Last year, the world of fintech startups – protagonist of the venture capital heyday of 2021 – started to crumble as VC funding became limited. As we enter mid-2024, large portions of the industry today are an absolute mess, particularly banking as a service which, ironically, experts told us last year was the bright spot.

The failure of Synapse fintech banking-as-a-service (BaaS) is, perhaps, the most dramatic thing happening now. While that’s certainly not the only bad news, it shows how treacherous things are for the often interdependent fintech world when a key player finds itself in trouble.

Synapse’s problems have damaged and destroyed a lot of other startups and affected consumers across the country.

To recap: San Francisco-based Synapse ran a service that allowed others (mostly fintechs) to incorporate banking services into their offerings. For example, a software provider specializing in payroll for 1,099 companies with numerous contractors used Synapse to provide instant payment functionality; others used it to offer specialized credit/debit cards. It provides these types of services as an intermediary between banking partner Evolve Bank & Trust and business banking startup Mercury, among other clients.

Synapse has raised a total of just over $50 million in venture capital over its lifetime, including a 2019 Series B raise of $33 million led by Angela Strange of Andreessen Horowitz. The start faltered in 2023 with layoffs AND filed for Chapter 11 in April this year, hoping to sell its assets in a $9.7 million fire sale to another fintech, TabaPay. But TabaPay walked. It’s not entirely clear why. Synapse placed a lot of blame on Evolve, as well as Mercury, both of which raised their hands and told TechCrunch they were not responsible. Once responsive, Synapse CEO and co-founder Sankaet Pathak no longer responds to our requests for comment.

But the result is that Synapse is now on the verge of being forced to completely liquidate under Chapter 7, and many other fintechs and their customers are paying the price for Synapse’s demise.

For example, Synapse client teen banking startup Copper had to do this abruptly discontinue its bank deposit accounts and debit cards on May 13 due to Synapse’s difficulties. This leaves an unknown number of consumers, mostly families, without access to the funds they had confidently deposited into Copper accounts.

For its part, Copper says it is still operational and has another product, its financial education app Earn, that is unaffected and doing well. However, it is now working to pivot its business towards a white-label family banking product, in partnership with other, as yet unnamed, larger American banks, which it hopes to launch later this year.

Crypto app Juno’s funds were also hit by Synapse’s collapse, CNBC reported. A Maryland teacher named Chris Buckler said in a May 21 statement that he was barred from accessing funds he held from Juno because of issues related to Synapse’s bankruptcy.

“I am increasingly desperate and don’t know where to turn,” Bucker wrote, as reported by CNBC. “I have almost $38,000 tied up due to the interruption of transaction processing. It took me years to save this money.”

Meanwhile, Mainvest, a fintech financier for restaurant businesses, actually is close due to the mess at Synapse. An unknown number of employees are losing their jobs. On its website, the company said: “Unfortunately, after exploring all available alternatives, a mix of internal and external factors have led us to the difficult decision to cease operations of Mainvest and dissolve the company.”

Based on Synapse documents, up to 100 fintechs and 10 million end customers may have been affected by the company’s collapse, industry observer and Fintech Business Weekly author Jason Mikula estimated in a statement to TechCrunch.

“But that may underestimate the total damage,” he added, “since some of these customers do things like handle payroll for small businesses.”

The long-term negative and serious impact of what happened to Synapse will be significant “across fintech, especially consumer-facing services,” Mikula told TechCrunch.

“While regulators do not have direct jurisdiction over middleware providers, which includes companies like Unit, Synctera and Treasury Prime, they can exercise their power over their banking partners,” Mikula added. “I would expect a greater focus on ongoing due diligence on the financial condition of these types of middleware providers, none of which are profitable, and a greater focus on business continuity and operational resilience for banks engaged in BaaS operating models.”

Perhaps not all BaaS companies should be grouped together. This is what Peter Hazlehurst, founder and CEO of another BaaS startup Synctera, is quick to point out.

“There are mature companies with legitimate use cases served by companies like us and Unit, but the damage done by some of the fallout you’re reporting on is rearing its ugly heads,” he told TechCrunch. “Unfortunately, the problems many people are experiencing today were introduced to the platforms several years ago and have worsened over time despite not being visible until the last minute, when everything collapses at the same time.”

Hazlehurst says some classic Silicon Valley mistakes were made by early movers: People with computer engineering backgrounds wanted to “disrupt” the boring old banking system without fully understanding it.

“When I left Uber and founded Synctera, it became very clear to me that early players in the “BaaS” space built their platforms as quick fixes to exploit a neo/challenger banking “trend” without any real understanding of how to do so . run programs and the risks involved,” said Peter Hazlehurst.

“Banking and finance of any kind is serious business. It requires both skill and wisdom to build and manage. There are regulatory bodies that protect consumers from negative results like this for a reason,” she adds.

And he says that in those heady early days, banking partners – those who should have known better – did not act as a support in choosing fintech partners. “Working with these actors seemed like a really exciting opportunity to ‘evolve’ their business and they bought in blindly.”

To be fair, BaaS players and the neobanks that rely on them are not the only ones in trouble. We continually see news stories about how banks are being scrutinized for their relationships with BaaS providers and fintechs. For example, the FDIC was “concerned” that Choice Bank “had opened… accounts in legally risky countries” on behalf of digital banking startup Mercuryaccording to a report by The information. Officials also reportedly criticized Choice for allowing overseas Mercury customers to “open thousands of accounts using questionable methods to demonstrate they have a U.S. presence.”

Healy Jones of Kruze Consulting believes the Synapse situation won’t be a problem for the startup community moving forward. But you believe that regulatory clarity is necessary for consumer protection.

The FDIC needs to “come out with clear language about what is and what is not covered by FDIC insurance in a neobank that uses a third-party bank as the backend,” he said. “This will help keep the neo-banking sector calm,” she said.

As Gartner analyst Agustin Rubini told TechCrunch: “The Synapse case highlights the need for fintech companies to maintain high operational and compliance standards. As middleware providers, they must ensure accurate financial record keeping and transparent operations.”

From my perspective, as someone who has been covering the ups and downs of fintech for years, I don’t think all BaaS players are doomed. But I think this situation, combined with all the increased scrutiny, could make banks (both traditional and fintech) more reluctant to work with a BaaS player, instead opting to establish direct relationships with banks as Copper hopes to do.

The banking system is highly regulated and highly complicated, and when Silicon Valley players screw up, the ones who get hurt are ordinary human beings.

The rush to deploy capital in 2020 and 2021 has led many fintech companies to move quickly, partly as an effort to satisfy hungry investors seeking growth at all costs. Unfortunately, fintech is an industry where companies can’t move so quickly as to take shortcuts, especially those that evade compliance. The end result, as we can see in the case of Synapse, can be disastrous.

With funding already declining in the fintech sector, it is highly likely that the Synapse debacle will impact the future prospects of fintech fundraising, particularly for banking-as-a-service companies. Fears that another meltdown could occur are real and, let’s face it, valid.

Want more fintech news in your inbox? Subscribe to TechCrunch Fintech Here.

Do you want to contact us with a suggestion? Email Aria at aria.techcrunch@gmail.com or text me on Signal at 512-937-3988. You can also send a note to the entire TechCrunch team at tips@techcrunch.com. For safer communications, Click here to contact uswhich includes SecureDrop (instructions here) and links to encrypted messaging apps.

Source