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London’s Lonely Unicorn: Two Frugal Expats and Their Billion-Dollar Startup

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By Jeremy Kahn for Blooomberg

When Taavet Hinrikus moved in 2007 from Estonia to London as an employee of Skype, his paychecks didn’t come with him: He still got paid in euros, via an Estonian bank account. Every month, Hinrikus had to wire money to himself in Britain, and each time he felt ripped off—by expensive and arbitrary fees and by an infuriating exchange rate. He could go to his computer and look up the current price at which euros could become pounds, and that wouldn’t be the rate financial firms quoted him. On a typical transfer of €1,000, which should have been worth £685 at the time, Hinrikus would end up with something like £620 in his British account. The bank would pocket the rest. “It was always a horrible experience,” Hinrikus says.

Another Estonian working in London, Kristo Käärmann, had the same problem in reverse: He was paid in pounds and often sent money back to Estonia. While chatting one day, the two discovered that they were each about to send equivalent amounts in opposite directions. It occurred to them that, rather than make two international transfers and lose all that money on bad rates and fees, Käärmann should simply move pounds from his British bank account to Hinrikus’s British bank account, while Hinrikus moved euros from his Estonian bank to Käärmann’s. “Local transfers are free and fast, and we saved a bunch of money on the exchange rate,” Hinrikus says. “It was cool.” Soon, the two started “the money chat,” a Skype forum for other London-based Estonians, where members could arrange similar matching transactions.

Kaarmann and Hinrikus.
Kaarmann and Hinrikus.
Photographer: Anna Ambrosi/LUZ/Redux

In 2010, Hinrikus and Käärmann created a company around the idea, and named it TransferWise. Customers who want to send money across borders are promised the “mid-market rate,” or what banks themselves pay when trading a given pair of currencies. When possible, TransferWise’s software pairs customers who are making equal and opposite transactions, a so-called peer to peer match. It’s like Hinrikus and Käärmann’s original swap, but it’s invisible and at bigger scale.

TransferWise wasn’t the first foreign-exchange startup, but its marketing has made the company nearly synonymous with the currency-converting trials of London expatriates. In the city center, where nearly four in 10 people are foreign-born, TransferWise bought ads in transit stations that showed actors depicting bank customers at the moment they learn how much bad rates have cost them: crying, choking on coffee, spilling their soup. Another campaign had TransferWise employees stripping to their underwear in front of London and New York landmarks to promote the idea of transparency.

The publicity has worked. In the U.K., TransferWise is responsible for 5 percent of all outbound international money transfers, according to October 2015 figures. The company operates in more than 60 countries, handling £500 million in transactions each month. It has landed on a series of “most innovative” rankings, including one compiled by Apple, and the World Economic Forum named it a tech pioneer. Early last year, after an investment by the U.S. venture firm Andreessen Horowitz, the company was widely credited with becoming one of London’s first startup unicorns by crossing the $1 billion valuation threshold. While such reports turned out to be premature, the company did little to dispel the perception; TransferWise didn’t earn its horn until May 2016. (Bloomberg LP is an investor in Andreesen Horowitz.)

TransferWise staged a 2015 protest in London calling on consumers to 'wake up' to hidden foreign exchange fees.
TransferWise staged a 2015 protest in London calling on consumers to ‘wake up’ to hidden foreign exchange fees.
Photographer: ED/JL/TransferWise/CameraPress/Redux

That prominence has come with some backlash. Recently, figures in the London startup scene have been asking just how innovative TransferWise really is. In January, Nick England, chief executive officer of VFX, another London payments platform, accused TransferWise of being “vaporware.” He said the company matches customers with other customers only a fraction of the time and, in most transactions, behaves far more like a conventional currency converter than it lets on. Mark Tluszcz, CEO of Mangrove Capital, a Luxembourg-based venture firm, has emerged as an outspoken detractor of the current crop of “fintech” startups, of which TransferWise is the most prominent, saying their supposed breakthroughs are overhyped. “Money transfer?” Tluszcz says. “For God’s sake, Western Union has been around for 100 years.”

TransferWise’s perceived worth and inventiveness is not just a question of pride. London is arguably the most competitive financial technology hub in the world today, with $962 million invested in the sector in 2015. The British government is easing regulatory hurdles for innovative young companies. London is also where many of the world’s largest banks, such as HSBC and Barclays, have chosen to locate their own fintech incubators. Relative changes as to whose tech is best has effects on hiring and venture capital.

Hinrikus says TransferWise is plenty innovative. “The idea that you don’t have to be a big bank to offer these services is pretty revolutionary,” he says in liltingly accented English as he sits in a coffee shop-chic conference room in the company’s London headquarters. “Giving people access to a better deal is pretty revolutionary.”

