Within the venture capital industry, the fintech sector has in the last few years become undeniably “hot”, attracting much attention from venture capitalists globally. But while the term “fintech” itself emerged only a few years ago, it by no means represents the birth of financial innovation. Indeed, the fintech sector has a very long history.
Today, when most people hear the term “fintech”, they tend to think about the latest mobile app that will allow them to pay for their morning coffee without ever swiping a card or touching cash or coin. Perhaps they think about the institution that can lend online without the customer ever visiting the bank, or a consumer buying insurance online without a broker.
Technology has always played a key role in the financial sector. The 1950s brought us credit cards to ease the burden of carrying cash and allowing consumers to pay over time. The 1960s brought us ATMs, replacing tellers and obviating the need to wait in line at bank branches. In the 1970s, electronic stock trading began on exchange trading floors. The 1980s saw the rise of the personal computer and software that enhanced our financial agility. In the 1990s, with the rise of the internet, e-commerce business models emerged and began to flourish. Online stock brokerage websites, aimed at retail investors, replaced the telephone-driven retail stock brokering model. The introduction of PayPal in 1998 addressed peer-to-peer payments online.
The point is that fintech is not new, and when the hype surrounding the sector begins to wane, and venture capitalists migrate to other industries, FinTech will continue to play a significant role.
Fintech 1.0 and 2.0
Fintech 1.0 refers, in very basic terms, to the emergence of technology aimed primarily at digitizing the customer experience and moving services online. Early focus was on online trading and lending, as well as wealth management products and payments systems. The technology was largely driven by fintech startups, with little participation by the banks. As a result, while these initial technologies brought considerable attention — and money — to the industry, the applications remained relatively simple and were largely limited to improving existing types of transactions.
The recent emergence of fintech 2.0 is significantly different in that the technology is largely being driven by artificial intelligence and greater computing power. It is aimed not simply at creating greater efficiency in current transactions, but in redefining and “creating the new”. It is more collaborative in that there is greater participation by the large financial institutions working with fintech startups, and a broader segment of industries is involved, such as insurance. As a result, its promise is significant and its potential impact on the financial industry is immeasurable.
The rise of crypto currencies and the use of blockchain might in the end prove to be the industry’s greatest innovations. While there is no shortage of skeptics, and there is undoubtedly complexity around trading in crypto currencies, implementation of the Ripple protocol (a real-time settlement system designed to be used by banks for currency exchange, remittance and gross settlement) and use of Ripple XRP (an issued token that uses the Ripple network) within the banking system itself continues apace. To date, 305 of the world’s banks are working with Ripple to reduce costs; 69% of banks are experimenting with blockchain; and the Chicago Board Options Exchange has launched derivative products based on crypto currencies.
Fintech in the U.S. and China
Fintech in the U.S. can be challenging as the regulatory system involves different players at both the federal and state level. This environment can make it harder for startups to navigate in the first instance and has had a significant impact on the development of a coherent “fintech policy”.
The most successful fintech startups have been able to steer their way through the complex regulatory environment, which has been a skill often missing with early stage companies founded solely by technology teams. The composition of a fintech startup team, therefore, has become increasingly important as the company scales and increasingly deals with issues of compliance.
The U.S. is seeing a broader increase in corporate participation, which has now jumped to nearly 20% for all deals in the U.S. This figure, though, remains significantly lower than the 40% participation rate for startups in Asia. Additionally, there has been a decline in angel investment and seed stage deals by almost 50%. At the opposite end of the spectrum are late stage deals in the wealth management sector, which continue to benefit from significant funding rounds.
Contrary to the belief of many, U.S. fintech investment is not concentrated solely in Silicon Valley, with many success stories emerging out of New York, Chicago and even Atlanta, Georgia. Nevertheless, California continues to lead with twice the total funding than New York, representing more than US$2 billion through October 2017. However, the emergence of New York as a growing fintech center reflects the additional skillsets required to scale and the increasing partnerships with existing financial institutions. New York has also invested significant capital in growing its startup base and is attracting a greater number of startups by providing easier access to the world’s largest financial institutions.
Financial innovation in China is referred to as “fintech” or “internet finance”, but the development and the drivers behind innovation in the sector are very different to that found in the U.S. In China, investment has been heavily concentrated in online lending and wealth management. We are also starting to see the emergence of more investment in the insurance sector. The Asian fintech venture market has heavily financed opportunities in the B2C market, though more venture capital is slowly beginning to flow into B2B. Fintech 1.0 in Asia solved some fundamental market inefficiencies, such as consumer lending, which had largely been ignored by local banks. That said, fintech 2.0 may prove more challenging given the growth in regulatory oversight and control by regulators. This does not mean advances will come to a standstill, but they will require venture backed companies to be more judicious at the very start and have adequate regard for regulatory trends in China.
The next 10 years
Given the rapid pace of change in the development and implementation of technology development applicable to financial services, it is difficult to predict the future. Nevertheless, there are some key trends; two sided marketplaces and the aggregator of payment flows will develop into financial services platforms including but not limited to payment apps; robo-advisory services for wealth with retirement planning, on demand insurance distribution as well as HR services including payroll and benefits. These platform services may in the end do more than provide transportation or e-commerce — they may in fact replace banking services completely. In Asia, this model has been pioneered by Alibaba, Tencent and Rakuten and is the model now being followed by GO-JEK in Indonesia. They are not competing head-on with the banks and insurance companies but are quality providing all of the financial services needs of the growing middle class.