The One Thing that Square, the Neobanks, and Buy-Now-Pay-Later All Have In Common
How Square’s pivot to Cash App has defined a generation of Fintechs
If you’ve followed Fintech or payments over the last year, you’ve witnessed Square’s absolutely meteoric rise to a $115 billion market cap — the company has appreciated by 400% in less than two years!
To be completely honest, it flew entirely under my radar until I dug into the fascinating story of Marqeta, a next-gen card issuing tech stack that IPO’d earlier this year on June 9th at a ~$14B market cap. Only after I took a look through Marqeta’s S-1 filing did it occur to me that:
70% of Marqeta’s card volumes were being driven by Cash App.
I was not at all aware (until I read Marqeta’s S-1) that Cash App had grown to such scale that it had become the largest of Square’s business lines. If this is the first time you’re hearing this, then be prepared for the 5 stages of Cash App enlightenment.
Stop to think about that for a second. The coffee-shop-card-swiping-dongle business that was founded back in 2009, which had been the livelihood of Square for the the last decade and helped the company emerge from startup stardom to the NYSE…well, that is no longer what Square is about.
How did this happen?
About 4 years ago, Square made a real push to commercialize Cash App as a p2p digital wallet, much like Venmo, as an app on your phone. Around that time, Cash App also started to put debit cards in the hands of its users.
This changed everything.
If you’ve ever used Venmo, the biggest challenge was getting your funds from your Venmo account to your checking account. After I collected all that 🍕 and 🍻 money from my friends and colleagues, I needed to transfer that 💰💰💰 from my Venmo balance to my checking account if I ever wanted to use it in the real world. I never paid for the instant transfer but I did have to wait 2 or 3 days before my funds were accessible from my checking account.
Cash App figured out that this was an unnecessary friction in the user experience. And they correctly figured out that if they got rid of this UX friction then users might just spend directly from their digital wallets.
Cash App’s Business Model
With a debit card in hand, Cash App users could use their digital wallet anywhere Visa is accepted. If you have a balance in your Cash App account, just tap/swipe/insert your debit card at the local coffee shop and voila!— you’ve successfully used the funds from your digital wallet, at a physical store, in just one step.
This was a transformative move for two key reasons:
- Cash App was no longer just a digital wallet — it could be used just like your checking account.
- Debit cards suddenly opened the door to a viable, stand-alone revenue model — something that Venmo had been trying to figure out for years!
So let’s talk about that revenue model
Like the credit card interchange model (which I’ve written about previously), there is a debit interchange model. Every time a Cash App user swipes their debit card at the grocery store, coffee shop, gas station, etc., the merchant pays a debit interchange fee of ~120 bps.
On average, Cash App will retain ~75 bps of the debit interchange fee. That may seem like chump change, but at the scale Cash App has grown to, it adds up quick. As Square revealed in its latest quarterly filing, Cash App generated $495 million of revenue from debit card transactions. And as I mentioned earlier, this is now Square’s largest source of revenue.
Btw, if you’re wondering why Bitcoin is such a small share of Square’s revenue, it’s because the pie chart uses adjusted revenue figures, which are provided directly by Square. TLDR: Square recognizes the whole dollar value of a Bitcoin purchase as revenue, which (some may say) is superficially high. I highly recommend this post from Aika Ussenova for a more in-depth analysis.
Neobanks also scaled using debit interchange
Cash App has grown rapidly to 40 million MAUs and $1.6 million of LTM revenue. Over the same few years, the neobanks have also scaled quickly.
Recent fundraising announcements in just the past few months highlight how large neobanks have become.
- Revolut raised $800M at a $33B valuation in July — 12 million users.
- Chime raised $750M at a $25B valuation in August — 12 million users.
- Varo raised $510M at a $2.5B valuation in September — 4 million users.
In the US, eMarketer forecasts that the number of neobank account holders will continue to grow at a healthy pace to surpass 53 million by 2025.
As many of you probably know, the appeal of the neobanks to most Americans is that they are free of fees — no monthly fee, no ATM fee, and oftentimes no overdraft fees. And aside from Varo, most neobanks are not federally licensed banks so they cannot hold customer deposits to generate net interest margin (the way traditional banks do).
So how do neobanks make money?
What’s fascinating is that the majority of neobanks have (similar to Cash App) capitalized on the debit interchange model. And because the merchant is the one who pays the interchange fee, neobanks are still fee-free (for users), even as they rack up the revenue (from merchants) each time a user swipes their debit card. In debit cards, the neobanks found a dependable and fast-growing source of revenue that defies the traditional banking model.
But there’s more — neobanks aren’t the only ones!
According to recent announcements from the likes of Affirm, Klarna, and Afterpay, it looks like Buy-Now-Pay-Later companies also want to join the party. For BNPL, debit interchange has the potential to extend their growth runway through a new source of revenue, not to mention de-risk their revenue mix away from credit-like products.
All said, Fintech has been an attractive destination for venture financings and public listings in recent years. Neobanks and BNPL together account for more than $20 billion of venture financing and today combine for over $230 billion of equity value.
For me, the 5 stages of Cash App enlightenment really opened my eyes to the powerful, yet stealthy, revenue model that completely changed Square’s DNA. The fact that so many other fintechs have followed Cash App’s lead highlights just how valuable a checking account customer can be. After all, a user’s debit card and checking account are such “sticky” products — people use these accounts for their (literally) everyday spending and they hardly ever switch (unlike credit cards) their checking accounts to another bank.
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Disclaimer: The views expressed here do not necessarily reflect those of my employer.
