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Money Without Borders: A Peek Inside Wise

Two forces have shaped the economy over the past several decades: technology and globalisation. While fintech is usually a play on the former, Wise (formerly known as Transferwise) is a product of them both. 

The company was founded in 2010 by two friends, Taavet Hinrikus and Kristo Käärmann. As origin stories go, theirs is well-rehearsed. The pair are originally from Estonia but met while working in London. Taavet had moved to the UK in 2006 in his role as director of strategy for Skype but continued to get paid in Estonian kroon. Kristo, a consultant at Deloitte, was paid in pounds, but needed Estonian kroon to make mortgage payments back home. 

As anyone who’s tried will know, using the banking system to move money across borders can be a cumbersome process. Banks evolved to satisfy a mostly domestic customer base. A network of correspondent banks exists to facilitate cross-border payments but the number of intermediaries involved makes it slow and expensive.

Taavet and Kristo designed a simple alternative. Once a month they’d look up the GBP/EEK cross-rate on Reuters. Taavet would then transfer kroon to Kristo’s bank account in Estonia and Kristo would pay Taavet back in pounds. Both got the currency they needed at the prevailing rate without incurring any charges. 

They soon realised that they were not the only two professionals in London with this problem. In 2010, there were nearly 4.5 million non-British nationals living in the UK, corresponding to around 8% of the population. The reverse numbers were also very high. Taavet had seen at Skype how a peer-to-peer system could disrupt telecommunications. With Kristo’s banking industry experience they resolved to do the same with currency exchange. 

The two founders got regulatory approval and launched Transferwise at the beginning of 2011. Their timing was very good. Consumer groups were increasingly pushing back at the high level of fees UK consumers were paying for foreign currency. A complaint was lodged with the Office of Fair Trading about fees – estimated at £1 billion annually – as well as the lack of price transparency offered by the currency exchange services.

In its early days, Transferwise marketed itself as a ‘peer-to-peer currency exchange’. Customers were told they could exchange currency with peers at mid-market rates, with Transferwise acting as a trusted third party. Initially, fees were fixed at £1 per transaction. The first currency pair the company supported was GBP/EUR. (Estonia joined the Eurozone at the beginning of 2011, so the founders could still use their platform to send money back home.)

Within five months of launch, the platform had done £1 million of volume and in its first year, it did €10 million. Taavet and Kristo raised $1.3 million of seed funding to take them through 2012. Their plans were to develop a scalable customer acquisition strategy, expand the range of currencies and increase revenue per payment. The pitch deck they used is fun to look back on.

Reflecting on the early days, Taavet has since said, “Something that probably I couldn’t articulate as well in the beginning, but which is a common truth inside Transferwise now, is that you need a 10x better product. It’s not enough if you have a product which is just 10% better; you need a product which is 10x better than the alternative. We typically charge around 10x less compared to a bank; instead of taking days to complete a transaction, oftentimes our money moves instantaneously; and additionally it’s incredibly transparent – we tell you how much we charge and for what. So, we’re easily 10x or an order of magnitude better.”

To win customers away from banks, Transferwise mounted an aggressive marketing campaign. The first iteration of the company’s website told customers: “Bankers keep your hard earned 5% to buy all sorts of useful office equipment, but also cars, mansions, suits and dinners.” Adverts on the London underground depicted bank customers in shock when they learn how much bank rates have cost them. Another marketing hook was transparency; campaigns involved teams of Transferwise employees stripping to their underwear in front of city landmarks to show that unlike banks, they “have nothing to hide”. 

This growth strategy was similar to the one deployed by other consumer-facing startups at the time, for example Uber. It required heavy investment. Between 2011 and 2015, Transferwise raised close to $100 million of venture funding. Andreessen Horowitz passed on the earlier rounds (“an investment decision that I have regretted ever since,” wrote Ben Horowitz) but led on the round in 2015, the one before it became a unicorn. By then, Transferwise had grown to a team of 250, active in 292 currency routes, and had done volume of £3 billion. 

As it grew and layered on more currency routes, the company couldn’t always marshal sufficient liquidity among its customers to support matching. It was forced to take principal risk, acquiring currency in the market to meet customer demand. Kristo said later, “Our peer-to-peer model was an innovative solution at the time, but as we scaled, the original model wasn’t scaling with us.” By 2016, Transferwise found true peer-to-peer matches on only 60% of its transaction volume on 20 currency routes.

