Joris Lochy | August 18, 2021
BNPL (short for "Buy Now Pay Later") is a hot topic in the Credit space. The recent funding round of Klarna (one of the most known BNPL players on the market) of $639 million at a valuation of $45,6 billion makes it Europe’s most valuable startup and shows that investors predict continuing exponential growth for this service.
This anticipated growth is coming from an increased negative perception of consumers towards revolving credit lines, like credit cards. As a result consumers look for cheaper and more user-friendly and convenient alternatives. Especially the younger generation of millennials seems to be attracted by this offer, with 15 percent of them already uses BNPL today, i.e. 5 times more than older generations.
Combine this with the continuous growth in e-commerce for which this type of credit is ideally suited and you can get a feeling why such an astronomical valuation could be justified.
The result is an exploding market of Fintechs offering those promising services, like Klarna, but also Affirm, AfterPay, Cashper, Divido, ratepay, scalapay, Cofidis, LayBuy… Additionally incumbent players like PayPal and AmEx have also started attacking this market.
Although many praise this new product for its user experience and convenience and its promise to offer zero-interest rate credits to nearly anyone, many specialists are also highly skeptical about this new trend, as it can push people in unneeded debt for products they don’t even need.
But what is BNPL and where is this hype coming from? And how is it different from traditional consumer credit cards or 0% interest consumer installment loans offered already for years by car dealers, electric appliances stores or kitchen/bathroom dealers?
In fact BNPL could be considered as the modern, digital equivalent of those consumer installment loans. Its characteristics could be summarized as following:
A short-term financing product
For relatively small amounts, i.e. maximum 1-2.000 EUR as a total maximum credit amount at a specific BNPL vendor (aggregated over all purchases paid with BNPL)
Linked to a purchase of a specific product or service
Usually interest-free, i.e. instead the merchant pays a commission to the BNPL provider.
Very strongly integrated in the check-out process of the merchant. Till now mainly for online merchants (usually as an additional payment method offered via the webshop’s PSP), although BNPL vendors recently have started to expand also to physical payments. Usually this is done by the BNPL issuing a virtual credit card (which can be limited to a specific store) with which the purchase can be done (with the smartphone emulating a physical credit card), but it can also be done via a QR code (generated by the merchant and scanned by the customer or vice-versa).
An excellent user experience, giving a near real-time, frictionless and fully digital origination process of the credit, i.e. in a few seconds the BNPL credit can be opened.
Usually consisting of an upfront payment (typically 25% of the overall purchase amount) at the moment of purchase, followed by a predetermined (= fixed schedule) small number(typically 4) of installments at future dates (typically with intervals of 2 weeks, meaning duration of 2 x 4 = 8 weeks) to reimburse the remainder. These reimbursements are usually done automatically by linking a debit or credit card or direct debit to the BNPL provider. This method is called "Slice-it" (i.e. the payment is spread over time), but many BNPL provider also provide the "Pay Later" method, which is also ideal for online purchases, as it allows the user to usually pay 14 days after his purchase. This corresponds with the moment the customer has received the product and has decided not to return it.
Using a soft-credit score, which uses other info (like e.g. all details of your current and past purchases) than the traditional credit scoring systems and doesn’t affect your credit score (unless there is a late payment or a failing to pay). This leads also to higher acceptance scores (of around 90%) than traditional credits.
The merchant is paid right away and the BNPL provider takes over all the risks, like liabilities due to fraud, chargebacks, defaulting…
If you read those characteristics, this product seems great for all involved parties, i.e.
Consumers get a cheap (often "free"), user-friendly, disciplined (i.e. a fixed well-defined repayment schedule) and frictionless way of funding a purchase, which they may otherwise not have been able to afford.
Merchants can increase their revenues, i.e. multiple studies have showed that people buying via BNPL tend to spend more than if they would be paying with a traditional payment method (i.e. increase of AOV = Average Order Value) and abandon less their shopping carts.
Research has also showed that BNPL can act as a Customer Acquisition Channel as a growing number of users considers BNPL (to be available as a payment method) as a key decision criterium to choose one webshop over another. Additionally the apps of BNPL vendors become more and more marketplaces advertising all their partners.
