A response to the Block short report

Block Inc was recently the subject of a short report from Hindenburg Research, which - amongst several other claims - allege that Block is lax in its procedures regarding user identification and complicit in allowing bad actors to conduct fraud on its platform. We have written extensively¹ on the opportunities and challenges that Block (and Afterpay) have faced, embraced and overcome as they have grown to what is in our view an exceptional payments business with a large opportunity for further value creation ahead of it. Here, we provide our view on the claims made in the recent short sellers report and their potential impact.

As is always the case with these reports, the authors throw a lot of assertions at the wall to maximise their impact. A large part of the report covers risks well understood by investors (e.g., the legal strategy to use community banks to access prepaid debit interchange rates), or are inflammatory (e.g., positioning Afterpay's model as an equivalent of payday lending), or are false (e.g., claiming Cash App has lax on-boarding procedures, is non-compliant and only requires criminals to use a zip & mobile to access the P2P platform to move money around - this is not correct).

Cutting through the noise, the key assertion that matters is whether or not compliance has been deficient post on-boarding, specifically where bad actors have been found. For example, a unique user ID (tied to a social security number "SSN") might have multiple accounts and if one of the accounts has been banned for breaching terms of service (attempted fraud in the worst case) but other accounts (tied to the same SSN) have been allowed to continue, that'd pose a problem in our view.

We’ve independently investigated these points speaking to ex-employees and industry experts and found no evidence of regulatory violations by Cash App. Contacts attested to the robustness of Block’s legal, compliance and technology investments to manage fraud risk, and cited Block’s culture as ethically aligned to protecting customers and placing people over profit.

It's par for the course that Cash App has to deal with fraudulent activity, the same as every other financial institution.

It’s likely Cash App over-indexes to fraudsters as P2P platforms have a regulatory blessing in order to create on-ramps back into the financial system for the underbanked and unbanked population of the US. Nevertheless, activity from fraudsters and schemers are of no financial benefit to Cash App. Any volumes they represent would contribute to the significant $700 million p.a. cost incurred by Cash App in providing the free-to-use, peer-to-peer service. And their presence creates a risk around consumer trust and the reputation of Cash App.

In Block’s announcement to the market on Thursday, it clarified some important data points for investors. Of 51 million monthly active accounts, it disclosed that 86% were fully verified accounts. Of these, 88% are tied to unique social security numbers. In addition, 97% of money moved onto the platform came from fully verified accounts in 2022. These data points are solid and de-risk the potential materiality of any bad accounts, while also indicating a much larger portion of the user base is already engaging with financial service features in Cash App beyond the free P2P services.

Summary

Looking ahead, it’s reasonable to believe regulation will play a catch-up role for US P2P platforms - as the scale of Cash App and Venmo has increased - with US regulators continually trading off the desire to give the underbanked population access to the financial system versus the implications for money laundering channels.

As we recently wrote in Block Part 3, we believe Cash App has a significant opportunity as it attempts to create a connection between commerce (merchants) and money (consumers). This is not to say the vision will be easily achieved: execution, competitive forces and regulatory changes will be substantial hurdles to overcome. The opportunity exists to move consumer finance to the top of the commerce funnel, but it is over to Block to achieve it.

^{1 Block - A Fascinating Case Study Part Three; Block - A Fascinating Case Study Part Two; Block - A Fascinating Case Study Part One; Capital Preservation - Afterpay In Focus; Afterpay - Is Visa a Risk?; What Regulation Would Mean for Afterpay in Australia.}