The concept of transferring money internationally without moving it across borders might seem novel, but in fact, it’s ancient. It’s the basis of hawala, the money transfer system that underpinned international trade throughout the Middle East and South Asia before the advent of modern banking; it is still used today in such places as Somalia and Yemen. Western Union, the money transfer giant founded in 1851, also uses a conceptually similar process for many transactions. But all these systems have a problem: Because people rarely want to move exactly equivalent amounts in opposite directions at exactly the same time, they must finance the transaction out of their own capital or rely on intermediaries to do so.

TransferWise is no different. The company says it finds true peer-to-peer matches on at least 60 percent of its transaction volume on 20 “routes” among Europe, the U.S., the U.K., and Australia. (A route is one side of a currency exchange—say, dollars to pounds.) Because of TransferWise’s prominence in Britain, almost every transfer into pounds is matched 100 percent peer-to-peer, says Harsh Sinha, a PayPal veteran that TransferWise recruited in 2015 to be its vice president of engineering. The company says it is always improving the software that automates the matching process, including complicated solutions that cover, say, a pound-to-dollar transaction with multiple dollar-to-euro and euro-to-pound swaps. If TransferWise can’t find a match, it becomes a market maker, using its own money to complete the deal in the hope that another customer who wants to send at least as much money the opposite way comes along later. In doing so, it is essentially acting just like a traditional foreign exchange broker.

Beyond the peer-to-peer matching software, the company has innovated in other ways, too, Sinha says, some more visible than others. “For the customer, they don’t care whether it is peer-to-peer or not,” he says, before parroting an internal corporate slogan: “What they care about is price, speed, convenience, and coverage.” TransferWise tries to make initiating a transaction as simple as possible, allowing customers to make repeat payments with the press of a button and offering a simple “request money” link that can be included on an invoice to streamline payments through TransferWise’s platform. It has also developed automated fraud and money-laundering detection tools, Sinha says. He has more than doubled the company’s engineering team in the last year, to close to 100 employees. One of their projects is a machine-learning system that could predict when the company will have to buy foreign currency on its own dime to meet unmatched transactions. Right now, much of that work is done by human foreign exchange analysts that the company employs.

Originally targeted at consumers, TransferWise has started marketing to small- and medium-sized businesses that need to pay for items in foreign currency or send money abroad to pay international staff. The company has also teamed with an Estonian bank, LHV Pank, and Germany’s first mobile-only bank, Number 26, to power their international money transfer services, and has begun scouting for similar partnership in the U.S. The moves suggest that the company’s future may lie less in being a stand-alone, consumer-facing business than in being a service for existing banks. “They will either have to build something similar themselves, partner with us, or get out of the international money transfer business,” Hinrikus says.

Photographer: Tom Stockill/The SundayTimes/Redux

Western Union made about $5.5 billion in revenue in 2015. Hinrikus says the company charges 10 times more than TransferWise, on average, and predicts that within a decade Western Union’s sales will fall by 80 percent, to just more than $1 billion, as it loses customers and cuts fees to compete. “How will a public company survive that?” he says. “The answer is, they won’t, and the same applies to the banks.”

Western Union spokesman Daniel Diaz says that because its services cover many different transaction sizes and different payment methods, “it is hard to generalize about price.” He adds that “trust, reliability, reach and diversity of pay-in and pay-out options” are also valuable.

Despite Hinrikus’s talk of putting banks out of business, TransferWise couldn’t function without them. It needs a bank account in every market it operates in, and it relies on the existing international bank transfer system to move money among its own operations around the globe. In April, after New Hampshire’s banking department cited TransferWise for operating in the state for a year without meeting money-transmitter regulations, the company agreed to pay a penalty equivalent to the fees it had earned during that time. (The startup has since begun offering its services in the U.S. through a partnership with a fully licensed bank, New York-based Community Federal Savings Bank, and has obtained its own money-transmitter licenses in many states.)

Separately, in May, the British advertising regulator ruled that TransferWise had improperly said its customers saved 90 percent on transfers without explaining its calculations. The company no longer makes the blanket claim in its marketing—saying instead that its service is “up to 8x cheaper”; on its website, customers can see how it calculates the savings for each currency route.

TransferWise isn’t profitable—it lost £11.5 million in the 12 months through March 2015, the latest period for which figures are available. But the same is true for many fast-growing startups, and sniping over perceived inventiveness could say more about jealous rivals and today’s tightening venture capital environment than anything else. Is TransferWise overhyped? In a sense, its founding ingenuity could be summarized as: Let’s not screw our customers. Banks have been gouging people on international money transfers for so long that this may be innovative enough.

First appeared at Bloomberg

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