(Bloomberg) — Imagine putting your savings in a digital bank, not thinking about it, and waking up one day to find it out of reach. This nightmare 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 up to 95 million dollars the value of the client's funds is missing. Founded in 2014, the Andreessen Horowitz-backed startup was one of thousands of companies that have emerged over the past decade aiming to improve traditional finance by integrating new technologies. Although not a household name, Synapse's collapse has caused a ripple effect within the fintech industry, due to approx. 20 banks and 100 fintechs with which he had partnerships.
What happened to Synapse?
Synapse was a financial technology company that served as an intermediary between FDIC-insured banks and third-party fintechs. In April, Synapse filed for bankruptcy and subsequently shut down services for some of its fintech and banking partners. According to court documents, the company's records of how much money was held in customer accounts differed from its partners' books. However, Synapse's problems – such as lingering concerns surrounding the company's management, its broken technology and its CEO – began much earlier than its bankruptcy.
However, the company's problems didn't escalate until last year, when Synapse's biggest clients, fintech Mercury and Evolve Bank & Trust, decided to drop Synapse as an intermediary and work directly with each other. In December, Mercury sued Synapse in an attempt to recover $30 million from the company, and Synapse countersued. In one Medium In a post written after the bankruptcy, Synapse CEO Sankaet Pathak claimed that Evolve was responsible for missing $50 million in end-user funds. Yotta, a fintech that was almost wiped out by the failure of Synapse, filed a complaint in September alleging that Evolve used its customers' funds to cover a shortfall in 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 into their platform. Some of Synapse's services included keeping a book of client accounts and risk management tasks.
What is the difference between a digital bank and a neobank?
Like traditional banks, digital or online banks are insured by the FDIC and have the same guarantees as traditional banks. The main difference is that digital banks do not 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 to problems that traditional banks may face in the digital world, such as mobile payments and money transfers. They are not the bank itself. Examples of neobanks include Chime and Current.
How can someone check if their money is safe with a fintech?
If it is not a bank, they really can't. According to Susan Josephexecutive director of Fintech at Cornell University. However, larger fintech companies, such as Plaid or Stripe, tend to have better-established payment infrastructures and are theoretically more secure, Joseph added.
What does the US fintech regulatory landscape look like?
The primary regulatory bodies charged with overseeing consumer protection in the United States are the Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC). If a fintech does something illegal within their jurisdiction, they can intervene, but there are still gray areas. There are also state-level consumer regulations, but mandatory compliance around issues such as data privacy, money laundering and cyber security is still a fragmented landscape. Synapse's collapse is being monitored solely by the California Department of Financial Protection and Innovation.
What happens next for Synapse?
In the wake of Synapse's collapse, the FDIC proposed a rule in September that would require banks to closely monitor accounts held 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 affected by Synapse's collapse and “address the risks associated with fintech partnerships.” AROUND 100 customers of Synapse's fintech partners were part of an email sent to the judge addressing how the bankruptcy has affected them.
Jelena McWilliams
Jelena McWilliams, the former head of the FDIC, was appointed in May as the Chapter 11 trustee in Synapse's bankruptcy case. Currently, McWilliams is trying to recover and distribute Synapse's customer funds. But because Synapse is not a bank, FDIC deposit insurance cannot protect consumers against the company's insolvency or bankruptcy.
As the case may be last state reportfiled on September 26th, Synapse's banking partner, Lineage Bank, has distributed almost all of its funds to consumers, while Evolve has not distributed any, but estimates that its reconciliation efforts will be completed by October 18th.
As all this unfolds, Pathak, founder and CEO of Synapse, has moved on. it announced in August that he raised $11 million for a new robotics startup called Foundation.