The Tsunami Of FinTech Startups – Reasons & Impact

Background

In the last 24-36 months, there has been a tremendous impetus in the FinTech startup ecosystem.  We have seen an unprecedented funding as evident from CBinsights report on FinTech investments.  Although there has been a slight dip towards the end of 2016, the sentiment is still strong for 2017.  If we look at geographically most of these investments have happened in North America, Europe, and China.

Whenever there is such a sudden burst of growth, it raises a few inevitable questions. What triggered this almost sudden boom in the FinTech space? What impact will it have on businesses/enterprises in the coming years?  While banking and financial services were early adopters of technology, the last decade has seen them trail as compared to some other sectors. Will that change? What impact will it have on regulations and their compliance?  These are some of the questions, this blog attempts to search answers for.

Inflexion point for FinTech

Company name Sector Funding (in Millions)
Oscar Insurance Tech 400
Payoneer Payment 180
Clover Payment 160
PaySimple Payment 115
Affirm Credit 100
Bright health Insurance Tech 80
Stripe Payment 150
Metromile Insurance Tech 103
Betterment Investment Technology 100
StoneEagle finance and insurance 76

 

Let us start by looking at 10 companies which raised the most money in 2016 in the US alone (Source CBInsights). The data clearly highlights that ‘Insurance tech’ and ‘Payment’ were the hottest trends which garnered maximum investments.  The payment solutions have especially seen a massive momentum.

The World over there has been accelerations of cashless transactions with mobile wallets gaining popularity. Payment using mobile wallet is not only faster and convenient for the consumer, but also important as retailers get to know some valuable information about user preferences with the help of technology.  The other aspect is seller-buyer can do cashless transactions without a comprehensive (Point Of Sale) POS setup using just the mobile phone or tablet. Internet of things technology adds another dimension where devices re-order consumables and authorize payments based on predefined rules.  Some startups are focusing on real time credit approval just when the user wants to make payment (online or in store) based on consumer credit profile.  These myriad ways of payment initiation also create a need on one side for sophisticated security and identity solutions and on the other side provide regulatory and compliance solutions.

Moving on to the insurance sector, a sector that saw 1.7 billion worth of investments in 2016 alone riding on 173 deals as per CBInsights. The tech investments seemed to be fueled primarily by a growing insurance needs for small and medium business sector. Another new area coming up is peer to peer insurance – which is really challenging the traditional insurance companies.  The objective of this type of insurance is to reduce (or eliminate) the inherent conflict between policy-holder and insurer at the time of a claim.  In a typical model, policy-holders will form a small group and part of the insurance premiums are retained by group fund and rest goes to the third-party insurance.  Minor damages are first paid out from the fund and only the excess claim goes to the insurance company.  In this way, the mutually invested outcome in the policies they buy aims to eliminate fraud and boost their return.  While these innovations are exciting, the insurance tech has to compete with very large traditional insurance companies.

Blockchain was conceptualized by Satoshi Nakamoto in 2008 and has a potentially large number of applications in various domains. Its reference implementation is some ways was Bitcoin – a crypto currency – which has fueled a large number of startups already. With its distributed ledger model, it challenges the existence of a number of central counterparties like payment processors, depositories, clearing houses and potentially even the government. Earlier this year, DTCC, the central bookkeeper for Wall Street’s securities trades, partnered with IBM and two Blockchain startups, Axoni and R3, to develop distributed ledger software for its post-trade processing.  Clearly, Blockchain is no more a hype and the VC’s are rightfully making deep investments in this technology.

Another trigger point for the startups is various regulatory changes. Consolidated audit trail (CAT) and MiFID require every trade order event sent to the exchange (or to another broker) to be timestamped (in sync with a central clock) and to identify a beneficiary in an unambiguous manner. A number of solutions are coming up to address this compliance need. Another initiative that industry saw was a T+2 settlement of trades and regulators that would like to further move to T+1 settlement eventually. The reduced time limit is creating opportunities for new startups to optimize the overall settlement process.

Yet another breed of startups is addressing unique challenges that enterprises in banking and financial services face when they embark on a cloud adoption journey.  While public clouds were considered untouchable by most banks and financial services companies, that attitude is certainly changing as AWS and Azure provide rich features, compelling cost savings and substantially reduced technology risks.

Machine learning is yet another gamechanger for most business domains– FinTech included.  With hyper-scalable infrastructure, an abundance of both structured & unstructured data and very sophisticated learning algorithms, predictive analytics is taking new dimensions.  Startups in AI are solving problems like reducing risk with sophisticated credit models, improved customer acquisition/upselling by intelligent customer profiling, intelligent algorithmic trading etc.

Challenges

While there is an abundance of funding and very real business drivers, yet these startups face some daunting challenges. To counter them, startups are changing the playing field by employing some smart strategy. Let’s look at some of the cases

  • Scale – The incumbent players in most cases are massive in size, have access to customers and have very deep pockets. This scale gives them enormous data for decision making and access to the customer makes marketing new products/service easier. However, scale also brings its baggage – like a slower change in processes, complex cost structure etc. The way I see the new edge startups trumping incumbent giants is by changing the buyer behavior led by technology. For example, Robinhood, a mobile stock trading app service is offering zero commission trading services as against an average ten dollar service by most traditional players. The way they do is no frills, zero touch mobile platform based service delivery while all heavy lifting is done in the cloud to keep the operational cost at its minimum.
  • Credibility – BFSI has always been very sensitive to the perception of risk in eyes of the customer. Simply by the virtue of being in that business for years, they have built a significant brand credibility. Most of the buyers have seen these large financial services brands for the most part of their life and customers intuitively trust them. To counter this storyline, the “Cloud born” startups are utilizing five-9 availability and eleven-9 reliability offered by public cloud platforms to build a solution that is always available at a predictable service quality level. Better features, lower cost, and always available service seems like a very tempting pitch for most customers

Time to market – Window for time to market is always short for any new startup but it will be more so for FinTech startups as incumbent vendors will also play the catch-up and will be able to build competing technology. Startups often use the strategy of “Technology Aggregation” –  by integrating services offered by other vendors to build a unique service for their customers. Add to that cutting edge open source tools, startups are churning out products at a blazing speed. The incumbent enterprises have operated in “technology secrecy” as a differentiator for a long time and are often stuck in baggage of existing technology and lack of trust in open source

Conclusion

Without a doubt, it is an exciting time for companies in the FinTech space. The latest trends in technology, business models, and regulatory framework are likely to have a deep impact on financial services space. Whether it is the case of “Central counterparties” losing their pivotal role due to blockchain or diminishing volumes for insurance companies’ due to peer to peer insurance or multimode payment systems revolutionizing the payment industry – startups addressing these problems have the tall technology and regulatory compliance mountains to climb in a relatively short time. The technology component is crucial as that is the key differentiator between these startups and the incumbent players. Our experience at GS Lab (GS Lab has worked with 100+ startups and product companies for over 13 years) suggests that building technology-driven businesses requires a team that has thorough understanding of capability for building scalable architecture, security & Identity, optimized usage of public cloud infrastructures like AWS/Azure/Google, API management for data sharing, DevOps for streamlined operations and cutting-edge tools for data integration & analytics. It would be interesting to see how the incumbents respond to these “challengers” and how the financial services industry will shape up over next the two to five years.

About Author

Nikhil Joshi has over 18 years of technology consulting experience of which a significant portion was in Fintech. In his current role at GS Lab, he handles business development, key account management, and strategic partnerships. His primary focus is on cloud technologies, automation, digital and security.  He can be reached at nikhil.joshi@gslab.com