The Real Fintech
After Slush 2016 I have become a bit of disillusioned about fintech. There is so much hype, so many buzzwords, yet very little actual innovation.
There was a guy on a big stage talking about blockchain. Thousands of listeners. All ears. He went on saying how he has traveled hundreds of conferences talking about blockchain, how he has done this and that and how he actually owns company called Blockchain. So — pretty advanced guy. And then he went on explaining, how transactions are most important part of banking and how blockchain will remove need for clearing houses and how banks will be completely disrupted.
I was completely deflated. If this is how little about finance can a person know and yet be considered a top fintech guy, then how much of a hot air all the fintech startup scene is?
Transferring money seems to me like a minor and insignificant part of the whole financial ecosystem. It has not changed that much in the last two hundred years, and if back then you needed a fast horse to transfer credit notes between banks and people, then later you could wire money via telegraph and later on via every subsequent iteration of telecommunications it became faster and faster. And if now, instead of a big book somewhere in a financial institution, there is a distributed ledger to keep track of money, then it is only an incremental innovation. And companies like TransferWise or TransferFast are nothing more than Faster Horses. They do not genuinely change how the financial system works, they just optimize a certain part of the existing system.
The same goes for peer-to-peer lending platforms like Bondora, Lendingclub and others. They optimize connections between small loans and small investments. They offer some risk-buying options to people who otherwise wouldn’t be able to buy such risks. They try to avoid regulation, that has been implemented to protect various parties. Basically, they take concepts, that were ruling financial world hundreds of years ago and then scale them, using modern tech stack. No actual financial product innovation, only very crude and simple products that are served via web.
Exactly the same story with crowd-equity platforms, like Fundwise and Invesdor, only risks are even bigger and harder to understand. And also bigger amounts of money are at stake. Yet no innovation at the core— same type of stock, that was bought and sold 200 years ago, before great fire of Chicago caused stock market collapse. Such things were happening back then, and they are still continuing. Only now such ‘great fires’ are happening at a much faster rate and are harder to predict.
Obviously, such ‘fintech’ companies are a clear sign, that banks have not been innovating fast enough. And probably governments also have overreached with their regulation efforts. So it is not all bad. However, I do want to see some real innovation. Something with real macro economic effects.
In Slush there was some talk about peer to peer insurance. That is something to look forward to. Insurance is all about information and we often have better information about our peers than any remote financial institution will ever have. There is a huge potential, but road will be bumpy, as lot of privacy and personal data issues will be encountered along the way.
Having better, cheaper and more targeted insurance could have a real macro effects, as it would act as a better safety net for numerous tragic accidents, that often destroy lives and push people out of labor force and participation in economics.
Besides better insurance, also better credit rating could be created in a similar peer to peer fashion. It is also based on information, though in this case probably peers would be various businesses. This already partly exists, as there are many intermediaries, who try to collect and resell information, but to make it really innovative, new credit rating product would need to become focused on the customer himself or tap into huge new world of shared economy.
In the first case, customers would be able to improve their own credit rating by choosing to add more and more data sources about their financial behavior and life choices, thus being able to provide more insightful information over time. And by the hard rule of externality, if enough people join the new rating system, then those who don’t, would start to lose out, and over time everybody would feel forced to be ‘part of the program’. Especially if there is some network effect built in. So, slightly distopian, but a plausible future product.
In the second case, the rating product would need to tap into vast amount of sharing economy systems, each with its on peer to peer rating system. There are a bunch of startups who are trying this, let’s see if they manage to get enough traction, as those unicorn companies are not the most willing ones, when it comes to sharing their data.
The macro effect would be similar to better insurance — the system would become more efficient, thus letting companies provide more goods and services, thus growing economy as a whole.
Better stocks would, of course, be very important as well. There are huge inefficiencies in the current system, due to historical reasons and regulation. Especially lately we can see that large successful companies are not going public, and somehow there is a feeling that it is not possible to participate in the tech boom, unless you are a venture capitalist. And when they do go public, then often all the incentives for companies become very short sighted, CEOs are valued by their stock prices, and stock price fluctuations correlate too much with quarterly results, instead of long term strategy and achievements.