Moving Money

The balance sheet model is one Wise still employs today. It’s more expensive; the £1 flat fee was abandoned a long time ago. The cost to send £1,000 to EUR is currently £3.70, consisting of a £0.20 flat fee plus 0.35%. The amount of both the fixed and the variable portion of the fee depends on the currency route, the transfer size, the type of transaction being undertaken and the payment method used. 

In its last financial year to March 2021, the company earned £381 million of cross-currency revenues. However, £34 million of that was absorbed by foreign exchange dealing costs. These costs stem from two sources.

The first is that Wise guarantees customers the rate they see on their screen for a period of time, a rate that can change before their exchange is executed. It also offers its services at the weekend, when the markets are closed.

The second is that the company runs an inventory of foreign exchange, whose valuations can fluctuate. At the end of March, its biggest exposures were short euro (£22 million) and long Philippine peso (£14 million). The company operates an FX trading desk to actively manage these exposures. It claims to have built proprietary machine learning algorithms to help predict customers’ need for various currencies and that 50% of traded volumes are currently predicted. But there’s a reflexivity in currency exchange that algorithms find it difficult to capture: customer activity will rise after an outsized move in the currency, and such a move is inherently unpredictable. The company suffered increased foreign exchange losses in March 2020 at the onset of the pandemic, when US dollar to euro exchange rates reached both a 12-month high and low in a single week.

From a customer’s perspective it doesn’t really matter whether the currency is sourced from Wise’s balance sheet, a Wise banking partner, or another Wise customer; what matters is price and speed. And on price, Wise has embraced an interesting model: 

“We believe customers should get what they pay for and so we aim not to cross-subsidise between customers, products or routes. We calculate exactly the costs involved in offering our various products and services, and we charge the customer that amount plus a small margin. When our costs go down, we aim to lower our prices.”

In this sense, the strategy is less Uber and more Amazon. In his 2005 letter to shareholders, Jeff Bezos writes:

“Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long-term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon.com.”

It’s a strategy investor Nick Sleep calls “scale efficiencies shared”. Most companies pursue scale efficiencies, but few share them. Wise explicitly states that its pricing is set not to maximize profits but to maximize customer savings – a number it pegs at £1 billion in the last financial year. Its mission is that its currency exchange services should eventually be free.

Last year, the company lowered prices for currency routes used by around three quarters of its customers, with a price decrease of 15% on average. It’s overall cross-currency take rate went up (from 0.68% to 0.70%) because of a shift in mix towards higher fee currency routes, but long-term the overall rate is expected to go down.

A difference with Amazon’s strategy is whether lower prices necessarily lead to higher customer volumes. Personal customers did an average £7,400 volume with Wise last year, flat on the previous year and up slightly (4%) from the year before that. Cohort analysis shows that customers jump in but their initial usage patterns don’t necessarily persist.

Last year, the company spent £7.20 on marketing per new customer, which isn’t bad. The company says that two-thirds of new customers sign up based on word of mouth and that on the one third it pays for, there’s a nine month payback period based on contribution margin. The flipside is that personal customers don’t necessarily stay active. In March 2021, Wise disclosed it had 10 million users, up from 7 million in March 2020. Total active customers – unique customers who completed at least one cross-currency transaction in the year – rose from 4.5 million to 5.7 million. The data suggests that over 40% of registered users lapse into inactivity.

Nevertheless, the market opportunity remains vast. Around £2 trillion of global cross-border payments were made by individual consumers in 2020. Around two-thirds of that is done by banks; Wise estimates that it has a market share of around 2.5%. The pool is also growing. Remember the 4.5 million non-British nationals living in the UK when Transferwise launched? That number is now 6.3 million. In unbanked parts of the world, the opportunity is even larger. The United Nations has a target to reduce the transaction costs of migrant remittances to less than 3%. This week, it observed International Day of Family Remittances to recognise “the more than 200 million migrant workers, women and men, who send money home to over 800 million family members.”

Wise now offers 2,500 currency routes and can send money to over 80 countries. Its biggest market is still the UK which contributed 23% of revenue last year, but other markets are growing faster. In aggregate, Europe ex-UK now contributes 32% of revenue, Asia Pacific makes up 22% and North America makes up 17%.

Becoming Wise

Earlier this year, Transferwise rebranded as Wise to reflect a shift away from just currency transfers. The company had already expanded into the business market. Today it has around 305,000 business customers, making up 23% of its currency volume and 19% of its revenue. 

