Thousands of Americans were deceived by fintech's false promise and lost access to their bank accounts.

• Government-backed accounts held at real banks offered customers the safety they desired, while the newest fintech apps provided the innovation, ease of use, and fun they craved.
• The revelation of Synapse's collapse has exposed the illusion of fintech's safety promise, leaving over 100,000 Americans with $265 million in deposits unable to access their accounts.
• The consequences of this catastrophe could have far-reaching effects. Among the most widely used banking apps in the nation, such as Block's Cash App, PayPal, and Chime, have opted to collaborate with banks rather than owning them.
• Fintech customers affected by the Synapse debacle were contacted by CNBC, who thought their funds were safeguarded by the FDIC.

Natasha Craft was so fond of her Yotta banking account when she first opened it in 2021 that she encouraged her friends to join.

Craft, a 25-year-old FedEx driver from Mishawaka, Indiana, was able to easily manage her finances and plan her wedding thanks to the app that made saving money enjoyable. She directly deposited her wages into a Yotta account and utilized the startup's debit card to cover all her expenses.

The app, which incorporates gaming elements into personal finance through weekly sweepstakes and other eye-catching features, occasionally recorded some of her financial transactions.

CNBC reported that Craft said he would sometimes buy something and receive it for free.

Her entire life savings of $7,006 is currently tied up in a complex legal battle in bankruptcy court, as well as being discussed on online forums like Reddit and regulatory channels. Additionally, other fintech startups and their banks are also facing a moment of reckoning in the industry.

Government-backed accounts held at real banks offered customers the safety they desired, while the newest fintech apps provided the innovation, ease of use, and fun they craved.

The startups showcased the protections provided by the Federal Deposit Insurance Corporation, thereby lending credibility to their innovative products. Notably, since its establishment in 1934, the FDIC has never lost a single penny of insured deposits, as stated on its website.

The collapse of Synapse, a fintech middleman, has exposed the false promise of safety.

Over 100,000 Americans, including 85,000 at Yotta, were unable to access their accounts starting May 11 with a total deposit of $265 million.

Fintech customers affected by the Synapse debacle were contacted by CNBC.

Individuals from diverse backgrounds and life stages, such as Craft, the FedEx driver from Indiana, the owner of a preschool chain in Oakland, a talent analyst residing in New York City, a computer engineer in Santa Barbara, a high school teacher in Maryland, a parent in Bristol, Connecticut who opened a savings account for his daughter, and a social worker in Seattle saving for dental work after Adderall abuse ruined her teeth, all utilize online banking services.

'A reckoning underway'

Yotta, a fintech app, partnered with Evolve Bank & Trust to offer checking accounts and debit cards. Synapse served as a crucial middleman, managing balances and detecting fraud.

Synapse, founded in 2014 by Sankaet Pathak, was a player in the "banking as a service" industry alongside Unit and Modern Treasury. Synapse helped customer-facing startups like Yotta quickly access the regulated banking industry.

According to an April court filing, the company had contracts with 100 fintech companies and 10 million end users.

Recently, the BAAS model has shifted from being a growth engine to a source of essential services for startups. These startups can quickly access the services they need without having to spend years and millions of dollars trying to acquire or become banks. In turn, small banks that cater to these startups have gained a source of deposits in a time when giants like dominate the market.

In May, Synapse, facing financial difficulties, shut down a crucial system used by Yotta's bank for transaction processing, leaving thousands of Americans in a state of uncertainty and causing chaos in the fintech sector.

Michele Alt, a former lawyer for the Office of the Comptroller of the Currency and current partner at consulting firm Klaros Group, stated that there is a reckoning underway regarding questions about the banking-as-a-service model. She believes that the Synapse failure will be an "aberration."

Fintech companies such as Cash App and Chime, which are among the most popular in the country, partner with banks rather than owning them. These companies account for 60% of all new fintech account openings, according to data from Curinos. Block and PayPal are publicly traded, while Chime is expected to launch an IPO next year.

Block, PayPal and Chime didn't provide comment for this article.

'Deal directly with a bank'

Although industry experts claim that those companies possess stronger ledgering and daily reconciliation capabilities than Synapse, they may still be riskier than direct bank relationships, particularly for those who rely on them as their primary account.

"According to Scott Sanborn, CEO of , it is crucial for consumers to deal directly with a bank when it comes to their spending money in order to determine if the conditions are met to receive FDIC coverage."

LendingClub, which initially partnered with banks as a fintech lender, eventually bought Boston-based Radius for $185 million and became a fully regulated bank.

Sanborn's acquisition of Radius Bank made him realize the dangers of the "banking as a service" industry. Regulators concentrate on scrutinizing middlemen like Synapse, but they expect banks to oversee risks and prevent fraud and money laundering, he stated.

Sanborn shuttered most of Radius' fintech business as soon as he could because many of the tiny banks running BAAS businesses lack the personnel and resources to do the job properly.

Sanborn stated that they were among those who predicted, "Something bad is going to happen."

The Financial Technology Association, a trade group representing large players including Block, PayPal, and Chime, stated that it is incorrect to assert that banks are the only trusted actors in financial services.

Fintech companies are trusted by consumers and small businesses to offer more accessible, affordable, and secure services than incumbent providers, according to the spokeswoman.

