A tour through payments: part 3 (SQ, FOUR)
Hi everyone,
A few weeks ago, I recorded a podcast with my friend @LibertyRPF, who writes the excellent Liberty's Highlights Substack. We discuss newsletter writing and investing.
Block (SQ)
I once argued how by taking the problem of merchant payments acceptance seriously, Block knew to start with what must at the time have seemed like the most commoditized part of the payments stack, card readers, when everyone else was obsessed with software. Cheap plastic dongles combined with transparent pricing and no contracts or sign-up fees disrupted a legacy apparatus of hidden fees and expensive terminals that made it tough for small, resource-constrained merchants to accept card payments. Atop this hardware foundation, Square layered on various other things that businesses need to run (working capital loans, instant deposits, checking accounts, payroll, POS software, marketing), then created industry-specific configurations of those things (Restaurants, Retail, Beauty). In 2021, merchants using 4 or more products account for 40% of Square’s gross profit, up from 4% in 2015; subscription and services comprised 18% of Square’s revenue over the last 12 months, up from 11% in 2019. The expanding collection of things they cross-sold to small merchants became increasingly “good enough” for larger businesses with more complex operations. Today, merchants processing more than $500k of sales on Square account for 40% of GPV, up from just 13% in 2015.
And Square’s just part of the story. The other half of Block’s gross profits comes from Cash App, which began as a P2P payment app and is growing into a self-contained financial ecosystem. Money flows into Cash App and feeds downstream tributaries of financial activity: Adam receives a direct deposit from his employer into his Cash App wallet and sends money to his sister Beth, who uses it to buy stock or crypto or spend on her Cash App debit card. The unit economics are terrific. Aided by the network effects of P2P transfers and boosted by pop culture1, Block is acquiring new transacting actives for just ~$10, a fraction of the $100-$200 paid by a traditional bank, and realizing $60 of gross profits over just 3 years, mostly from instant deposits, interchange, and Bitcoin trading fees. With a sponsor bank on the back-end, they are now expanding into consumer credit, starting with $200 loans whose underwriting is informed by Cash App deposit balances and can be repaid in installments or as percent of Cash App inflows. Financial products (trading, Direct Deposits, Borrow) don’t just generate direct profits but have spillover benefits. Compared to customers who only use Cash App for P2P, those who adopt financial products bring multiples more inflows2 and those inflows translate into revenue generating activity.
Square has become synonymous with mom-and-pop merchant acquiring, its vertically integrated model inspiring a slew of copycats. Cash App began as a corporate side hustle and now brings in $2.6bn of gross profits a year. So what do you do with 2 thriving complementary ecosystems? Naturally, you try to bring ‘em together. A closed loop ecosystem, where a digital wallet on one side is used to discover and transact with merchants on the other, has long been the white whale of fintech and payments. For Block, it started innocent enough. A Square merchant direct deposits paychecks to the Cash Apps of their employees, who can earn discounts (”Boosts”) by spending their wages at other Square merchants. Then in fintech fervor of 2021, Block took a big step forward, yolo’ing into closed loop commerce with their acquisition of Afterpay.
Before it was acquired by Block, Afterpay had it own closed loop ambitions that expressed itself in two ways: 1) commerce – a shopper could tap the Afterpay button on a merchant’s checkout page to purchase a $100 purse and Afterpay would pay the merchant ~$95 while collecting the full $100 from the shopper over a series of 4 equally sized payments; and 2) discovery – based on a shopper’s purchase history, the Afterpay app would surface discounts and promotions from relevant Afterpay merchants. So now imagine fusing that two-sided ecosystem with Block’s. Square sellers can integrate Afterpay into their point-of-sale; Block’s 50mn monthly actives can discover and BNPL with Afterpay merchants directly inside Cash App. With just 6% of Cash App actives also using Afterpay at the time of acquisition, Block could flood Afterpay with leads.
Silly valuation aside, I thought Afterpay would “thrive” as part of Block. In the year since the deal closed, there’s been little evidence of that. At the time the acquisition was announced, Afterpay was growing gross profits 75% y/y, on top of 88% the year before. Since then, growth has decelerated to just 6%, making the 40x revenue multiple that Block agreed to pay for Afterpay at the peak of the fintech mania appear rather reckless, even if it was funded with Block shares that were trading at a less absurd (but still absurd!) 24x.
And this gets to my ambivalence about Block. The company is clearly capable of building great products with terrific unit economics, as evidenced by Square and Cash App. But it also straddles the line between crazy and genius. In 2013, you might have wondered what right a vendor of POS software and terminals had to win in P2P payments. A closed loop thesis justifying the initiative would not have panned out 10 years later. The success that Cash App has enjoyed so far is entirely its own. You need a little crazy to get Cash App. But crazy also gets you TIDAL, a “global music and entertainment platform that brings fans and artists together through unique music, content, and experiences”, an opportunity you’d think would make more sense for Spotify, if it even makes sense at all. It gets you a clothing line, Cash by Cash App, “because money is inherent to lifestyle”.3 It gets you fervent commitment to Bitcoin.
As I discussed in part 1 of this series, a payments company should in the business of surfing waves, not spawning them. It’s one thing for a merchant acquirer or a payment network to accept or convert Bitcoin because hey, who knows, consumers may one day transact with it for certain use cases and why not be open to any popular form of payment, whatever shape it takes. But it’s quite another to zealously push Bitcoin or promote crypto as the centerpiece of your future. Today Bitcoin trading is just 3% of Block’s gross profits, not a big deal. But Block’s May 2022 Investor Day is riddled with enough wild Bitcoin talk to make me suspect that it one day could be. Block has a dedicated crypto division, Spiral, whose sole aim is to “work on whatever they thought best for Bitcoin”, which includes things like an SDK for wallet for developers to build on the Lightening Network and decentralized Bitcoin mining systems and wallets. They say cultish stuff like “we see self-custody as being the future of decentralized finance, a world in which people control their own financial destiny” and are creating integrated software and hardware “for those wanting to participate in the new economic reality.” I….don’t love this.
I wonder if the Bitcoin stuff has widespread buy-in at Block. At times it sounds like something being force fed into the organization by Jack Dorsey. Like I can picture all these talented engineers and designers building beautiful and useful products at Block…and then Jack ambling around the office, contemplatively stroking his face bramble like “mm that’s cool I guess but where’s Bitcoin fit in?” and everyone’s got to smile and nod and pretend Bitcoin is somehow relevant. Nothing would surprise me. Block could convert to a DAO for all I know.
Shift4 (FOUR)