial services to their customers. Think of DoorDash or Uber issuing credit cards to their gig workers. These BaaS startups basically build the financial and banking infrastructure for other companies so they can launch financial products.

Synapse was a promising BaaS startup with institutional VC backing that launched in 2014 and had partnered with over 100 fintech companies and had more than 10 million end users. Synapse had partnerships with banks such as Evolve Bank & Trust. Many neobank startups such as Yotta were built with Synapse providing the infrastructure to connect to the FDIC-insured bank.

To summarize, the neobank Yotta was built on top of the BaaS provider Synapse who provided the pipes to multiple banks inlcuding Evolve. Synapse was effectively the middleman. If you created an account at Yotta, you would interface with the Yotta app, but your money would be sent through the Synapse infrastructure to Evolve.

Unfortunately Synapse went through some difficulties and after a failed merger, the company went bankrupt and shut down operations in May. Many of you might be thinking, well the money went through Synapse to Evolve, so the money is at Evolve. Can’t we just have Evolve return the funds to the end user? And if Evolve is also on the verge of bankruptcy, then shouldn’t the funds be safe because of FDIC insurance?

Unfortunately, things are much more complicated than that.

💸 Where is the money?

Right now, it’s unclear. This is an ever-evolving situation with the courts, regulators, and a US Trustee appointed to sort out the mess.

The crux of the issue is a disagreement between Synapse’s records and their partners, including Evolve and Yotta. Synapse is bankrupt and has claimed that they have delivered all appropriate ledgers which keeps track of customer funds to the neobanks (Yotta), banking partners (Evolve), and the courts trying to sort out the mess.

Evolve has come out and said that Synapses’ ledgers do not add up. While they are able to match certain customer accounts, there are some that do not reconcile at the moment, up to $95M in deposits. Synapse is firing back and saying that Evolve is responsible for the shortfall.

As of right now, we don’t know who is ultimately responsible and where that missing cash went. Synapse is saying that Evolve has the money. Evolve is saying that their records do not add up. So who is telling the truth and where the hell did that money go?

To make matters worse, the FDIC is saying that while Evolve is covered under their insurance, they do not regulate BaaS startups such as Synapse. If there was wrongdoing by Synapse, i.e. they spent customer money rather than depositing it at Evolve, then those funds may not actually be covered by the FDIC because they never made it into an insured bank account.

Of course, there’s a bunch of other “interesting” things to note. Former Synapse CEO Sankaet Pathak joined one of the court hearings from Santorini, Greece in May during the height of the company’s collapse. He has also been raising funds for his new startup and has been accused of exaggerating claims in his pitch. At best, this is an awful look for someone whose company’s bankruptcy has caused over $250M+ in working class American money to be locked up.

Yikes. That was painful for me to write especially as someone who works at another FinTech startup. The stories coming out on Reddit and other mediums are equally painful to read as these are everyday Americans, many of whom are unable to pay bills.

I hope that this gets cleaned up quickly and efficiently, and that government agencies come in to do their part to make sure end-users get their funds. It’s a wreck right now and I encourage anyone interested to start following Jason Mikula who is a FinTech reporter doing amazing work right now covering the situation. 

↗️ Where does FinTech go from here?

This is a hit to the reputation of the industry, but I want to emphasize that this mess should not define FinTech, specifically BaaS and neobanks. I believe FinTech as a whole has been a net positive.

Chime provides banking to over 22 million customers in the United States who are traditionally overlooked by the large legacy banks. We have seen FinTech startups such as NuBank serving over 100 million customers that were previously unbanked in LatAm. There are many other BaaS startups like Unit providing technology and services to companies that allow end-users to benefit.

FinTech will get through this and continue to provide crucial technology and financial services that benefit society. There will be rough patches such as the last couple of months, but FinTech is here to stay and I remain excited for the future of the industry.

Let me know what you think by replying to this email. Until next time!

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