LTS is one idea, how to fix the incentives and there are plenty of startups, who try to open up investments to larger public without forcing companies to go into IPO with its strict regulatory regime and substantial associated costs.
Those are all good ideas, but probably there are ways how to innovate even further. How to make it possible for people to invest time and money into companies and rewarding those, who place right bets and letting lose those, who fail to predict the capabilities of the team, business environment and general technology progress. At the same time avoiding traps, where people risk everything they have and are hit too hard, when companies fail.
What is needed, is stock, that is smart enough to include protection against all the worries that regulators usually have, yet would offer ability for both entrepreneurs to get the investment they need and general public to invest and be rewarded for their risk without jumping through too many hoops. I don’t have a fully-fledged idea ready here, but I am sure that, by applying the right amount of cutting edge tech, peer to peer information gathering, as well as right government support, something very interesting could be cooked up.
The macro effect could be very high, if the right amount of risk protection is built in, and people actually start to invest more. Especially if participation rate increases among those, who are not rich enough to invest anywhere right now.
If only minimum bank fees and mandatory brokers could be eliminated, it would already boost the participation. Currently to buy one stock worth five euro, you need to pay five euro minimum fee, making it pointless to do small investments. (Similar blocks are on road to micropayments)
In the last decade all sorts of short term loan companies, or payday loan firms, as they are sometimes called, have crept up all over Europe. And before that there have always been pawn shops and predatory credit card issuers and all sorts of ways of how to give people short term credit for sky high interest rates.
And people are constantly taking them, making it one of the most profitable customer facing financial industries. And one of the ugliest. The amount of ruined lives can not be compared with almost any other financial instrument.
There are some peer to peer lending companies that are addressing this segment, at least partially, and they seem to be doing OK, while keeping their image less predatory than those companies, whose ads can be seen on bus stops everywhere. Yet they are not that innovative — mostly they play by connecting lenders and borrowers more directly and then mediating the game and doing credit scoring and debt collection on behalf of the lender and sometimes doing other similar risk alleviating tasks for a small fee.
But to do those risk profiles and to collect those debts, they most often outsource it to traditional companies in this field. Putting more human factor into the lending, may make borrowers more likely to repay the loan, yet I am not convinced that taking banks and thus international money markets completely out of the process is the best for economy on macro level. Looking from this angle, it seems more like the opposite of financial innovation.
To really innovate in short term lending, there would need to be a mixture of peer to peer ratings, money supply from institutional sources, unconventional collateral items as well as some extra trust sources, for example family or peer groups. Mixing that together and stirring with machine learning and blockchain tools would produce some truly innovative fintech products.
Money markets and commercial paper are so far removed from my daily life, that I can’t immediately think of a lot of ideas, yet I am sure that those could be treated similarly to short term loans for salaried people, when it comes to paths to innovation. Especially when it comes to SME companies who do not have personal traders on speed dial.
All the exciting, profitable and dangerous financial innovation in the last decades has been concentrated around various bonds, mortgages, loans and their derivatives. And derivatives of those, bundled up, and then sliced and diced. And then some mutually exchanged risk. And then some collateral insurance on top. And then some more slicing and dicing, until the resulting product tastes sweet and predicts unlimited profits, but is, in fact, toxic.
This innovation has produced tremendous amount of financial company interconnections, risk that is impossible to understand as well as toothless over-regulation. At the same time, it has made all sorts of mortgages historically cheap for individuals, allowing for higher and higher quality of life for everybody in the society. So innovation, as it often happens, has two sides.
And, if new fintech companies want to take on Wall-street in this fight head on, they need to think similarly. They need to produce products that would have the effect of CDO, but without the toxicity. They need to create instruments with the risk profile for even pension funds to invest in, yet with some real returns. Or maybe products, that are not more profitable than what Lehman Brothers would put out, but can deliver tangible side-effects that might fit well with some investors. For example, guaranteed jobs created for each million invested, or guaranteed tons of green house gasses sequestered, or poverty reduced, or any other socioeconomic goals that might distinguish financial instrument from the competition. All that is possible with modern tools, but requires thinking out of the box and some real financial innovation.
And macro effects of that are immeasurable. And very very exciting.