The Path to Success is Never Linear

Mike Cagney is an entrepreneur who likes building financial services firms. He founded Finaplex, a wealth management technology firm, co-founded Cabezon Investment Group, a global macro hedge fund and co-founded Sofi, an online personal finance company. He joins host Arthur Levitt to talk about his newest ventures; a financial services startup called Figure and Provenance, a blockchain protocol for the origination, custody, trading and securitization of whole loans and other assets.Host: Arthur Levitt Producer: Madena Parwana

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Episode Transcript

Speaker 1 (00:00):
This is a closer look with Arthur Levitt. Arthur Levitt
is a former chairman of the u S Securities and
Exchange Commission, a Bloomberg LP board member, a senior advisor
to the Promontory Financial Group, and a policy adviser to
Goldman Sachs. Mike Cagneys an entrepreneur who likes building financial

(00:22):
service firms. He founded Finniplex, a wealth management technology firm,
co founded Cabazon Investment Group, a global macro hedge fund,
and co founded so Far, an online personal finance company.
He's here today to talk about his newest ventures, a

(00:43):
financial services startup called Figure and Provenance, a blockchain protocol
for the oor origination, custody, trading, and securitization of whole
loans and other assets. He joins me now for a
closer look, I should mention that I am an advisor

(01:03):
to Figure. Mike, you have two new ventures, Figure and Provenance.
Wuld you describe the difference between the two and then
we can delve into the details of each Sure and
thanks for having me here. So Provenance is a blockchain
that we built to address the rent seeking and financial

(01:25):
services and the idea was to use blockchain technology to
eliminate the need for traditional intermediation such as custody agents
and trustees and administrators. And it was clear to us
early on that unless we had a tangible use case
for Provenance, it would just be technology that we would build.
And so we created Figure to generate assets to actually

(01:47):
put onto Provenance, and that was a forcing function to
get the by side to engage to buy those assets
on blockchain. That forced the cell side to come in
and Financio's assets on blockchain, and it kicked off the
ecosystem them. So you can think of the two businesses
as being independent in the sense of their business lines,
but synergistic in that Provenance really needed Figure to break

(02:10):
through and generate broader adoption. So you've created a chain
where you can put an entire loan on it. Could
could you explain how you do that? Sure? So, most
of what we thought about in blockchain to date has
been the idea of tokenization of assets, where we put
a token to represent an asset off chain, and from

(02:33):
our perspective, that wouldn't work effectively. Here. We wanted to
be able to digitally originate an asset native to blockchain,
and that's why we ended up building our own distributed
stakeholder blockchain to satisfy that. But in doing this, you
want to capture the characteristics of blockchain being distributed, immutable,
and trust less. And starting with trust less, that means
when I put a loan on the blockchain, all the

(02:55):
information related to that loan, whether it's a credit report
or income verification or a property valuation, and has to
be digitally signed by source, so that I'm not representing
that information is true. I'm actually proving that it's true.
And then each of these stakeholders that takes that information
and independently adds that to the chain has information like
my underwriting box, my criteria for credit, such that they

(03:18):
know with certainty whether I've underwritten that that loan correctly.
So the asset is native to digitally native to the blockchain. Now,
starting in July, Figure began generating home equity loans and
in August selling them on provenance. How's it going so far?

(03:40):
Are you getting the results you hope for using the
blockchain that you've built, and who's buying the loans? So
I think it's a It's always good to remember that
the path the success is never linear. And so we've
certainly had some interesting challenges as we started to originate
assets on blockchain, which which no one's done before. But

(04:01):
by and large it's worked the way that we anticipated.
The blockchain in particular, the technology has worked the way
that we had hoped um on the loan origination side.
We're doing some pretty innovative stuff on on the home
equity line of credit, doing things like video notary for example,
and so we've had to work out some bugs there,
but by and large it's worked the way that we've anticipated.

(04:22):
And we're currently selling loans to a major investment bank
and a major hedge fund that's receiving financing from that bank. Now,
Provenance is going to upend the way that we originate
securities and trade assets. Explain that, please, so. Our our
hope is to up end things, and and basically it

(04:43):
rests in a couple of different fronts. The first is
if you think of securitization as an example, and the
process of securitization and the number of intermediaries that you have.
The goal is to eliminate the need for those intermediaries,
eliminate the need for the custod bank, for the trustee,
for the administrator or and in doing so massively cut
the cost out of creating the securities, and the idea

(05:06):
being that the securities are resident on the blockchain. So
the blockchain is a registry, and what that does is
it allows for real time exchange of assets without counterparty risk,
without settlement risk. Everything that we've done to get to
T plus two, you're now getting to T plus instantaneous,
and we think this is the wave of the future.
The blockchain technology will become the fundamental exchange in which