Nonetheless BNPL is not all sunshine and rainbows. Several pitfalls can be identified, which could endanger its future growth, i.e.
Increased regulation: while many BNPL vendors have slipped through the cracks of severe regulatory supervision (i.e. in many countries BNPL vendors try to be exempt their product from the definition of a credit), the impressive growth of this credit product is about to change this. Regulation will fiercen, as a high percentage of consumers using BNPL already cope with financial difficulties to pay back their installments. One potential improvement could be to demand for more transparency, so that there is an aggregated view of all your pending BNPL payments at different BNPL players.
With more and more merchants offering this service, the product will become a commodity, meaning the advantage of being a "Customer Acquisition Channel" will disappear. One might wonder as well if it is desired that every merchant starts offering this payment method. E.g. in certain countries pizza restaurants are already offering to order your pizza and pay with BNPL. If consumers start using too much BNPL, it will become extremely difficult to keep a good financial overview and the advantages of BNPL like user-friendliness and a disciplined repayment schedule might disappear.
The operational and support model is not always top yet. As BNPL vendors take over all liabilities, it is unclear who is responsible for the delivery of a product. A few months ago I had myself a particular bad experience with BNPL. On a webshop I selected BNPL as a payment method, but never got any invitation to pay. The webshop didn’t want to send the item as they were not paid yet and they referred me to the BNPL vendor, who in its turn referred me back to the webshop. In the end, given the urgency for receiving the product, I said it could be cancelled, which required again a message to both parties. In the end everything got straightened out, but it was not a pleasant experience for me as a user, nor for the BNPL vendor and the webshop who both had a lot of work without any revenue.
A similar issue exists when deciding to return a delivered item and get reimbursed. As a consumer you will return the package to the webshop, but it’s the BNPL vendor who should cancel the BNPL arrangement. Often this requires a lot of hassle for the customer to arrange all this.
This shows the complexity of this model. In this kind of partnerships it is extremely important to align on responsibilities (cfr. my blog "Ecosystems - The key to success for all future financial services companies" - https://bankloch.blogspot.com/2020/11/ecosystems-key-to-success-for-all.html). Ideally as a consumer you would like to have only a relation with the webshop (given the strong embedding of BNPL in the checkout process it is difficult to make a clear distinction for users), i.e. the fact that other parties like the PSP and the BNPL provider are also involved in the flow should be hidden away for the consumer. This is far from being the case today.
With this product being used more and more, customers might also get a negative perception of this credit, as the zero-cost credit comes with a lot of hidden costs. First of all there are considerable fees and interests in case of missed payments (as much as 30% of the invoice amount), but additionally the BNPL vendor is still paid with a more traditional payment method, like a debit or credit card or direct debit. If there is insufficient funding on the bank accounts linked to those payment methods, customers will still pay costs for failed direct debits, expensive overdraft debt interest rates and/or credit card debt interests (which people tried to avoid in the first place).
Additionally BNPL tends to make the origination of a credit so easy, that there is a big risk of putting customers into financial issues for products they didn’t really need in the first place.
BNPL usage still negatively impacts the margin of the merchant. Even though BNPL can be considered as a means to attract additional business (revenue), the cost for the merchant is still considerably higher than other payment methods. E.g. VISA and MasterCard are typically situated around 2-3% transaction commission, while BNPL methods are typically situated between 2 and 8% (usually 4-6%).
Consumers tend to miss out on rewards or cashbacks earned on purchases (often offered by credit card companies). This means an additional hidden cost for the consumer.
BNPL Fintechs are expected to get a lot of competition of incumbent players like incumbent banks and PSPs offering those services themselves. Those players can offer a lot more integrated features (e.g. a full integration in the banking app and an immediate link to the customer’s current account) and can exploit a lot of competitive advantages compared to BNPL Fintechs, e.g. lower cost of capital from deposits, synergies with other products… Although those players have been late adopters of this technology, they are likely to take a serious cut of market share from BNPL Fintechs, once they get the offer setup. Already today, Fintechs, like Amount, have created white-label BNPL products, which can help banks to quickly setup a BNPL product.
