Financial fairness - Kristo Kaarmann, Dan 'Puzz' Aisen & Rebecca Blumenstein

Kristo, thank you for joining me today. I first want to get started by talking about the initial idea for your company. TransferWise is now in 60 countries, but how did this start? I understand there were some frustrations with money exchange from Estonia involved.

Dan, talk about how you got started. You're featured in the Michael Lewis book Flash Boys. You were at the Royal Bank of Canada, developed a very well-known stock trading platform. What made you want to do something further, to do something on your own?

Got it. So yeah, I worked at Royal Bank of Canada straight out of college. I worked in stock trading, so we built trading algorithms to trade on behalf of institutional investors, so mutual funds, pension funds, hedge funds, family offices, and help them navigate the stock market, trade on all the different exchanges. It's a very fragmented market. So at RBC we kind of put our name on the map where we built some kind of very successful trading strategies. And really kind of our big thing at RBC was it was all about being very, very open and honest and transparent with our customers. RBC is a Canadian bank, has a very good reputation for being nice and honest, and so that's how we kind of got known in the industry. And the idea was, I mean, really all the time at RBC we were always talking about startup ideas and things totally off the wall, not even within finance, but we never really took any of that seriously. But one day we're all kind of talking together about what's going to be the next thing, and we thought about this idea of kind of taking a lot of the same philosophical things we were doing at RBC, using our knowledge of how the stock market works, but trying to do it on a bigger scale. So trying to take those benefits and move them into the exchange space so that our customers could get those benefits no matter where they trade.

Now you told me earlier that you actually have nine founders, which seems to be quite a high number, and also that this trying to create a stock exchange is not exactly an idea you had from your garage.

Yeah. So yeah, we started with nine people, five of whom were, you know, very senior people. Eight of the nine came from RBC, so we all worked together at RBC, and there was one very senior person from Nasdaq who joined us, and that was the founding team. So yeah, it wasn't kind of a small effort in the beginning. Basically we all got behind our leader, Brad Katsuyama, who is the main character in Flash Boys. He's just, you know, an unbelievable person, unbelievable leader. And I think he kind of rallied us all behind him. But yeah, like you were saying, starting an exchange is not an easy prospect. The regulatory hurdles just to get off the ground are crazy, in addition to the technology hurdles. Basically when you go live as a stock exchange, the way the regulation works is that you need to see all of the trading activity on all of the other markets in real time so that you know the fair price of a stock at any given moment, so that you can ensure that you're trading in line with the rest of the market. And so you need to be able to consume all this data in real time, process it very, very quickly. On day one we basically need to have the same technology stack that a Nasdaq or New York Stock Exchange has before we trade a single share.

Kristo, can you talk about what you do? You said initially people thought you were crazy. And my question earlier is, well, why don't the big banks just do this? I mean, it seems like a simple proposition. Why don't they turn around and copy what you're doing?

I want to talk about regulation. Obviously there's the promise of new technologies, but in FinTech you run straight into regulatory obstacles. Could you please describe the process that you're going through? You are in the middle of applying to be an exchange in the United States, and your application has been delayed twice. It seems that big banks have all lined up behind you, but there's some very powerful interests that have lined up against you.

Sure. So yeah, so like I was saying, it's a pretty big hurdle just to get off the ground from a technology perspective, but the regulatory side was also quite a hurdle. We started the company in early 2012, and you know, from the very beginning we had this kind of vision that we would try to become a stock exchange. And you know, first you need to get approvals from FINRA, from the SEC, and so we're in that process now. We began socializing with them probably two years ago at this point, and we were supposed to get a decision from them in December, and they asked us to extend it until March, and then in March they still weren't ready, and so they extended themselves until June. And so at this point in June we're expecting to, or I mean we're hoping to find out from the SEC if we can be a full-fledged stock exchange or continue operating as the sort of kind of pseudo stock exchange that we are right now. At this point we're already about 2% of the US stock market, so you know, we're in pretty good shape, we can continue. And the New York Stock Exchange by comparison is about 10%, so you know, we're doing reasonably well. But to make that next leap forward and to be able to kind of extend our services to a broader population, we need to get exchange approval.