Fintech companies with a long history are regulated and collaborate with banks to establish robust compliance programs that safeguard consumer funds, she stated. Moreover, regulators should adopt a "risk-based approach" when overseeing fintech-bank partnerships, she emphasized.

The Synapse disaster has far-reaching implications, and regulators will continue to punish banks that provide services to fintechs. Last month, Evolve was reprimanded by the Federal Reserve for improperly managing its fintech partnerships.

The FDIC clarified that the collapse of nonbanks does not result in FDIC insurance, and even when fintechs collaborate with banks, customers' deposits may not be safeguarded.

The FDIC's response on whether fintech customers are eligible for coverage: "It depends."

FDIC safety net

Despite their varying circumstances, all customers interviewed by CNBC for this article shared a common belief: that the FDIC's backing of Evolve guaranteed the safety of their funds.

"The Oakland preschool owner stated that her fintech provider, Curacubby, functioned like a bank for her. She explained that she would inform them of the tuition amounts to bill, and they would handle the billing and parent communication, ultimately resulting in her receiving the payments."

The 62-year-old business owner, who requested anonymity from CNBC to avoid alarming employees and parents of her schools, revealed that she has taken out loans and utilized credit lines after $236,287 in tuition was frozen in May.

The possibility of selling her business and retiring in a few years appears more distant now.

"She said, "I probably won't see that money, and if I do, how long will it take?""

Rick Davies, a 46-year-old lead engineer for a men's clothing company that owns online brands including Taylor Stitch, recalls feeling comforted by seeing the FDIC logo of Evolve when he signed up for an account with crypto app Juno.

"Davies stated that it was prominently displayed on their website, and they made it clear that Evolve was handling the banking, which he knew as a fintech provider. The entire package appeared legitimate to him."

Weeks have passed since his $10,000 was frozen, and the FDIC hasn't provided any assistance, leaving him feeling enraged.

After regulators swiftly seized Silicon Valley Bank last year, protecting uninsured depositors including tech investors and wealthy families, Davies found the situation even more baffling. His employer banked with SVB, which collapsed after clients withdrew deposits en masse, so he saw firsthand how fast action by regulators can prevent distress.

Davies expressed frustration over the contrast between the FDIC's prompt action in assisting San Francisco-based tech companies and its ineffectiveness in addressing a similar, consumer-oriented predicament.

Despite the fact that none of the banks associated with Synapse have gone bankrupt, the regulator has not taken any action to assist affected users.

Alt, the former OCC lawyer, acknowledged that consumers may not fully grasp the intricacies of FDIC protection.

"The FDIC insurance is not a general pot of money to make people whole, but rather it is there to ensure that depositors of a failed bank are made whole."

Waiting for their money

The worst-case scenario is unfolding for the customers involved in the Synapse mess.

Despite some customers receiving funds recently, most are still waiting for their payout. Those further down the line may never receive a full payment due to a shortfall of up to $96 million owed to customers, as stated by the court-appointed bankruptcy trustee.

According to court filings, Synapse's poor record-keeping and practice of pooling users' funds across multiple banks make it challenging to determine who is owed what.

Jelena McWilliams, the former FDIC Chairman currently serving as trustee for the Synapse bankruptcy, has stated that locating all customer funds may be an unattainable task.

Although weeks of effort have been put forth, there seems to be minimal advancement in resolving the most challenging aspect of the Synapse issue: The management of funds in "for benefit of," or FBO, accounts. This technique has been employed by brokerages for many years to provide FDIC coverage to wealth management clients on their cash, but its application in fintech is relatively new.

"LendingClub's Sanborn stated that if the information is in an FBO account, the end customer's identity is unknown, and the fintech is responsible for the work."

Despite McWilliams' proposal of a partial payment to end users weeks ago, which has the support of Yotta cofounder Moelis and others, no action has been taken yet. Obtaining consensus from banks has been challenging, and the bankruptcy judge has expressed concern about which regulator or government body can compel them to act.

Judge Martin Barash stated that the case of "uncharted territory" meant that because depositors' funds are not part of the Synapse estate, it is unclear what his court can do.

Evolve has expressed reservations about making any payments until a full reconciliation occurs, according to filings. Synapse's ledgers indicate that almost all of the deposits held for Yotta were missing, while Synapse claims that Evolve possesses the funds.

"Moelis stated on CNBC that he is unsure of who is correct, but he knows the amount of money that entered the system is accurate. The money cannot vanish; it must be accounted for."

The former Synapse CEO and Evolve have experienced a lot of activity in recent weeks.

Pathak, who participated in early bankruptcy proceedings while in Santorini, Greece, has been trying to secure funding for a new robotics company, using marketing materials that exaggerate its partnership with an automaker.

Following a censure from the Federal Reserve regarding its handling of technology partners, Evolve suffered a cyberattack by Russian hackers who posted sensitive user data from multiple fintech companies, including social security numbers, on a criminal forum on the dark web.

For customers, it's mostly been a waiting game.

Craft, an Indiana FedEx driver, admitted that she borrowed money from her mother and grandmother to cover expenses. She is concerned about how she will finance the catering for her upcoming wedding.

"We believed our money was FDIC-insured at Yotta, as it was prominently displayed on the website," Craft said. "The revelation that FDIC only covers a limited amount of our funds was a significant blow."

She now has an account with the largest and most profitable American bank, which is Chase.