Is "FDIC insurance" enough to ensure safety? In-depth analysis of the collapse, concerns, and regulatory loopholes of Fintech startup Synapse

Fintech startup Synapse announced bankruptcy earlier this month, affecting hundreds of fintech companies and tens of thousands of users. On one hand, it was discovered that there was a nearly $100 million funding gap between Synapse and its partner bank Evolve. On the other hand, claims of user funds being insured by the U.S. Federal Deposit Insurance Corporation (FDIC) were refuted as not falling within the coverage. Currently, the bankruptcy liquidation process is at a standstill.

Background: What is Synapse?

Synapse was founded in 2019, offering Banking-as-a-Service (BaaS) including real-time payments, credit cards, and debit cards. It allows thousands of startups to embed Synapse's banking services into their products. Synapse also acts as a financial intermediary between multiple banks and tech companies.

As a prominent Fintech company, Synapse secured a Series B funding of $33 million led by A16z in 2019.

However, with the economic downturn, Synapse faced difficulties in 2023 and filed for bankruptcy in April of this year under the U.S. bankruptcy law, leaving thousands of businesses and their users who relied on Synapse's services facing financial issues.

Are Fintech Accounts Claiming "FDIC Insurance" Truly Insured?

As evident from Synapse's collapse, this may not always be the case. However, many details remain unclear:

Starting with Yotta Savings

In 2019, Yotta Savings gained popularity among American families as a financial technology app that offers cash rewards, savings interest, and financial cards through a unique lottery incentive system. It claimed that user funds were protected by the Federal Deposit Insurance Corporation (FDIC).

However, following Synapse's bankruptcy, it was reported that approximately 200,000 financial technology app users, including around 85,000 Yotta users, totaling $112 million, were not covered under FDIC insurance.

Adam Moelis, the founder of Yotta, revealed in an interview with CNBC:

We never anticipated this situation. We had worked with FDIC member banks, but no regulatory body stepped in to help us.

Jelena McWilliams, the former FDIC chair appointed as the trustee for Synapse's bankruptcy case, stated:

There is a $60 to $96 million funding gap between accounts and the banks with Synapse, indicating not just financial information gaps, but potential losses even before the bankruptcy filing.

FDIC: Not Within Our Jurisdiction

As stated in the official announcement by the FDIC, the situation might be worse than anticipated:

FDIC deposit insurance does not intervene or compensate for the bankruptcy of non-bank companies like Synapse. In such cases, consumers may potentially recover some or all of their funds through the bankruptcy process handled by the court, but this could take time.

In other words, "this is not within the FDIC's purview."

Presiding over the Synapse case, U.S. Bankruptcy Court Judge Martin Barash expressed shock at the regulatory gray area, prioritizing the return of funds to ordinary people, but with limited authority:

I believe users still think they are protected and immune from the disaster. However, the situation is quite severe, and users are in crisis.

Clarifying FDIC Insurance Standards

As a federally established insurance corporation, the FDIC provides coverage of up to $250,000 per depositor per bank for deposits held in insured banks and savings associations.

However, delving into the coverage scope of FDIC insurance reveals the following points:

• Applications that coordinate deposits with banks or the user's deposit bank must be "members of the FDIC," while transactions involving cryptocurrency exchanges and non-bank financial technology companies themselves are not covered by this insurance.
• Only deposit-based products fall within the coverage, such as regular deposit accounts or money market deposit accounts, while stocks, bonds, and crypto assets are not covered.

Furthermore, FDIC insurance tailored for financial technology companies or other intermediaries is often through "pass-through insurance" via bank accounts. User deposits are directly placed in banks covered by FDIC insurance and are held in the bank under the name "for the benefit of (FBO)" the user.

Therefore, in the event of a financial technology company's closure, as long as they have clear account records, users can usually promptly retrieve insured funds. Conversely, if the relevant data and records are insufficient or incomplete, users may not be able to retrieve funds immediately.

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Regulatory Gray Areas

It is evident that most financial technology companies are currently offering bank-like services, often partnering with small or less mature banks without the need for registration or strict regulation, potentially posing varying degrees of risk.

Paul Clark, Senior Counsel at Washington's Seward & Kissel law firm, stated:

Most people hold financial assets through brokers or banks that are heavily regulated and specialize in the business. However, in some situations, you could become a custodian of other people's assets without any license.

He added, "There is a significant gap in the current financial structure, which is also a severe regulatory loophole."

In June of last year, the Consumer Financial Protection Bureau (CFPB) in the U.S. also warned that any deposits or assets on mobile payment apps might not be covered by FDIC insurance.

U.S. Regulators: Money in Mobile Payments Not FDIC-Insured, Whether Fiat or Crypto Assets

Conclusion: Exercise Caution in Choosing Fintech Services

While financial technology companies indeed drive innovation rapidly, consumers and investors need to remain cautious when choosing these services due to the following considerations:

• Risks in Fintech Accounts: Despite claims by financial technology companies of FDIC insurance protection, the actual safeguards may not be comprehensive, especially in cases like Synapse, an intermediary facing bankruptcy.

• Regulatory Gray Areas: There may still be regulatory loopholes between financial technology companies and banks, enabling these companies to offer bank-like services without strict regulation, increasing user risks.

• Limited Regulatory Authority: Regulatory bodies like the FDIC have limited authority when intervening in the bankruptcy of non-bank financial technology companies, potentially further increasing user financial risks.

On the other hand, financial technology companies need to enhance compliance and transparency, while banks need to monitor their partners more rigorously.

Simultaneously, regulatory authorities must strengthen benign supervision of financial technology companies and necessary enforcement, as well as establish clearer industry standards to address the aforementioned regulatory loopholes.