BNPL Fintechs are already taking action to address those concerns, e.g. BNPL providers offer
A lot of features to improve customer’s financial literacy. Although very noble, it still seems a bit of window-dressing to please regulators and public opinion.
A shift to also support physical payments, as explained above.
The app of BNPL vendors is turned more and more into a marketplace, where specific (products of) merchants (being a customer of the BNPL vendor) are directly offered, meaning the BNPL vendor becomes the direct customer entry point instead of the webshop.
BNPL vendors are using more and more their collected data for offering targeted marketing, like personalized recommendations, advertisements, discounts in the form of coupons and cashbacks… This can be an interesting additional source of revenue.
Many BNPL vendors are starting to handle the logistics of a transaction. Obviously this allows to ask higher commissions to the merchants, but also allows to provide a better end-to-end support flow.
BNPL credit limits are being increased to allow for more BNPL payments for 1 customer, but also to attack merchants with more expensive product offers, like high-end luxury goods. Obviously this change is slippery slope as it can increase the risk of credit deferrals/defaults and also increase negative perception.
BNPL vendors are transforming more and more into Challenger banks themselves, offering also more traditional banking products.
The apps of BNPL vendors is extended with additional value-added features, like managing spending limits, getting insights into your spending habits, receive personalized budgeting tips, get product recommendations based on your purchase history, initiating refunds…
BNPL vendors are starting to increase the customer relation via loyalty programs (e.g. Vibe from Klarna)
All this seems the traditional story in Fintech. Fintechs come with very innovative ideas, but often have difficulties to make those products profitable and keep their competitive advantage on the long-term, as incumbent banks develop similar offers after a few years and the Fintechs are automatically becoming more bureaucratic, complex organizations (often forced by regulators) similar to the incumbent banks, which they tried to disrupt in the first place (cfr. my blog "Neobanks should find their niche to improve their profitability" - https://bankloch.blogspot.com/2020/12/neobanks-should-find-their-niche-to.html). Let’s see how many BNPL Fintechs are still around 5 years from now.
Read MoreJoris Lochy | August 18, 2021
NFTs are at the moment a real buzz. The word NFT stands for non-fungible token, which means a unique, irreplaceable cryptographic object. It aims to manage ownership of digital content (digital collectible items) by storing the ownership in the form of a digital certificate on a blockchain (usually on the Ethereum blockchain, but other blockchains can also be used). This way the buyer can prove that he is the owner of a certain digital item.
The fact that the NFT token is unique and irreplaceable, generates traceability of the owner, but also ensures authenticity and (digital) scarcity, thus resulting in its value (via its uniqueness it becomes a collectible item).
This makes it an attractive asset for both buyers and sellers. For sellers, creating (= minting) an NFT gives an easy option to monetize (without intermediaries like galleries or auction houses) their digital content (products), like digital pictures, animations, music, videos…. Additionally NFTs have the feature that the author can also get a percentage of future transaction amounts (thus profiting of a future increase in value of the NFT).
The buyer can invest in digital art and can be sure of the uniqueness and his ownership (i.e. the bragging right that you own the art) and the ownership can easily be transferred to any other buyer in the world (becoming the new owner) with the click of a button.
NFTs started in 2017 with CryptoKitties (a game to breed and trade digital kittens) and CryptoPunks and gradually increased over the last years, but it exploded in 2021 (i.e. in 2020 the market was estimated to $250 million over the whole year, while in the month of February 2021 alone already $360 million of NFTs were traded), with some record transactions, like:
The record is held by the digital composite called "EVERYDAYS: The First 5000 Days" of the digital artist "Beeple" (Mike Winklemann), which was sold at Christie’s for $69.3 million. Of the same artist also a video was sold for $6.6 million.
Christie’s auctioned recently also an NFT of 9 virtual rare CryptoPunks for a record amount of $16.9 million
The first tweet on Twitter of the co-founder and CEO of Twitter Jack Dorsey was sold for just under $3 million
The Canadian singer-songwriter Grimes (also known as the partner of Elon Musk) sold for around $6 million of digital artworks, including an NFT of about $400.000 for a 50-second video.