In 2017, the company expanded again and launched a multi-currency account, “designed for people living international lives, whether expats or travellers.” The account allows people to add, receive and hold money in different currencies in a single place. Account adoption is currently running at 22% in personal and 48% in business. Account holders are typically more active than non account holders, converting twice as much currency volume. Although Wise makes money from interchange when these customers use debit cards, much of the upside comes from higher engagement with transfers.

At the end of March there were £3.7 billion of customer funds sitting in Wise accounts, equivalent to around £2,300 per account holder. This is a higher average balance than at challenger banks such as Monzo (£360, February 2020) and Revolut (£240, December 2020), reflecting the different demographic.

However, Wise isn’t regulated as a bank which means its deposits aren’t insured. It is regulated as a payment institution in the UK and Europe and as a money services business in the US. As a result, it is subject to safeguarding measures restricting what it can do with customer funds. As at the end March, £3.1 billion of the customer funds were held in cash at regulated banks; £0.7 billion was invested in listed bonds. 

The advantage for Wise not to be regulated as a bank is that it can hold less capital. Its regulatory capital requirement is around £68 million, equivalent to 1.6% of assets. As long as it doesn’t intend to offer credit to its customers, it doesn’t need to seek a banking license. That doesn’t stop it launching other products, and an investment product is in the pipeline. 

As well as its expansion into accounts, Wise also operates a ‘platform’ business which allows other companies to plug into its payments network. To date, the company has integrated fourteen banks in eleven countries, including Monzo, N26 and Stanford Federal Credit Union. 

Wise is something of a paradox. On the one hand it has a medium-term revenue growth target of 20% a year. But on the other hand, its mission is to reduce its fees to zero. Of course, if online brokers like ETrade and TD Ameritrade had harboured a similar ambition, they may not have been waylaid by Robinhood. But for investors, it’s an unusual thing to wait for. The question overhanging Wise is whether “scale efficiencies shared” can be pulled off in the foreign exchange markets.

The registration document for Wise’s direct listing on the London Stock Exchange is available here.

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Stripe

Stripe Sessions is worth watching to understand what the biggest privately-owned fintech is working on. Co-founder and CEO Patrick Collison announced that Stripe processed more payments last year than the entire e-commerce industry did when the company was founded in 2010. In one sense, that’s not surprising – we all know e-commerce has grown a lot since then. But it also shows the upside from betting on a growing market that’s not zero sum. 

Stripe is also no longer simply a payments company. It supplies products and services to help companies launch new business models and uncover new lines of revenue. One area it has invested in is fintech. “Any platform can now use Stripe’s financial services infrastructure to essentially become a fintech company themselves, to do things like unlock access to capital, issue expense cards, and provision accounts to their users.” The convergence between commerce and financial services is accelerating, with Stripe the catalyst.

UK Challenger Banks

The UK challenger banks, Monzo, Revolut and Starling presented at a conference on disruption hosted by Goldman Sachs this week. Compared with presentations in the past, the focus was much more on how to make money. Monzo and Revolut each laid out three sources of earnings. They both relied very heavily on interchange in the past and are looking for alternative sources of revenue. In Monzo’s case, that’s lending. It did lending badly in the year before Covid but spent 2020 investing in underwriting systems. Right now, its loan book is still very small compared with its deposit book, but if it can win some lending business away from customers’ other providers, there is some upside. Its third source of revenue is marketplace and subscription fees. 

Revolut did not address lending, but anticipates picking up incremental revenue from product sales like insurance and from subscriptions. It has benefitted from crypto trading in the past year, which provided an offset to cross-border interchange, but will be looking for more sustainable revenue streams against a softer crypto trading backdrop.

One challenger bank that didn’t present but which I am intrigued by is Ziglu. It was set up by a founder of Starling (another Starling founder went off to launch Monzo) and unlike some of the others has integrated DeFi into its offering. By using DeFi protocols, it converts sterling deposits into stablecoins and lends them in crypto markets to generate a 5% yield. The risk factors are long, but it’s a model I’m keen to examine.

HSBC

We discussed HSBC here a few months ago. The bank has been looking to get out of France for a while. Getting in was easy – it simply paid more than anyone else for its target, CCF, and completed the deal in a few months in 2000. Since then, however, retail banking has lost a lot of its allure and exiting is hard. At the time, we quoted a €500 million number that HSBC would have to pay to have someone take CCF off its hands. That number was finalised this week and it’s higher. Cerberus will pay HSBC a single euro to assume $2 billion of tangible book capital from HSBC, together with 244 branches and nearly 4,000 staff. That amounts to a negative $8 million per branch. Low interest rates are having their mark.