Financial technology, or Fintech, is a great example of an industry in which the world’s top venture capital firms are investing their time and money.
Q3 2021 hedge fund letters, conferences and more
According to McKinsey, there’s been a fundamental shift in adoption of financial technologies over the past two years. For example, real-time, account-to-account payment infrastructures that have emerged over recent years are incredibly popular.
Fintech firms gain ground on larger banks every day, taking customers by building user-friendly products that are affordable, convenient, and secure.
There’s no question that the need to digitize finance has reached a tipping point; larger institutions are losing market share to peer-to-peer applications that don't require an intermediary. The convenience and appeal of real-time funding without settlement fees is crystal clear.
Despite investing in major tech initiatives, legacy institutions are still play catch-up, struggling to provide services outside of their core competencies. One example is how initial attempts at mobile apps lacked intuitive UI and adequate security.
Decentralized finance applications that use blockchain are a lightning rod for innovation, and investors are betting big on the technology’s benefits and long-term value for customers.
"Investments in instant payments have begun to reap greater benefits, both in POS and e-commerce usage of instant solutions." (“Accelerating winds of change in global payments | McKinsey”) The trend, writes McKinsey, is a response to consumer demand for speed, lower fees, and greater adoption of customer-facing applications.
As CEO of a leading family investment office, Vincent Puma, River Capital Group Holdings (River Capital) has extensive experience in finance, technology, private equity, and venture capital investing.
"The market landscape is changing, and large organizations have much harder time pivoting than smaller ventures," explains Puma. "It’s like comparing a tanker’s ability to turn around to that of speed boat. Banks cannot make significant changes quickly due to heavy regulatory burdens and high barriers of entry.
"Another important factor influencing change is how the cryptocurrency market has attracted billions worth of capital."
As of August 2021, the total market cap of all cryptocurrencies was estimated to be over 20 trillion. For better or worse, crypto is on the cusp of being considered mainstream.
Cybersecurity And Fraud Detection As A Differentiator
Banks are also being held accountable for their slow response to the digitization of money, largely due to archaic legacy systems - which can be costly and time consuming to maintain. Large banks have been roasted in the media for waiting hundreds of days before they even acknowledge a security issue where sensitive customer information might have been compromised. This delay in reaction combined with outdated authentication methods has eroded trust in financial institutions across the board.
In addition, fraud detection is difficult for larger institutions because algorithms must be able to adapt quickly. As companies become more reliant on data analytics and machine learning to detect fraudulent behavior, they need access to vast pools of customer information. While average banks are no longer using file cabinets filled with paper records to solve fraud investigations, there's still a glaring need for AI-powered solutions.
By comparison, fintech companies can access information from social media feeds, GPS data, wireless signals, and thousands of other sources – giving them a much better picture of any potential red flags.
It's true that some financial institutions have been quick adopters of new technologies, but those that have done so with success are few and far between.
Financial Technology Is Enabling Sectors Across The World
As I mentioned, the need to digitize finance has become increasingly important as bank profits continue to be squeezed by peer-to-peer applications that are not only secure, but don't require an intermediary for transferring funds. For example, farmers might only sell 20 percent of their crops every year which means that they don't qualify for most types of bank loans. The lack of access to capital has spawned platforms like Lendio that are addressing the needs of these underserved customers.
The number of fintech companies with valuations of several billion dollars is growing faster and faster.
Over the past few years, consumers have acclimated themselves to digital wallets with payment processors' support for mobile transactions nearing ubiquity.
"Increasing business competition is forcing banks to review their operations," added Puma. "Over the past five years, Fintech firms have gained market share at an increasing rate by building affordable, user-friendly products that are as convenient as they are secure. For example, online marketplaces like eBay and Etsy now support peer-to-peer lending while property letting sites allow real estate investors to borrow money directly from their clients rather than deal with old-school, third-party providers.”
Meanwhile, crowdfunding platforms that offer small businesses access to capital loans which they might not be able to source through other sources at competitive rates. In 2021, the global crowdfunding market was valued at 12.27 billion U.S. dollars and was forecast to double by 2027, growing at compound annual growth rate (CAGR) of 11 percent, says analyst firm, Statista.
The Investment Landscape Is Changing For Banks
We have seen numerous financial institutions adopt new technologies to better serve customers and cut costs. However, many of their investments have been minor compared to outside players who tend to be able to make much larger bets on growth initiatives like Fintech.
In the meantime, financial institutions continue to spend billions on information technology (IT) systems that aren't easily integrated with outside apps and services. The result has been a general lack of innovation that's forcing many companies to compete on price rather than service - a race to the bottom that only burns more cash while undermining their brand name.
Given these challenges, the reasons venture capital firms' appetite for fintech investments is going strong is not too hard to figure out. What's also important to note and worth keeping an eye on, is that banks are turning towards Fintech firms for help when it comes to building better products and improving customer relations.