NBA’s Top Shot has generated more than $230 million in selling NFTs of NBA highlight videos, with a top transaction for a movie of Lebron James dunking, which was bought for over $200.000. These NFTs have become the digital equivalent of the paper sports collection cards.
While those transactions get the news headlines for their record amounts, thousands of NFTs are also sold for a few thousand euros. E.g. a selfie of Lindsey Lohan was sold for $59.000, Bad Luck Brian yearbook photo for $36.000 or the "Charlie bit my finger!" YouTube clip was sold for $761.000, not to mention the thousands of transactions that do not get any media attention at all.
These enormous prices definitely attract a lot of media attention and investors, but nonetheless NFTs remain difficult to grasp. While for traditional art, the owner has the physical artwork in his possession, this is not the case at all for NFTs. For example, the NFT for the Beeple picture sold for the record amount can perfectly be downloaded on the internet at no cost. This downloaded file will be identical to the digital file owned by the buyer (i.e. the copy is literally as good as the original).
Obviously, this is a new technology which raises a lot of questions and issues, e.g.
What do you actually own? The NFT is just a digital certificate on a blockchain. The blockchain does not even contain the digital artwork, but just a link to a location where the digital artwork is stored. This raises automatically questions like:
What is the legal ground of an NFT? Can you claim the ownership in court, i.e. will the courts consider the blockchain as sufficient proof of ownership? Will the judge even understand it? Will it have the same legal basis in any country in the world? Can I win at court if someone exploits commercially the digital content owned by me?
What happens if the link to which the NFT refers is no longer available? Does the NFT lose its value? Can the link be adapted?
What is the exact digital asset I am owning? On the blockchain a hash of the digital asset, together with some ownership info, is stored. However if someone changes 1 (invisible) pixel to a digital artwork, the hash will no longer match. Do I also have the ownership of this new (nearly equivalent) digital artwork?
How transparent and well-defined are the properties of ownership? E.g. do you also buy the copyright and reproduction rights? Are you allowed to ask royalties if the digital item is downloaded/published? Are you allowed to ask BigTechs (like Facebook or Google) to remove all copies they store of your digital asset?
NFTs are typically sold via intermediate platform (like OpenSea, Rarible, Superrare, Foundation, AtomicHub, Nifty Gateway, KnownOrigin…), managing the contact with the artist, setting up the NFT, managing the transactions on the Blockchain and also storing the digital artwork in the cloud (i.e. location to which NFT refers). This raises a number of questions about the trustworthiness of those platforms:
Will they ensure the link to the artwork remains available (i.e. not lost or broken)? Even if they go bankrupt? More and more decentral IPFS network or blockchain based storage is used to mitigate this risk.
Does the platform ensure an artist does not create multiple NFTs of the same (or slightly changed) digital asset?
Do they ensure that the NFS is minted by the real artist (creator) of the content and not by an imposter? Which procedures do they have in place for verifying that?
Even though the decentralized nature of the underlying blockchain ensures trust, buyers and sellers still need to trust the platforms facilitating these NFT transactions. This is for me a general issue of blockchain use cases (cfr. my blog on blockchain "ttps://bankloch.blogspot.com/2020/02/blockchain-beyond-hype.html" - Blockchain - Beyond the hype), i.e. although the blockchain entry can be perfectly trusted, the end-to-end user journey is much more extensive, thus requiring still trust in a central party.
How future-proof are the blockchains? With blockchains in full evolution, will the Ethereum blockchain (or other blockchain on which an NFT is held) still be around in 5 years or in 10 years (or not be replaced by a more popular and more modern blockchain)? Will it be possible to keep the decentralized nature of this blockchain while volumes increase enormously? Beginning of June 2021 the Ethereum blocksize (of the full blockchain) was over 800 GB, an increase of more than 100% compared to the year before. This shows that storing the full blockchain (and then we do not even speak about the resources required for mining) has become more and more a specialist job, hence more centralisation and less guarantee that a lot of parties will continue to keep track of the full blockchain. Furthermore it means it becomes less straight forward to prove your NFT ownership, without consulting a specialized party which stores the full blockchain.
