The Three Waves of Financial Disruption
Despite a wave of investment and attention around fintech, it has become reasonably clear that the first wave of ‘classic fintech’, based around reinventing existing financial services providers in digital form, has largely delivered incremental improvements on the existing financial services offerings in market — sustaining innovations, when viewed through Clayton Christensen’s lens of innovation theory — rather than innovations that have the potential to topple major financial incumbents.
However, more potent threats to financial incumbents have been developing in the background. In a recent presentation to the Stanford Alumni Association in Sydney, I shared our understanding the three waves of financial disruption that have the potential to completely reshape our relationship to financial services moving forward.
‘Classic Fintech’ has largely not delivered, and in fact we believe won’t ever deliver, on the threat of disruption that some have imagined.
We count in this many of the robo-advice solutions, neo-banks and even some of the more successful digital lenders. While many of these ventures have created strong businesses, they lack the fundamentally differential economics that would indicate the serious disruption akin to what we have witnessed in relation to newspapers and music — possibly because, in Australia at least, there is no significant ‘underbanked’ population. Moreover, classic fintechs have not been aided by the network effects that accelerated disruption in the media business. It turns out that, unlike in digital classifieds or social media businesses, the value proposition is not significantly enhanced by the involvement of other users and consequently the cost of acquiring users doesn’t come down significantly over time.
However, we believe disruption is occurring, though perhaps in less obvious ways.
The first wave of disruption is emerging from two related trends — modularisation of the banking stack and the embedding of financial services. Modularisation of the banking stack is where ventures pick off core technologies such as data, security, identity and transactions, then roll these technologies out across multiple financial services providers or even multiple industries. This trend foreshadows potential ‘disruption by outsourcing’, similar to Clayton Christensen’s anecdote about Dell computers, which outsourced each of its value creation stages one at a time until it was left with no defensible competitive advantage.
Importantly some of the layers that banks are outsourcing will potentially have significant data network effects (eg next generation credit models) meaning that market power may move from the bank to the data provider. Enabled by this first trend is the second, the embedding of financial services in adjacent industry verticals, evidenced for example by REA’s acquisition of a mortgage broker. This first wave has underpinned our thesis to date, with most of our portfolio investments from Fund 1, and a large number from Fund 2, directly leaning into this form of disruption.
Embedded financial services, while potentially impactful on a national scale, is even more potent on a global scale and underlies what we regard as the second wave of disruption starting to be felt — global consumer platforms extending into financial services. With dominant digital players in China, such as Alibaba, moving into payments, insurance and lending, we are now seeing their ambitions extend towards India and South East Asia. By the time these emerging giants exhaust growth options in developing markets and turn their sights to western markets, they will likely be multi-trillion dollar companies, dwarfing the scale and financial firepower of banks globally. Google, Facebook, Apple and Amazon have also begun to enter financial services in a similar way, but have been slowed by the relative complexity of Western financial regulatory environments when compared with the regulatory environment in China and the relative ease of other growth options. Nonetheless, the playbook laid out by Chinese tech players has appeared to hasten the advance of the GAFAs into financial services.
The potential third wave of financial disruption on the horizon is in the emergent space of blockchain technology, or Web 3.0. Rather than value being held with the current consumer internet giants, blockchain promises to shift value to the protocol layer. While there is ongoing debate around the merits of permissioned versus public/permissionless blockchains and the obstacles to adoption, there are already emerging solutions to key issues around scalability, privacy and control. We are at the starting block in terms of what is possible with blockchain technology, but the powerful network effects combined with potential applications in markets currently unserved/underserved by existing financial services suggests this third wave of disruption could be the most game-changing yet.
