Back in 2010, amid declarations that “software is eating the world,” it seemed like the combined waves of mobile devices and cloud computing would change everything.
As tech wrecked havoc upon transportation, hotels, and numerous other industries, Silicon Valley started salivating over its next target. It spied a crown jewel, a slow-moving, half-trillion dollar behemoth of an industry: banking.
The prize looked ripe and juicy, a thoroughly old-school industry with high fixed costs and collectively reviled by consumers even as its services remained ubiquitous.
We had also just recovered from the Great Recession, where we saw missteps by banks cause the largest financial crisis in recent memory. The time was right. Silicon Valley started moving in, VC checks chasing entrepreneurs in hope of transforming finance with technology.
Fintech was born.
Seven years later, Square and Stripe boom in merchant payments, Wealthfront and Betterment challenge asset management and the tech world is fixated on the price of Bitcoin, but the core of US consumer banking remains largely untouched.
In fact, over that period the strongest incumbents have become stronger. Once heralded as the stars of the space, Lending Club and Prosper are struggling. Winners certainly exist, but tech has yet to revolutionize banking in any real way.
The tone of the Fintech space has shifted from disrupting incumbents to partnering with them, and VC dollars have started to shift to more promising fields.
Perhaps we just haven’t seen the right company yet, but the oracles of disruption would have painted a very different picture for 2017 than where we are today.
We predicted mobile payments, all-digital banking, new credit models and a truly inclusive financial system. While the picture is not entirely bleak, it’s worth asking why were we so wrong (so far) about the potential for disruption in an industry that appeared so ripe for it. Here are some thoughts.
Checking, Saving and Personal Finance: The Vitamin Problem
Disruption grade: F (these grades are subjective, of course)
I’ll start with my own company: Level Money started with a budgeting application, a simple way for our users to view their finances as an ‘allowance for adults.’
We thought that we could use Level as a new front-end to banking, slowly integrating financial products into the application while maintaining a simple interface. But along the way, I wrestled with the question that sat at the core of our challenge in building a next-generation bank: “are we a vitamin or a painkiller?”
We tried to convince ourselves that we had a painkiller, a solution that solved a burning problem for lots of people. But in reality we were a vitamin, something that if taken every day would have long term benefits, but that doesn’t necessarily fix an urgent need right now.
While banking is certainly not loved by many consumers, improvements to the system (Simple, Moven, Digit, Check, Level Money and others) slam into the vitamin problem over and over again.
Consumers may have some latent desire to switch their bank at some point, but putting it off until tomorrow isn’t going to kill them. They also may nominally desire some greater financial clarity, but the path of least resistance is to maintain the status quo.
If it’s necessary to convince a consumer that they have a problem before you even start to tell them that you’re the best solution, you’re fighting a losing battle.
To date, no industry newcomer has succeeded in gaining significant traction in transactional accounts, even as countless startups and the likes of PayPal have tried.
Lending: Slow Money in a Fast World
Disruption grade: C
Banks don’t make their money with checking and savings accounts anyway; many treat transactional accounts as loss leaders for loans. Loans are the bread and butter of the industry, and there seemed to be huge room for improvement in lending using new data sources. Enter Lending Club, Prosper, SoFi, Affirm and many others.
As we later learned, the fundamental challenge with lending startups is time. A new lender’s competitive advantage will generally be how they separate good loans from bad ones, but that advantage only gets proven after years as customers pay back their debts.
In the meantime, lenders must be careful not to grow too quickly, because a bad tweak in the lending model may not have yet to show itself. That’s frustrating for a VC and startup industry accustomed to exponential growth and the returns that accompany it.
In addition, credit quality is highly dependent on the macro-economic credit cycle: we’ve been in a great credit environment for a number of years, which has been friendly to new companies in the space. It’ll be a very different story when the market turns.
Payments: Cards Work Pretty Well, Actually
Disruption Grade: B-
There are several bright spots to highlight in the payments space: Square, Stripe and Venmo have all made significant waves. Square sent the industry scrambling to imitate its mobile card acceptance platform, and Venmo prompted a comically bad attempt at a competitor from financial institutions.
But before we congratulate ourselves, let’s remember the scale of the original ambition in the payments area. Of all areas in financial services, this was the one where mobile devices should take over.
Mobile payments was the way of the future, before it ended in tears. Countless startups rode the hype then crashed hard (remember Clinkle?). Google Wallet rebooted and failed several times. Even Apple — almighty Apple! — saw its attempt at mobile payments fail to gain adoption.
We’ve seen lots of progress in payments, but it’s nothing near where the oracles of disruption predicted it would be at the beginning of the Fintech era.
After so many attempts by companies large and small to prompt a shift to mobile payments, the fact that little has changed is particularly frustrating. The reason is simple and its own version of the Vitamin Problem. Electronic payments are highly superior to cash, but payments via mobile device is not that much better than swiping a card.
Square and Stripe succeeded in allowing merchants to accept cards, where the alternative was cash or other forms of payment. Venmo did the same for person-to-person payments. But saving five percent at Target via Google Wallet is not enough to change a deeply ingrained habit.
People don’t use new technology because it’s new, snazzy or philosophically superior, they use it because its way better. That seems obvious in retrospect, but somehow we forget it all the time (see entries: Segway, Bitcoin 1.0).
Investment Management: The Robo Era
Disruption grade: B+
The area where we’ve seen real industry movement is in investment management. When Wealthfront was founded back in 2008, the investing space looked radically different.
By waging a war on high fees for low performance by active managers, robo-advisors have ridden (or created) a wave favoring passive management dominated by ETFs.
At the same time, Robinhood is attacking trading fees: it’s fee-free application has accumulated 3 million users (E*Trade has 3.6 million).
Still, it’s estimated that robo-advisors manage $182 billion in assets in the US. That’s a noble sum, but only a small chunk of the $20 trillion of retail investors’ total assets.
Change always takes time, but a true takeover in financial management will be a particular slog. Even if robo-advisors scoop up much more of the market, the race-to-the-bottom pricing structure will present long-term profitability problems.
However, real change has taken place in an industry not used to change, due at least in part to strong tech challengers.
Tech has certainly not given up on financial services, though the rate of VC investment in Fintech has cooled. Established companies like Credit Karma are expanding into new areas, and newer companies like Aspiration, Upstart and ActiveHours are showing promise.
But I hope we’ve also learned the degree of the slog that awaits. To truly attack an area like lending, VC dollars must do what they’re very bad at doing: wait. The market will need to back a seasoned entrepreneur who’s willing to slog it out with large financial institutions long enough for the model to prove itself (for lending in particular, my bet is that Max Levchin will be that person).
As the world becomes fixated on cryptocurrencies and other technologies, we’d do well to learn a lesson from the first waves of Fintech: when you have a good hammer, everything looks like a nail.
Just a few years ago, that hammer looked like cloud computing and mobile devices. Now that we’ve seen that cycle play out, we’re all looking for the Next Big Thing. Not wanting to miss the next wave, Silicon Valley too easily buys into the “this changes everything” storyline.
We often forget when we’re wrong, discounting how much better new products truly need to be to change the status quo. Let’s not just celebrate when we’re right, but carefully think about why we were wrong before we jump on the next hype train.