Is the energy consumption for an NFT sustainable and will it not negatively impact the future success of NFTs?. For example, the energy consumption to create an NFT of a simple animation is equal to using 1.5 million times a pressure cooker. However with blockchains switching more to Proof of Stake-consensus mechanisms this will likely be resolved in the coming years (although Proof of Stake raises naturally other new concerns about centralization and potential manipulation).
Are the NFTs currently sold for a lot of money sufficiently time-lasting? This question can be raised for both the digital artworks as for the technology underpinning it:
Are the digital artworks not too time-specific, i.e. linked to current, non-lasting hypes? E.g. will YouTube movies which are popular now still be remembered and popular in 5 years? In the traditional art, certain historical artists (like Monet, Van Gogh, Picasso…) have an established reputation/track record, but for this digital art there is of course no historical records to turn to and as a result it is very difficult to predict future trends.
NFTs are also more and more used in games, to describe ownership of virtual plots of land or unique weapons or armors. This makes the NFT practically usable, but what is the value in a few years when the game is no longer popular?
Is the technology sufficiently robust? Not only is there a risk due to the above-mentioned dependency on blockchains and the platforms for storing the digital asset, but besides that you also have to ensure the file format of the digital content can still be read or ensure you can still access your digital wallet.
Due to popularity of the underlying blockchains (like Ethereum), NFTs are confronted with high transaction costs(high gas fees to get your NFT on the blockchain). While this transaction cost is marginal for the above record amount NFTs, it does pose an issue for cheaper NFTs (as transaction cost become too significant compared to the NFT price).
The whole process of minting, buying and transferring NFTs is not so user friendly, i.e. you need to onboard on an NFT platform, you have to acquire the right crypto-currency (e.g. if the NFT is on the Ethereum blockchain, you need Ether coins, i.e. Bitcoins won’t be usable) and you have to pay with crypto-currencies, which is still not so user-friendly (i.e. typically via a browser plugin, which might be easy for a computer specialist, but still difficult to setup for the common layman).
Clearly the concept of NFTs is great, as there is a need for managing ownership of digital content. With more and more digital content being produced and some artists even only exclusively producing digital content, there is a need for them to make money and NFTs are a good way to do this. However the too strong focus on the underlying (blockchain) technology and the bullish prices, make it still too much a playground for the (mega)-rich, than a common investment asset class. However even if it remains such a playground, it is still interesting to follow. As there are as many as 100,000 people who have $1 million or more stashed in crypto-currencies, there is an enormous audience with the means, interest and risk appetite to try out NFTs. For them, there is the cool factor of trying out something new, the potential of making same profits as with crypto-currencies, the emotional and bragging aspect of owning digital arts (compared with owning parts of the moon or owning a star. This has no legal ground, but is still very romantic and fun) and the Robinhood aspect of pushing governments to change and fighting the traditional art system (cfr. the actions on Robinhood to stop the short-sellers on the share of GameStop).
This being said, NFTs are clearly an excellent real-live experiment, where fundamental questions around ownership, value, digitalization and authenticity are being addresses.
The question remains however if ownership can be managed outside governments, i.e. as ownership requires laws to protect the owner, it is very difficult to manage this outside a government.
Clearly governments should sponsor some kind of register of such digital ownership. This will ensure that there is legal ground and also long-term continuity, as unlikely governments will disappear/go bankrupt. However if done by a government, there is no real need for a blockchain, as you have a central, credible authority, which could perfectly store the ownership (personal details of the owner) and the full digital content (so not just a hash) in a traditional database.
While governments are starting now to explore an alternative for crypto-currencies in the form of CBDCs (cfr. my blog "https://bankloch.blogspot.com/2021/05/cbdc-new-kid-on-block.html" - CBDC - The new kid on the block), this will likely happen as well for NFTs.
In the meantime, it is good the conservative art world is shaken up by these kinds of innovations.
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