Today’s FinTech is Just the Tip of the Iceberg
We are in for a radical change in economic society as we know it
Historical Context
Through all of human history from its earliest beginning until now, there have been only three basic stages of economic life:
1) Hunting and gathering societies
2) Agricultural societies, and
3) Industrial societies.
Now, looming over the horizon, is something entirely new, the fourth stage of social organization: information Societies.
— Sovereign Individual
The industrial society, which we are currently living in, and which is at the end of its life, was primarily driven by capital (as in financial capital) / credit[1]. During this industrial period, we have seen a continuous increase in the availability of capital (Credit). Some are wary of the high levels of credit in the system and call for tighter norms, some see it as an inevitable result of the way we have designed the capitalist system, but that is a discussion for another day.
The capital creation process is driven by banks, regulated by central banks, and used by governments to keep the economic engine running. In order to function, the financial system needs two primary mechanisms:
1) Enablement of credit/capital access
2) Enablement of the logistics of money
Traditionally, both the responsibilities have been managed to varying degrees of success by the banks. But given the capitalist structure of the society, which incentivizes growth, the cost of delivering these services has made it prohibitive for traditional methods to achieve the levels of acceptable (or should I say expected) growth.
And not surprisingly, we have primarily these two categories of FinTech startup firms.
1) Accessibility to capital (Lending companies)
2) Logistics of money (Payment companies)
Impact of Digital Technology
It is well known that one of the basic fundamental economic changes which digital technology has brought in is the reduction of marginal cost to (near) zero.
Referencing Wikipedia:
“In economics, marginal cost is the change in the total cost that arises when the quantity produced is incremented by one unit; that is, it is the cost of producing one more unit of a good.”
Digital technology has radically changed industries by eliminating marginal costs. It takes a cost “each time” to make an additional pizza, but it does not cost anything to make a digital copy. Music, Movies, Books, News … the dynamic of all these industries has been changed forever. True to the prediction by Marc Andreesen in his famous essay “Why Software Is Eating the World”, every industry dynamic is challenged and subsequently changed for good by software.
If we observe the way digital technology has penetrated down the value and distribution chains of the industries, we see a pattern:
- Radically increases distribution efficiency and in turn, drastically [1] [2] increases margins.
- Incrementally increases operational efficiency
- Once the above is achieved to a threshold, challenges the fundamentals of the industry by democratization
To give you an example, take entertainment. Not so long ago, music distribution was an industry in itself:
Then,
- Apple iTunes (and similar services) radically changed distribution
- Advancement in music software allowed better and better quality
- Challenged the fundamentals by making both distribution and creation available to the masses
Today, even I, with my bathroom singing ability, can create a song, publish it, and monetize it. Who would have thought this would be possible just 20 years ago? Large music distribution companies were challenged like never before.
What to expect?
Similarly, If we apply the same pattern to the finance industry.
- Change in distribution (of capital/money)
- Advancement in the backend processes of managing and “creating” capital
- Challenging the fundamentals by making both distribution and creation available to the masses
Today, we are seeing a wave of FinTech companies trying to make the distribution of capital efficient. We are also seeing a wave of FinTech companies trying to make logistics easy at a click of a button. We already have cutting edge technology companies powering the backend of the banking system, right from core banking solutions to fraud detection to underwriting.
Where are we headed? How will the democratized financial system look like? Will banks go down the same path as the music distribution companies did? It is for sure that we are in for a radical shift in how the finance industry works. One thing is clear though, it is going to be within our lifetime.
[1] Money and Credit are different. The concept of money as a proxy of value has existed for a longer period and will not go away.
