Fintech Is Just Getting Started
In just the first week of trading in 2016, the S&P 500 lost 6 percentage points and more than one trillion dollars in market capitalization. With the worst start in more than a century, the markets seem to be predicting a slow period for the U.S. economy.
One segment that I think has the potential to survive, if not thrive, in the expected volatility this year is financial technology. Of course, this may prove to be a relative measure. There will likely be a broad pullback in velocity of investment with an uncertain U.S. election cycle, as well as instability in the global economy that will be a result of the economic slowdown in China. However, I believe fintech has the potential to “buck the trend.” There are five categories I see positioned to succeed in continued investment and innovation this year: payments, cryptocurrency, retail financial services, institutional financial services and capital formation (equity financing).
Payments, as a category, is coming off a solid year in 2015, and the trend should be expected to continue into 2016. Mobile apps will likely see the largest amount of investment, and development will remain focused on creating a faster and more flexible platform to transmit funds. Globalization of existing payment infrastructure will continue at a slow, albeit consistent, pace.
Security will remain a critical focus and necessary constraint to disruptive innovation, though we should expect to see some surprises this year as to new ways of moving money.
2016 is shaping up to be a wild ride… hold onto your hat.
Watch for continued growth in market share for dominant players in this space as the category continues to mature.Much of the investment seen will be in mobile application developers, as well as in emerging participants that will seek to embed transactional efficiency into platforms where current methods of conducting commerce are limited (think Pinterest, LinkedIn, etc.). A surge in interest and development in blockchain-payments potential and limitations will spill over into cryptocurrency.
Appreciation of the dollar will keep downward pressure on commodities. Equity markets will remain generally volatile, though there will be winners that significantly outperform their peers — most of which will have dollar-dependent products or services and a strong balance sheet. Rising interest rates will keep downward pressure on fixed income markets.
With such volatility, the investor will seek opportunity and returns — which I believe will draw attention to cryptocurrency as an “asset.” With increased interest in the currency from non-developer participants and a growing interest in significantly broadening the use of blockchain, I believe cryptocurrency will see a strong year in investment.
In the long run, bitcoin may or may not prove to be the most efficient mechanism for use of the blockchain. Competition such as Linux is already entering the space, and consistent modernization is bound to result. This industry remains relatively unregulated (perhaps inherently) and will eventually require state intervention, though how that might look is entirely unpredictable. The technology and thought behind the concept are sound — it is now up to brilliance and innovation to continue its trajectory toward mainstream adoption.
Watch for increased attention to the blockchain this year, especially among banks doing business in multiple jurisdictions. This will be a continuation of what we saw in 2015, evidenced by the increasing number of institutions signed to the R3 consortium. Adam Smith said:
“…every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it.”
Appreciation of the dollar will keep downward pressure on commodities.
Capital will seek out promise, and I believe that cryptocurrency will show promise relative to other asset classes in 2016… real or perceived. The interconnectedness of the monetary world will eventually demand a cost-effective and safe way to transmit some measure of a “store of value” — as long as capitalism continues to prevail, a digital medium for the exchange of goods and services will be a necessary component of global financial infrastructure. Blockchain is only the beginning.
Retail financial services
Slowing, stagnant and declining markets have historically had a direct correlation to acceleration in consolidation with retail service firms. The collapse of realty capital — a juggernaut that was a part of, if not the cause of, a severe inflection point for valuation in retail broker/dealers — will draw attention to acquisition opportunities at a substantially discounted price from just two to three years prior. Additionally, the clients of captive financial advisors with “wirehouse” firms will question their accounts in the face of declining prices, which will prove an opportune time for the advisor to find a new firm or go independent.
The disequilibrium in this space will be the catalyst behind a number of changes, which will include a laser focus on profit margins and cost efficiency. Companies that service retail client accounts, large and small, will aggressively look to lower the cost of service delivery and provide their advisors with tools that will create brand loyalty and reduce the time needed for things like account updates and periodic reviews. Watch for continued growth in the “Robo-Advisor” space, both in proprietary systems and those that will be licensed to multiple firms.
Institutional financial services
The push for innovation in the retail category will create upward momentum for innovation in the institutional arena. Many systems require data aggregation, performance measurement, quantitative reporting and other such services to deliver meaningful interfaces to their end users, as well as value to the institutions that develop and or lease those interfaces. Providers that offer scalable solutions that easily integrate with existing institutional systems will find demand and investment.
The trend of replacing administrative personnel with tech personnel is likely to continue for larger companies over time as they continue to leverage technology to improve service deliverables and improve their bottom line. Additionally, firms will endeavor to broaden their value proposition by including features such as voice-based commands and other UX enhancements to their interfaces. Watch for the emergence of new providers of data aggregation and significant acquisitions of existing firms, both inside and outside the existing fintech space.
Capital formation (or equity financing)
Dodd-Frank was a sweeping reform bill that held significant transformative legislation for capital formation in the United States. Though effected in July of 2010, many of the changes it held are only now coming to fruition. I believe this category holds the greatest potential for growth in the short run. Obviously, I have a bias given my role with a startup seeking to revolutionize the way entrepreneurs and investors connect… but I believe my reasoning is sensible.
The rule framework for Regulation CF will become final on May 16, 2016, though several filing-related rules became final on January 29, 2016. This will mark a new era in the way capital formation works in the United States. For decades, investing in early stage ideas and their companies has been reserved for sophisticated investors, or “Accredited Investors.”
The demand for return on investment has been a long-understood foundation of investor thinking.
Defined as persons or entities with a specified net worth or income, only investors that met certain qualifications could make an investment in an ambitious entrepreneur by meeting certain guidelines provided under Regulation D. Dodd-Frank legislation, such as Regulation A+ and Regulation CF, changes that (see the FlashFunders blog for a high-level overview of some of the regulations).
I believe Regulation CF will prove to be revolutionary. It fundamentally blends the societal notion of investment with the longstanding capitalist definition, resulting in a decision that is based in both consumer and investor aspirations. Phenomena such as Kickstarter and Indiegogo have demonstrated that it is a natural inclination of people to want to be part of something bigger than him-or-herself.
The demand for return on investment has been a long-understood foundation of investor thinking. “Crowdfunding” essentially synthesizes these ideas by reducing minimum investment amounts and allowing for web-facilitated crowd validation of entrepreneurs, while still permitting contributors to participate in the success (or failure) of an early stage startup.
Of course, this model is fraught with issues. Investors must understand the risk that accompanies investment in unproven and often insolvent companies. There is a high probability that many will not be successful, and that return on investment will just not be a practical conclusion to their participation in an entrepreneur’s idea.
However, for those investors who understand the risk and have the financial wherewithal to lose their contribution, the opportunity is undeniable. Imagine having the opportunity to be a founding investor in an idea that ends up as a constituent of the S&P or DJIA. Or imagine putting a few hundred dollars into a company that ends up solving a serious social issue or curing a deadly disease. This is the true impact of Regulation CF — it changes the way we think about capitalization and fosters hope for entrepreneurs and their causes.
Assuming a timely regulatory implementation, watch for substantial investment in “Funding Portals.” There likely will be one or two high-profile failures, but this category will eventually earn a prominent place in the fintech segment.
All of my projections rely on a base assumption of a volatile, if not declining economy. However, should an unexpected player enter the stage and cause a surge in economic activity (such as an unanticipated geopolitical event that has abrupt impact on commodity prices), the fintech segment should still perform relatively well. The enduring trend for the past decade has been for firms to seek solutions that allow for scale without the need for expensive human capital. Technological development has been and will continue to be the underpinning of this trend.