And could we take a moment, could you describe the coil or the technology that you came up with? It is attempting to basically make the playing field even for individual investors over the exchanges.

Sure. So we haven't really talked about what it does, and our big kind of our big principle is that we want to basically expose and educate the public on the existing practices within the stock market, some practices that we consider unfair, and then try to offer an alternative. And so one of those practices is what happens when the price of a stock is moving. So the prices of stocks move up and down throughout the day all the time, but when it's actually in transition, there's kind of a brief window of opportunity where the price of a stock has changed, but the exchanges and the dark pools and all the different places you can trade a stock, those venues themselves don't actually know that the price has changed, until they're still willing to execute trades at the old prices. So the price of a stock moves up, you know, a very, very fast buyer can come in knowing that it just changed and buy at the old lower price on a platform that's not as fast, it doesn't realize the price of the stock has changed. And so what we do is we delay every single order that comes into our system to make sure that by the time that order hits our system, we have the most up-to-date view of what's happening, and we have a more up-to-date view than whoever initiated that order. So what we do is we coil a cable for about 38 miles, and so every message, everything is electronic, but this message travels this cable for 38 miles just in circles in a loop, and by the time it actually gets to our system, which is a third of a millisecond later, that's enough time to make sure that whatever trades happened elsewhere, whatever quotes changed elsewhere, we've seen that and we can adjust our prices accordingly.

Kristo, you say you run into people all the time who say, 'Oh, I don't need your service, I have free banking fees, I use one of the big international banks.' Do people just not have an understanding of the delays, the fees, and the way that exchange rates work? And you've also had to get regulated, speaking of regulators, in every state in the U.S. that you do business in.

There's a lot of talk in the U.S. right now that FinTech has an advantage in the UK and Europe, perhaps not because of less regulation, but more the ease of operating. Would you agree with that? And do you think Dan's experience is perhaps emblematic of that?

Dan, you're focusing on the U.S. and getting your license before you break abroad in any way, shape, or form?

Yes. So I mean, all of our background, all the founders, we all came from the stock market in the U.S. That's, I mean, I guess at RBC we also worked in Canada as well, so we considered that market off the bat as well. But I mean, the U.S. is just a much bigger market, and we know it a lot better, so we're focused for now.

So you both are part of what's being known as FinTech, very different companies. Where is this heading more broadly? Are the FinTech players going to truly disrupt the banks? Right now a lot of the banks are buying up FinTech. There's a sense that, well, maybe the companies are going to get swallowed up and this will all slow down. Where is this going to end?

I think that technology companies are now changing finance in a very meaningful way. I was just saying earlier that I think this movement actually started about 10, 15 years ago with companies like E-Trade, which started taking the old, you know, brokerage businesses online. And then we have PayPal, and we have TransferWise, now we start to get stock exchanges. And I think we're starting to see parts of the industry, parts of the like the universal banking business being done so much better by tech companies that these things are just going to fall off. So the big question is what's going to remain. You know, perhaps everyday banking, you know, using a card and an ATM, maybe that's what banks do well. Maybe that's fine. Maybe we should be using the brands that we have today for, you know, just this simple operation.

Do you agree that it's speeding up? So think of, you know, 15 years ago brokerages, and then it took like five years for PayPal, and then took another five years for the next thing. I think now it's starting to move much faster.

So I think that is interesting, it's an interesting idea. I'm not sure how much I agree about that in the institutional trading space, because it's just such an, you know, it's still kind of an old boys club, and it's still, yeah.

And before we leave, I wanted to be sure to ask you your advice for the entrepreneurs out there, the people who are trying to launch startups. Given your experience, what would be the piece of advice you'd have for them?

So I would echo that. And then we were having breakfast earlier, and Kristo mentioned that there's really nothing stopping anyone else from going into TransferWise's market, and he would even encourage other firms to do that. And really just the more companies are trying to do the right thing, trying to be transparent, like I would encourage people, you know, everything that you do, just make sure that you're doing something that's genuine and honest and transparent and making the market better or the world better or FinTech better. And don't be afraid about, you know, stopping the competition necessarily. It's just really just about making the whole system better, and that's just better for everyone.

Please join me in thanking Kristo and Dan.