For many readers of this blog, Uber represents a cautionary tale. While the company attributed its initial success to cutting-edge technology—such as dynamic pricing, matching algorithms, real-time data—subsequent analysis has demonstrated that its growth was largely driven by ignoring, breaking, and then bending taxi regulations to suit its business model.
For companies in the fintech sector, however, Uber’s approach represented a blueprint to follow. From lending to payments to stock trading to crypto, prominent fintech businesses have found a competitive edge not in technology itself, but in using narratives about technology as a smokescreen for the profitable arbitrage of financial regulations. This modus operandi is encouraged by Silicon Valley’s venture capitalists, who decide which businesses to fund and often provide advice, gin up hype, and lobby for the businesses they’ve chosen. Our society continues to shower VCs with public subsidies, but as I argue in this brief post, if regulatory arbitrage is what we’re getting from Silicon Valley’s VCs in exchange, it’s well past time to reconsider this relationship.
The Innovation Bait-and-Switch
The VC business model has typically found success in funding businesses that commercialize technologies developed by others, often the military or universities supported with public funding. But when it comes to software, the internet, and smartphones, many if not most of the applications have already been exploited. This perhaps explains why Silicon Valley firms are increasingly pitching innovation but delivering regulatory arbitrage—a business doesn’t need better technology to succeed if it can operate on more favorable regulatory terms than its competitors.
As I describe in my new internet serial Fintech Dystopia, there is a familiar pattern to this bait-and-switch. First, develop a business model that centers a particular technology. Tell some stories about how that technology will solve a legitimate problem (preferably using the words “democratize” and “disrupt”). Bend or break some laws with that business model, and profit from not complying with the law. Get away with bending or breaking the law, and with harming people along the way, because lawmakers and regulators are too timid to stop “innovation.” Get big enough that you can convince lawmakers and regulators to change the law so that you never have to comply with it and those who are harmed have no recourse. Bonus points if the law is changed in a way that guarantees you a monopoly or oligopoly position. Lather, rinse, repeat.
The business model of nearly every fintech firm, once you look past the hype, relies on playing by a different set of rules than their competitors. Fintech lenders like Elevate, for example, rely on “rent-a-bank” relationships—partnering with regulated banks to avoid state-based caps on interest rates that apply to non-bank lenders. Buy-now-pay-later providers like Klarna and providers of earned wage access products like Earnin avoid these same caps by claiming that they aren’t making loans at all, even though fees can make buy-now-pay-later as expensive as a credit card and earned wage access products cost as much as a payday loan. Payments providers like PayPal claim not to be accepting deposits even though they hold customer funds, thus avoiding the banking regulation that applies to deposit-taking institutions. The fintech brokerage firm Robinhood has been fined by both the SEC and FINRA for misleading customers about how it makes its money (primarily from a practice called “payment for order flow” that involves selling orders from unsophisticated traders to sophisticated traders to fill) and for delegating required customer screening to bots, which let unsophisticated customers make all-or-nothing bets on highly complex options.
And then, of course, there are crypto exchanges like Coinbase, whose entire business model is predicated on avoiding the securities laws. If those laws were properly applied, it would be illegal to create crypto assets out of thin air and sell them to the public, so Coinbase would have far fewer assets to list. It would also be forced to disaggregate its conflicted brokerage, exchange, venture capital, and transaction validation services. The appeal of crypto, moreover, would be significantly reduced if anti-money laundering laws and economic sanctions were enforced against traders.
Financial regulations were adopted over time to protect consumers from harm, protect our economy from debilitating financial crises, and further law enforcement and national security objectives. All this regulatory arbitrage is profitable for the fintech industry and the VCs who fund it, but it leaves most of us worse off. In addition to exposing the public to harm, fintech has rarely delivered on its promises to improve financial inclusion, or to make the financial system more efficient, competitive, or secure. Not content to keep skirting regulations, many fintech businesses and their VC backers have successfully lobbied regulators and Congress to change rules and laws to permanently accommodate and legitimize their business models. These efforts erode faith in our democratic process, and in the law’s ability to protect people from harm.
Subsidizing Fintech
All of this would be troubling enough on its face, but it is particularly galling that the public is propping up these fintech businesses by subsidizing Silicon Valley’s VC industry. Earnin, Robinhood, and Coinbase were all funded by prominent VC firm Andreessen Horowitz. PayPal, which was founded back in the 1990s, in many ways developed the playbook for launching startups through aggressive regulatory arbitrage. Many PayPal alumni—including Peter Thiel, Trump administration crypto czar David Sacks, and Reid Hoffman—are now VCs in their own right, encouraging new startups to emulate their example.
Some of the subsidies from which VCs benefit are so prevalent and long-standing that we forget that they’re subsidies at all. For instance, VC funds are typically structured as limited partnerships, which means that partners can only lose the amount they invested in the partnership, no matter how much the partnership owes. That limited liability is a gift from the state to encourage entrepreneurship. VCs would be less likely to encourage the startups they invest in to skirt the law if they could be held financially liable for violations.
Other subsidies come from laws that allow retirement funds to be invested in VC funds. The VC industry lobbied heavily in the 1970s to loosen investment guidelines under the Employee Retirement Income Security Act (“ERISA”) so that pension funds could invest in their risky ventures—the resulting revisions supercharged the growth of the VC industry. Changes are now being contemplated that would allow individuals to invest in VC funds through their 401(k) plans, giving VCs even greater access to the nation’s retirement funds as capital.
Some of the most important subsidies for the VC industry are in the tax code. VC funds typically operate on what is called the “2 and 20” model—they collect a fee of two percent of the amounts invested with the fund, as well as twenty percent of the profits generated by the fund. Only the 2% is taxed as income, and the 20% “carried interest” is taxed at a much lower capital gains rate. The Inflation Reduction Act passed during the Biden Administration initially included a provision that would have closed this carried interest loophole, but Senator Kyrsten Sinema insisted on its removal before she would vote for the legislation.
The VC industry was also an enormous beneficiary of the accommodative monetary policy that followed the 2008 financial crisis and the Covid pandemic. Flush with cash, VC investors pumped money into American tech start-ups, pushing the valuations to nearly unthinkable levels. Finally, as mentioned above, the VC industry benefits both from public funding for the technologies it commercializes, as well as from the special legal treatment that gives tech startups an edge over more regulated competitors.
Leading VC firms are well-aware of the important role played by this special legal treatment. Lobbying, media blitzes, and hiring government officials for access are all part of the VC industry’s standard operating procedure, but the playbook has been deployed with particular zeal when it comes to crypto. The crypto industry was responsible for 44% of all corporate expenditures during the 2024 election cycle—with most of it coming from Andreessen Horowitz, Coinbase, and another crypto company called Ripple. It’s worth bearing in mind that the public is not merely subsidizing a financial grift when it comes to crypto—it is subsidizing an ideological project with techno-libertarian goals of avoiding regulation, taxes, and eliminating central banks. Crypto is intended, for instance, to provide the infrastructure for the Network State movement backed by Andreessen Horowitz partner Marc Andreessen and Coinbase CEO Brian Armstrong, which aims to create tech-CEO led dictatorships outside the boundaries of democratic governance.
In sum, not only does the VC industry saddle us with faddish businesses insulated from real competitive pressures by legal dispensations and subsidized funding, some influential VCs are committed to upending longstanding financial regulatory regimes and maybe even subverting our democracy. If that’s our return on investment, it’s hard to justify continuing subsidies for venture capital.
