(Bloomberg) -- Imagine putting your savings into a digital bank, not thinking about it, and waking up one day to find it inaccessible. That nightmarish scenario is exactly what happened to more than 10 million end users earlier this year when fintech startup Synapse Financial Technologies Inc. filed for Chapter 11 bankruptcy – and left as much as $95 million worth of customer funds missing. Founded in 2014, the Andreessen Horowitz-backed startup was one of thousands of companies that have emerged over the last decade aiming to upend traditional finance through the integration of new technologies. While not a household name, Synapse’s collapse has caused a ripple effect within the fintech industry, due to the roughly 20 banks and 100 fintechs with which it had partnerships.
What happened to Synapse?
Synapse was a financial-technology company that served as a middle man between FDIC-insured banks and third-party fintechs. In April, Synapse filed for bankruptcy and then shut down services to some of its fintech and bank partners. According to court documents, the company’s records on how much money was held in customer accounts differed from the books of its partners. However, Synapse’s problems – such as longstanding concerns surrounding the company’s management, broken back-end technology and its chief executive officer — began much earlier than its bankruptcy.
Yet the company’s troubles didn’t escalate until last year, when Synapse’s largest clients, fintech Mercury and Evolve Bank & Trust, decided to cut Synapse out as the middleman and work directly with each other. In December, Mercury sued Synapse in an effort to recover $30 million from the company, and Synapse counter-sued. In a Medium post written after the bankruptcy, Synapse CEO Sankaet Pathak alleged that Evolve was responsible for the $50 million shortfall of end-user funds. Yotta, a fintech that was almost wiped out by Synapse’s failure, filed a complaint in September claiming that Evolve used its customer funds to cover a shortfall of money owed to customers.
What was Synapse — a digital bank, a neobank or something else?
No, Synapse was a banking-as-a-service startup, meaning the company helped licensed banks integrate digital banking services onto their platform. Some of Synapse’s services included maintaining a ledger of customer accounts and risk-management tasks.
What is the difference between a digital bank and a neobank?
Much like traditional banks, digital or online banks are FDIC-insured and have the same guarantees as traditional banks. The main difference is that digital banks don’t have physical branches. Some examples of digital banks include SoFi Bank, Ally Bank and Varo Bank. Neobanks, on the other hand, are fintech companies that offer solutions for problems that traditional banks in the digital world might face, such as mobile payments and money transfers. They are not banks themselves. Examples of neobanks include Chime and Current.
How can someone check if their money is safe with a fintech?
If it’s not a bank, they can’t really. At the end of the day, it boils down to trusting what a fintech company’s management or auditor says, according to Susan Joseph, executive director of Fintech at Cornell University. However, larger fintech companies, such as Plaid or Stripe, tend to have better-formed payment infrastructures, and theoretically are more secure, Joseph added.
What does the fintech regulatory landscape look like in the US?
The main regulatory bodies in charge of overseeing consumer protection in the United States are the Consumer Financial Protection Bureau (CFPB) and Federal Trade Commission (FTC). If a fintech does something illegal within their jurisdiction, they can step in, but there are still gray areas. There are also state-level consumer regulations, but enforced compliance surrounding issues such as data privacy, money laundering and cybersecurity is still a fragmented landscape. Synapse’s collapse is only being monitored by California’s Department of Financial Protection and Innovation.
What happens next with Synapse?
In the wake of Synapse’s collapse, the FDIC proposed a rule in September that would require banks to closely monitor accounts maintained by their fintech partners. In addition, nine congressional representatives sent a letter in August to banking regulators asking them to “take concrete steps” to help those who were affected by the Synapse collapse and “address risks associated with fintech partnerships.” Around 100 customers of Synapse’s fintech partners were part of an email sent to the judge handling the case about how the bankruptcy has affected them.
Jelena McWilliams
Jelena McWilliams, former chair of the FDIC, was appointed in May as the Chapter 11 trustee in Synapse’s bankruptcy case. Currently, McWilliams is attempting to recover and distribute Synapse customer funds. But because Synapse is not a bank, the FDIC’s deposit insurance cannot protect consumers against the company’s insolvency or bankruptcy.
According to the case’s most recent status report, filed on September 26, Synapse’s bank partner, Lineage Bank, has distributed almost all of its funds to consumers, while Evolve has distributed none, but estimates that its reconciliation efforts will be completed by October 18.
While all this unfolds, Pathak, the founder and CEO of Synapse, has moved on. He announced in August that he raised $11 million for a new robotics startup called Foundation.
The Reference Shelf:
- Synapse’s third Chapter 11 status report and other bankruptcy court documents.
- Bloomberg Law on how Synapse’s meltdown shows bank middleman risks.
- FDIC document on conducting due diligence on fintechs.
