Follow the rules, still get in trouble
Running a crypto startup is a trip. You can do everything right and still find yourself in hot water, simply because your whole industry is on the outs. Surviving a bear market isn't just about dealing with Number Go Down. You also need to adjust quickly when plans, partners, or programs inevitably fall through.
With crypto, banking, and the surrounding regulatory atmosphere as context, I'm reminded of this scene from Armageddon about always having a backup option. My dad actually used to play that clip for his students when he taught entrepreneurship.
As I've mentioned before, Hedgehog had no direct exposure to FTX — nor any of the preceding scandals in 2022, for that matter. But the shockwaves sent throughout crypto, those are affecting us directly.
Here's the problem
Imagine a crypto startup that does everything by the book. The team's background in conventional consumer fintech left them with no desire to play fast and loose with other people's money. They'd rather not cut corners while setting up a financial institution, which is what this crypto startup aspires to become. The company needs a more solid foundation than hype or "creative accounting."
This crypto startup doesn't launch a token, because it's unnecessary to the business model. Instead, the company registers with the SEC* to be able to lawfully offer crypto investing advice under the agency's supervision. The startup's product will help people create and maintain diversified crypto portfolios. It will generate revenue in a straightforward manner, by charging a fee for assets under management.
*Being registered as an investment adviser does not imply a certain level of skill or training.
According to SEC guidelines, the product is designed to sequester customer funds in individual accounts, on both the fiat and crypto sides. This startup invests heavily in technical security as well, architecting every layer of infrastructure based on the number-one priority of protecting users.
Let's say the startup is called Hedgehog — because it is. Since I'm the CEO, I can tell you what happens to that careful startup. The main banking partner still drops the company at the 11th hour, less than two weeks before the app was planned to launch. Even after a signed agreement was in place for seven months, personally approved by the bank's CFO.
As I wrote in a recent newsletter:
It's almost funny, since crypto was created to avoid being surprised by banks. But the way things have evolved, the fiat and crypto systems need to be able to talk to each other for the sake of customer convenience.
I can't name our former bank due to confidentiality provisions in the contract we signed, but to be honest, we felt blindsided by the sudden about-face. Hedgehog was relying on this banking partner for the fiat side of our custody solution. Now we have to figure out a different system, and push back fiat-based deposit and withdrawals to post-launch.
On the positive side, I cannot say enough wonderful things about our partner Gemini. They've really stepped up to help as we explore alternatives for fiat depositing and withdrawal. Still, this is an unexpected blow, especially when we were so close to the finish line.
Hedgehog jumped through all the bureaucratic hoops and came ready to play with an SEC registration in one hand, a legally binding status as a fiduciary in the other. But traditional finance was still spooked by the potential disapproval of regulators.
This is the state of the crypto industry, and the environment that startups in this space must navigate.
We would love some clarity and stability regarding how to actually satisfy the regulators that oversee banks' risk teams, but that just isn't available at the moment. Hedgehog has to respond to the reality on the ground, which is that crypto finance is still a work in progress.
What happens next?
In the immediate term, Hedgehog is adjusting the design of our previous custody system. Instead of launching with fiat onramps and offramps, we're in the process of integrating crypto deposits, purchases, and withdrawals (originally slated for immediately after launch).
Working with WalletConnect has been a slightly complicated pleasure so far.
As ever, Gemini remains a solid partner, so we're confident in the crypto side of Hedgehog custody. I'm optimistic that we can still launch the Hedgehog 2.0 app in Q1 this year. Reminder, we'd be thrilled to include you in the beta release when it's ready!
Hedgehog is also exploring a variety of alternatives to our ex-banking partner. The payment processors Plaid and Stripe both offer robust crypto integrations, which might be a fit for our requirements. Nothing is definite yet, but Hedgehog has options. We know that fiat support is an important feature, and we're not going to drop it from our plans altogether. For now it's moving a bit further down the roadmap so we can focus on launching the core crypto experience.
Startups — especially crypto startups — need to be nimble and resourceful. Sometimes an assumption that held true for most of a year becomes false overnight. It may not feel fair, but, welp, life ain't fair.
As I said in the beginning, the ability to pivot fast is part of how a small, scrappy company can survive a bear market. There are other businesses with more resources in the war chest, but a lean startup like Hedgehog can rely on hunger, heart, and quick feet.
To paraphrase the great A.J. Frost, "Just give 'em 10 more seconds. They don't know how to fail." I'm so proud of the team for taking this setback in stride, brainstorming solutions, coding said solutions, debugging said code, and taking a "leave it all on the sports field" approach.
Upward and onward!