Original Title: Replaying the Neobank Mistake in Crypto Or Rebuilding It Right?

Original Author: @0xcoconutt

Original Translation: SpecialistXBT, BlockBeats

Editor's Note: This article serves as a wake-up call regarding the currently hot "crypto bank" sector. The author incisively points out that the vast majority of "traditional internet banks" have failed to achieve profitability because they overly rely on meager interchange fees and lack core lending operations, ultimately becoming expensive "deposit warehouses." Now, most crypto neobanks seem to blindly repeat this mistake, using high incentives to attract unprofitable deposits.

Did you know? Less than 5% of internet banks (Neobanks) are profitable.

The selling points of internet banks are enticing: fully digital banking services, lower fees, and better user experiences. However, it has been proven that the economic model of these digital banks has fundamental flaws.

This article will delve into why many traditional internet banks struggle to be profitable and why crypto internet banks are following in their footsteps.

Image Source: @ashwathbk (https://x.com/ashwathbk/status/1975899128745054710)

Business Model Overly Dependent on Interchange Fees

The vast majority of internet banks' revenue relies on "interchange fees," which are the small commissions banks earn each time a user swipes their debit card.

This model only works under economies of scale, provided that profit margins are maintained and total spending is high enough. However, in practice, this economic model often yields thin profits and is extremely fragile.

Take the American internet bank Chime as an example; it does not have its own banking license and can only rely on partner banks to hold deposits and issue cards—this is very similar to how crypto internet banks operate. Its business model is highly focused on card transactions. In 2024, about 80% of its total revenue will come from interchange fees.

However, regulators in many regions have already set caps on interchange fee rates:

EU: 0.2% per transaction

US (Durbin Amendment): about $0.21 per swipe + $0.05

Chime utilizes small partner banks and can charge up to about $0.44 per swipe.

But this "regulatory arbitrage" is facing increasing pressure, and for internet banks, relying solely on interchange fees is already a thin profit margin, making it difficult to support a sustainable business model.

Moreover, interchange fee income is highly sensitive to consumer spending cycles. During economic downturns, if people reduce card spending, internet banks' revenues will decline accordingly.

Capital Idleness: No Lending, No Interest Income

The core income of banking operations comes from lending interest, not payments.

Traditional banks convert deposits into loans, earning interest through mortgages, credit lines, and commercial financing.

However, internet banks, even those with banking licenses, mostly fail to establish this core function.

Traditional banks derive 60-65% of their income from net interest income, with a loan-to-deposit ratio of 55-65%, and the global average is even higher. However, most internet banks lag far behind in this primary source of income, with the only exception being Starling Bank, which acquired a mortgage portfolio.

Crypto internet banks operating under a self-custody model lack the ability to earn interest income from deposits. They cannot use users' funds to generate returns. At best, they merely "route" deposits to DeFi protocols like Aave or Lido, extracting a small portion of the returns as commission. However, this integration does not provide risk underwriting or true control over funds and introduces its own unique risks, such as protocol hacks and stablecoin de-pegging.

In both traditional fintech and cryptocurrency models, the same paradox is replayed: deposits pile up, yet they cannot be monetized.

Essentially, many internet banks (including crypto internet banks) are just expensive "deposit warehouses."

High Customer Acquisition and Maintenance Costs

Traditional banks historically achieved organic growth through branch networks, while internet banks must compete for every customer in a crowded digital market through marketing and referrals. This leads to extremely high customer acquisition costs, severely squeezing their profit margins.

Due to higher entry barriers and the required user education costs, the customer acquisition costs for crypto internet banks are even higher. Not to mention, most of them also use high annualized and token incentives to attract user deposits. This constitutes "deferred liabilities" that the company needs to repay, significantly increasing customer acquisition costs.

The cost-to-income ratio of crypto internet banks is even worse than that of traditional internet banks:

Stablecoin-based payments compress the profit margins of foreign exchange and interchange fees, leading to "race-to-the-bottom" competition in an increasingly fierce market.

Regulatory obligations (even when using a self-custody model) also require KYC, deposit and withdrawal controls, and card compliance. If fraudulent card transactions are detected, chargebacks and fines will be borne by the crypto internet banks. They may even face the risk of being suspended by centralized issuing institutions.

Most users are low-balance retail customers (with deposits of $1,000), while the costs of customer support, fraud prevention, and infrastructure are fixed.

Rebuilding the Business Model: Winning Through Embedded DeFi

Given their self-custody nature, the business foundation of crypto internet banks is entirely different, making it impossible to win by imitating Chime or Monzo. I do not believe that crypto internet banks have any advantages over traditional internet banks, but I think that crypto technology can help internet banks improve profitability through "embedded DeFi."

Using Trading as the Primary Source of Income

Trading revenue has become a mature way for traditional internet banks and crypto wallets to drive high-profit income.

Revolut's wealth division (including crypto business, 2024): Revenue of £506 million (16.3% of total revenue), a year-on-year increase of 298%, primarily driven by customers' cryptocurrency speculation rather than traditional banking operations.

Phantom Wallet (expected in 2025): Profiting $79 million through in-wallet token trading.

Embedding trading functions has become an industry standard. Applications need to offer a wide range of asset classes, trading pairs, MEV (Maximum Extractable Value) protection, fast execution, and other features to stand out and ensure users have the best trading experience.

Structured Returns and On-Chain Financial Products

Internet banks do not need to lend directly but can package complex DeFi products into financial products that are easy for retail investors to understand and invest in.

Self-issuing stablecoins to earn the underlying U.S. Treasury (T-bill) returns by prompting users to exchange for that stablecoin.

Carefully curated yield vaults and retail-oriented savings protocols.

On-chain ETFs / Real World Assets (RWA).

Insurance.

I have not seen many Western internet banks successfully replicate the success of the "Alipay Wealth" product suite.

Screenshot of Alipay Wealth Management Product Interface

In providing a wide range of wealth management products, crypto internet banks have an advantage; they can simplify DeFi and make high-yield financial products more accessible to a broader audience.

Embedded DeFi helps to greatly enrich the product line of internet banks.

Building DeFi "Tracks" Instead of Recreating Banks

Internet banks have always had thin profits. And crypto internet banks, despite having DeFi-native tools, face even more severe challenges: lower rates from stablecoin payments, higher compliance costs, more difficult user onboarding, and fierce competition once traditional internet banks also "embrace crypto."

As Revolut and Nubank begin to offer stablecoins, cryptocurrency trading, and on-chain yields on their existing infrastructure, "crypto-first" internet banks will find it difficult to compete for mindshare with them.

The real key to winning is not to recreate an internet bank but to provide "tracks": that is, to develop yield routers, stablecoin foreign exchange layers, DeFi wrappers, or curation protocols that can be plugged into existing bank distribution channels. It is challenging to compete with internet banks that have already built a large user base, but we should strive to leverage crypto technology to supplement and enhance their profitability.

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