FinTech: Believe the Hype? (Maybe)
Part One: The Hype Cycle and Bitcoin
The Hype Cycle
When I lived in Hong Kong in the early 00’s, it was not uncommon to run into someone from the industrial heartland of America who had come to Hong Kong to find out why everyone was talking about China. They would have taken a few guided tours of factories across the border and were about to return home with a plan to transform their company by outsourcing their manufacturing to China.
Fifteen years later, China’s industrialization has changed the world. China’s share of global manufacturing has risen from less than 3% in 1990 to about 25%. Yet, outsourcing to China has not been the panacea many expected. Long lead times and large production runs are capital intensive and economic development in Western China has led to labor shortages and wage inflation in the manufacturing hubs on China’s east coast. For the small to mid-size producer of widgets, the long-term impact of China’s industrialization was not to increase profits, but to enable multi-nationals to eat your lunch with their access to cheap capital and the scale to diversify their supply chain.
Unrealistic expectations are not unique to China’s industrialization and was described by Roy Amara, as it relates to new technologies, in Amara’s Law:
We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.
Gartner extended Amara’s Law and developed a Hype Cycle were the promise of something new leads to inflated expectations, followed by disillusionment before eventually reaching a steady state of productivity.
FinTech
Having experienced the China bubble as an equity trader in Hong Kong and the Dotcom bubble as an equity trader in NY, it seems obvious to me that FinTech is in the hype cycle somewhere to the left of the peak of inflated expectations. What makes the hype over FinTech somewhat unique is that FinTech is not one new thing, but a broad category of newish technologies that may change financial industries is some way. Wikipedia defines FinTech as the
new technology and innovation that aims to compete with traditional financial methods in the delivery of financial services.
Furthermore, the idea that new technologies will change the financial industry is also not new (think ATM or credit cards). If FinTech is not a thing, but an idea about things and that idea itself is nothing new, why the hype?
Regulatory Capital and Bitcoin
When a large financial institution fails, it can hurt the whole economy (think Lehman). Governments, therefore, require financial institutions to hold large capital cushions to lower the risk of failure. In the recent past, a start-up who wanted to #disruptthebank needed to develop innovative tech or new model and raise a amount of regulatory capital. This made investing in disruptive minded FinTech start-ups riskier with lower returns. Unsurprisingly, most FinTech investments were in technologies that could be sold to banks; leading to the far less hype inspiring #selltothebank. Bitcoin changed all this.
It is no longer science fiction to imagine the development of peer-to-peer financial service models that do not required regulatory capital (not sure there ever was a finance sub-genre of science fiction). Billions of dollars have been invested in disruptive minded FinTech start-ups and a bitcoin has gone from something you couldn’t buy a pizza with to worth just south of $5,000. Whether you get caught up in the hype or not, in my opinion, should be a function of understanding the potential use cases for peer-to-peer financial services when considering the costs and benefits relative to a trusted third-party model.
Unfortunately, most of the discussion around this topic is focused on the price of Bitcoin and who thinks it will go to $50,000 vs. who thinks it will go to zero. Few talk about the underlying technologies that make it work. Understanding how Bitcoin and the blockchain work is necessary to determining what is a realistic use case like why consumers will mostly likely interact with a blockchain in the grocery section before they do at the cash register. In my next blog post, I will attempt to explain how Bitcoin and the blockchain work in a way that does not require a PHD.