(05:28):
assets are traded, and they'll be done in a way
without encouraging or without taking on counterparty risk and settlement risk.
You've met with some of the largest global banks to
discuss issues with blockchain adoption. What are their concerns, what
do they worry about, what what bothers them? So so
I think the starting point is and why a lot

(05:50):
of people call blotchain distributed ledger technology or d LT
these days, is the first version of blockchain, what we
call blotching V point one or V one point. Oh,
was a lot about tokens, um it was about bitcoin,
it was about other types of digital current digital tokens
or digital currencies. And I think there's a lot of
apprehension and concern about that within the banking community, in

(06:12):
particular because of the regulatory issues that that can potentially introduce.
And so one of the first things that we had
to do was just educate people that what we were
using blockchain for was a technology, technological solution to a
problem that we all face within the securities market. And
I think once we were able to get people comfortable
with that, then it was just the normal process of diligence,

(06:33):
regulatory compliance, technology, all the boxes we had to check
to show that we could do everything on chain that
we've done historically off chain. Mike, blockchain was supposed to
change the world, but it seems slow to take off.
Even you decided to create an asset for your own

(06:55):
block chain to give it a better chance. Why hasn't
it taken off the way it's predicted. I think one
of the biggest challenges is there are a lot of
blockchains that have been created out there, a lot of
tokens that have been created out there, but not enough
real world problems to use the technology. And and that's
one of the nice things in terms of what we're doing,

(07:17):
and that we have a very tangible problem within the
securities market, the financial services marketplace um the amount of
intermediation that exists there, and so by creating Figure to
be the first user, what we were able to do
is control our own destiny. We were able to drive
adoption based on our ability to execute, and we're paving
a path to show others how blockchain technology has a

(07:38):
significant impact in things like liquidity, costs of origination and
and visibility. How do you gauge the credit risk of
borrowers and how can you do it so so much
quicker than most banks do so I think one of
the one interesting things that we did when we created

(07:59):
Figure is we wanted to be able to do a
home equity line of credit, but do it very, very quickly.
And if you work with the capital markets, there are
certain things like electronic appraisal versus physical appraisal that within
particular ranges UH the capital markets are comfortable with, and
so information that's available in terms of credit title, property

(08:20):
value provide for a relatively quick underwriting process. The historical
challenge has always been the notary process, where one has
to notarize a document because you're perfecting a lean to
the property and what we've done there is we use video,
and that's something innovative. It's something that's recent with states
like Texas and Nevada supporting the notary where when you

(08:42):
get to the point of the lean, UH, you basically
video the notary show them your idea in your face.
We do a biometric recognition, and we can perfect the
lean electronically, notarize and perfect electronically, and that's massively cut
down the time to delivery, and that opens up huge
opportunity in terms of use cases for the credit lease back.
Property then becomes a token and even its own R

(09:06):
E I T. What does that mean? So what what
we do is is, in consideration to the growing demographic
of folks entering retirement and being underfunded for retirement, we
produced an alternative to a reverse mortgage, which is we
buy your home and run it back to you. We
call it a buy lease back and and the relevance
of that is as a homeowner, I get my cash,

(09:28):
I'm no longer on the hook for property tax or
or maintenance UH and I can stay in the home
as long as I wish. That home and the financing
that goes with it are actually on blockchain and What
that allows us to do is, rather than the traditional
process of forming a reat where we would go to
a custody bank and a trustee and drop these assets

(09:48):
in there and deal with that relatively costly perfection process,
we simply issue a token against those assets on chain
and that token becomes the reat, same legal structure, just
very different mechanics. From this standpoint of the borrow, is
this a choice of last resort or is it a
viable economic transaction for that homeowner? So so what we

(10:12):
what in terms of both the product itself, if you
look at it side by side versus reverse mortgage or
cash cash out refinancing, it's an extremely attractive product and
in most cases by rent back works better from an
economic standpoint in terms of blockchain, the consumers getting the
benefit of the blockchain in terms of reduced costs to execute,

(10:33):
and ultimately that technology will translate to better pricing for consumers,
lower costs for consumers, and so blockchain will have a
relatively significant impact on anyone who does any financial product.
A traditional home equity conversion mortgage is usually ensured by
the Federal Housing Administration. What guarantees does figure offer for

(10:56):
the lease back loan. So in terms of the buyer ace,
they're they're they're buying this as they would a nonconforming
mortgage in the sense that or or sorry, a jumbo
mortgage in the sense that they're taking the credit risk
related to it. Um What they're really taking in terms
of credit risk is the ability of the rent to

(11:16):
pay that rent. And so one of the things that
we do is we es grow some of the proceeds
such that should the renter have any problems, we can
tap that as grow and ensure that the owner of
the property can get their rent payments. Mike SEC Enforcement
Division co head Stephanie Avakian said initial coin offerings have

(11:37):
the potential to fundamentally alter the way public companies raise money.
What is an I c O and what are the
advantages versus traditional equity? Sure, if you if you think
about traditional equity, the value of that equity is the
present value of the net income related to that company.

