Tech

Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

Fintech start-ups once wanted banking to be cheap. Now they want it to be free. And they’re making it happen with the help of the big banks they tried to displace.

Fintech Funding Frenzy
Total funding to digital banking start-ups has boomed in recent years
Source: CBInsights

Circle, a U.S. social payments app backed by a venture arm of Goldman Sachs, will start operating in Britain on Wednesday, offering free cross-currency payments and transfers between friends using the medium of Bitcoin.

Circle doesn’t have a banking license itself -- it's partnering with Barclays in the U.K. -- but it reckons that offering a zero-fee payments and transfer service is just the first step before eventually adding other premium services when enough customers climb aboard.

It’s not an original idea: China, which admittedly has had much more appetite for alternative finance than Europe, has seen money-transfer platforms boom.

But while there are plenty of online services from e-mail to music streaming that are free, as well as free money-transfer services on platforms like Facebook Messenger or Gmail, free banking is controversial in Britain.

Regulator Andrew Bailey once called it a “dangerous myth” because it encourages lenders to use aggressive tactics to offset their costs -- think cross-selling other products, hefty charges for being overdrawn or earning a spread from customer deposits.

Circle argues its cost of bringing in new customers is a fraction of a traditional bank because it uses smartphones rather than branches and has built algorithms to take the place of traditional compliance employees.

That should mean the company is under less pressure to find creative ways to offset its costs, and can focus on growing its customer base.

Entrenched Banks
EY's Fintech Adoption Index puts the U.K. at below the global average
Source: EY 2015 survey tracking digitally active consumers of fintech services

But leanness can also be a weakness. Being a mobile-only bank in the U.K. is hard going: branches are still consumers’ preferred place for five out of eight basic tasks, according to a survey by Ernst & Young. Another study found that the U.K. had a below-average rate of fintech adoption at 14.3 percent. This might mean a longer slog ahead and a steeper bill for marketing costs than expected. TransferWise -- a peer-to-peer transfer app that actually charges its users for transactions -- was still unprofitable as recently as last year.

Then there’s the issue of financial risk. Circle's compliance algorithms don't appear to have been truly tested by a true economic downturn or a market blow-up. Circle is also exposed to currency markets and volatility, not just across sterling and dollar but also for Bitcoin. Circle uses its own systems for instant payments and transfers among its customers. For transfers outside its network, it converts currencies into Bitcoin -- and needs a treasury operation.

The company says that team manages liquidity and hedges customer flows profitably. But if it doesn't grow fast enough, there’s a chance Circle's traders could be tempted to take bigger risks to offset a lack of revenues.

But if it does take off, the banks partnering with Circle will benefit the most. Circle's fintech rivals that compete purely on price risk are the ones at greatest risk of being squeezed.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lionel Laurent in London at llaurent2@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net