(11:58):
And to take that into con iteration once looking at
the revenue, but also the operating margin, the expenses, the
idiosyncratic risk of the firm. If you think about the blockchain,
when one has a token on the blockchain, that token
generally represents an access fee and it represents a pro
roder revenue share to use that blockchain. So there are
a hundred tokens. Each token would have a one percent

(12:20):
stake in the revenue that comes off that chain. And
so when you think about token valuation, rather than looking
at a dis kind of cash flow of net income,
you're looking at this kind of cash flow of revenue.
This is a much easier evaluation approach because you don't
need to take into account the operating margin of the firm,
the idiosyncratic risk of the firm. The token in general

(12:41):
is being used, so it's liquid, you're not waiting for
a liquidity event. The token has a finite amount, so
it's non delutable, you can't issue more of it. And
generally the token will have a voting right into the
governance of the foundation, and so on a side by
side basis, there's some very attractive characteristics of token versus
traditional equity. The new tax law limited the deductibility of

(13:04):
home equity loan interest. Is that a problem? Well, it
limits it for purposes outside of home improvement, So home
improvement you still have the ability to deduct the interest.
But the reality is if you think about that market
space and you look at it versus unsecure consumer lending,
you can still generate a much lower cost of capital
and much lower interest rate being able to leverage the

(13:26):
equity in your home than you can just borrowing on
an unsecured basis. So even without the tax benefit, it
can be a very compelling alternative. When you started, figure
you raised cash by issuing traditional equity, not a token
or I c O. Why not? I think in the beginning,
we needed to create the blockchain to actually have a

(13:48):
token that could generate value, and unlike a lot of
the I c O s that have been happening in
the marketplace where people were raising capital on the hopes
of executing, we thought it was more salient to actually
demonstrate how the black chain could work, demonstrate a tangible
addressable market, actually have it working before we issued the token.
And so it's been somewhat unique in that people would

(14:08):
call this a reverse I c O to the extent
that it is an I c O. But in our view,
it was more important how the blockchain and production and
the token yielding before we were before we went to
sell that token. Do you think you will raised money
in the future with and I c O. So what
what we hope to be able to do is, given
the view that the SEC has that tokens or securities,

(14:32):
our view would be to do a registered offering of
the token. So rather than do an I c O,
actually do an I p o UM. Now, of course
that's not happened thus far, but we think it's something
that that could and should happen, and and that's really
what we're targeting in terms of next steps for provenance.
How will the venture capital and private equity firms be

(14:57):
disrupted by fundraise thing moving to I c O s
and tokens? So I don't I don't think they could
get disrupted. I think what happens is they change their
offering memorandums such that they can invest in these tokens
because I think, again the token is a very attractive
alternative traditional equity and there's still a need for capital.
And so what we see is describe such a transaction.

(15:21):
Well sure, So, so if I was a venture capitalist
and I was doing an early stage investment, I'm I'm
buying equity that is most likely not profitable, doesn't yield,
is not liquid um, is delutable, and has some voting
rights associated with it. Well, in lieu of that, I
could be buying a token that is a revenue share
on a platform is yielding today, UM doesn't have the

(15:42):
idiosyncratic risk of the firm is non delutable, has voting rights,
and so it's a it's an interesting alternative for me
as a as an investor to do something that is
actually a lot more simplistic in terms of valuation. Now,
the Commission, YESEC is very concerned that I see, oh,

(16:04):
exchanges and issuers can't protect themselves from cyber criminals. How
do you deal with that? Well, I think it's it's
a general issue and having come from the financial services
universe where we hold an enormous amount of data, UH,
security is always one of the one of the paramount
considerations that we have, and I think once you have

(16:25):
a token in play and the ability to move that
token there, there becomes a real risk. One of the
things that we've done is our token is native to
our blockchain, so the registry is actually the blockchain itself.
There is no wallet and no exportability of the token,
and that significantly limits some of the risk that you
have in terms of of hacking and malfeasance. Mike. The

(16:49):
Controller's decision to allow online payment companies and lenders to
have national bank charters is being challenged by the top
banking regulator in New York, who wants state control of
banking standards. Are you in favor of the national non
bank charter? So, I'm in favor of the idea of

(17:11):
having a common set of rules in which operators execute against.
And one of the challenges in the state governorship is
every state has different rules, different considerations, different usery rates,
different requirements, and so there's great efficiency that can come
to the consumer on a common set of rules. That
doesn't preclude the states from establishing a set of rules

(17:34):
that are consistent across states. And that's a completely viable
way to do this. But we need something because the
current patchwork process we have of of navigating each state's
individual rules is challenging and problematic for originators and ultimately
that has a negative impact to borrowers. You once had
a goal of creating a fintech company that would become

(17:55):
the Wells Fargo the future. Do you have the same
dream now or is it different? It's definitely different. I
think that if you look at what we've done on
the fintech side, we we believe there's an enormous opportunity
for figure as an alternative lender and delivering innovative financial product.
But what are real focuses is on blockchain and how
much substantive change blockchain will bring into the financial ecosystem.

(18:18):
The banks will benefit from that change. So I think
one of the big differences from where I was six
or seven years ago is rather than competing with the
banks in terms of the art mind share of the consumer,
we're actually providing infrastructure that makes it much easier and
more efficient for financial firms to offer products to consumers.
What's the next disruption in finance? Mike Well, I think

(18:41):
blockchain is still in the very niece in stages, and
I think that the impact it's going to have on
the mid and back offices of the financial firms is significant.
All great technologies deflationary, and blockchain is certainly deflationary. Uh
and I think we're at the very beginning of what,
over the next five to ten years, will be a
significant wave of blockchain eliminating a lot of the traditional

(19:03):
functions and entities that that provided intermediation. What will personal
finance look like in five years, is everything going to
be done on the phone? Well, on online? That's right.
I think that we're moving in that direction, but it's
hard to say. And and and personal finance in particular
investments one of the most difficult things to forecast, because

(19:24):
we've been wrong consistently for the past decade in terms
of where we thought it would end up. I think
what will happen is it will look like something that
we can't imagine right now. And and that's again I
think facilitated by blockchain and the intermediate disintermediation that blockchain
brings to market. But but I don't I don't have
a clear view in terms of or clear objective in

(19:45):
terms of what where we land other than I'll be
surprised when investors ask you about the risks for uh,
your consumer loan business, what do you tell them? Well,
one of the things that we did in in the
construct of home equity line of credits that we built
out is we went to the capital markets and and
talked about what they wanted from an underwriting standpoint. So

(20:07):
rather than me trying to impress that I've come across
a great black box underwriting methodology that everyone should buy into.
We simply said, how do you want us to underwrite
the assets? And is that commercially viable? And so what
we've done is a much more cooperative process with the
capital markets to bring assets to market that that they
want to buy and that consumers get a benefit from using.

(20:28):
All of the big banks are investing billions of dollars
in technology. Will they be able to compete with the
more nimble startups or will they bury them? I think that, uh,
it's an interesting dynamics certainly. Certainly, if you look at
the budget of any technology or any any financial institution,
it dwarves any startup in terms of what we spend

(20:49):
on engineering resources. And that's why, at the end of
the day, the real innovation that happens in the financial
ecosystem is not so much technology as the moat. It's
the ecosystem that we build out because technology, especially today
can be easily replicated in any any form or any dimension,
and so I think there's always opportunity for startups that
aren't encumbered by some of the legacy structure that large

(21:12):
financial institutions have to innovate in the ecosystem. But it's
not technology that's necessarily the innovation as much as it
is the people they bring together, the processes they put
in place, the policies they build out that that really
create value. Turning to basics, how would a listener who
wasn't familiar with technology of the blockchain but listen to

(21:34):
us and heard about the opportunities that we've described in
a new era with new product, what would you tell
them to do? How would they go about learning about it,
investing in it, and profiting from it? Well, I think
the key factor is understanding what the characteristics of blockchain are.
So blockchain is a distributed, immutable, trust less technology, and

(21:59):
if apply ideal the function of alledger a registry and exchange,
one can start to get a picture for how the
technology will disrupt the current ecosystem. And I think getting
a firm grasp of those characteristics and identifying points of
traditional intermediation that could be disintermediated is really a starting
point for an investor to think about where value is

(22:20):
going to be created and where value will be destroyed.
He's found in multiple financial service companies, including so Far,
but his focus now is how to leverage blockchain technology
to disrupt the way that we originate securities and trade
assets first up. His blockchain protocol Provenance will facilitate approvals

(22:44):
on loans offered by his financial services firm figure in
minutes rather than days, and he hopes it will have
applications across debt, equity and payment markets. My Cagney, thanks
for joining us US. By the way, if you have
comments about the program or suggestions for topics, please email

(23:06):
me at a Closer Look at Bloomberg dot net. That's
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Closer Look with Arthur Levitt.