In the last three years alone, global fintech investments have grown to a total of $122B, led by the U.S., China, and the European Union. Decentralization is being driven by millennials who are seeking responsive, cost-effective, and transparent banking and finance platforms. Incumbent banks are both under competitive threat from and reliant on fintech startups to bring innovation from the outside.
Financial institutions are at risk of being relegated to execution and transactions by millennials intent on taking direct control of their financial destinies. Financial advisors are being replaced by complex data algorithms and robo-advisors. Single and multifamily offices are on the rise as people set up their own shops to invest in equities and finance projects, taking away control from large traditional players.
Conglomerates like Amazon are deploying investment divisions to finance synergistic businesses. While Amazon’s 2017 investments of $27.82B won’t rival 2017 PE and VC investments of $879B and $164B respectively, they do represent significant investment from operating businesses, allowing new portfolio companies to benefit from the operating company value and distribution to drive growth.
The expectations of millennials are giving rise to a golden age of entrepreneurship and innovation in insurtech, cyber security, machine learning, and blockchain technology. In support of these waves of innovation, the U.K. and European Union are creating regulatory sandboxes where new financial services, business models, and products can more quickly be deployed and tested in a live environment. These projects are driving regtech: regulatory technology designed to streamline regulatory processes and reduce compliance costs.
Power is shifting from large banks and financial institutions to clients, operating businesses, and sophisticated investors/families who are setting up their own shops.
According to the numbers compiled by Pitchbook Data, family offices did $100.6B in deals in 2016 relative to $25.1B in 2011. Among the major players are Redwood Capital Investments, the family office of billionaire and Allegis Group co-founder Jim Davis, and MSD Partners, LP, the family firm that invests the assets of Michael Dell.
Innovators in the Fintech Space
Fintech innovators are now some of the most valuable financial firms in the world. Disruptive smaller innovators are also challenging incumbents.
* Ant Financial, the payment arm of Alibaba, is now valued at $150B, making it more valuable than American Express, Goldman Sachs, or Morgan Stanley.
* ZHongAn and Pin An, China’s first and second largest Chinese insurtech firms respectively, are driving what is estimated to be a $211.66B Chinese insurtech market by 2021.
* Kabbage, a small business lender that provides loan and lines of credit online within just seven minutes, serves 115,000 small businesses in the U.S., providing $3.5B in funding.
* Kreditech uses machine learning-based underwriting to provide credit ratings and loans to people without a credit history in Russia, Poland, and Spain. It has plans to expand into India.
Decentralization can be defined as any process that removes a major intermediary, but it can't just move control from one party to another. To qualify as decentralizing, control must have moved to a system that is more democratized than before.
For example, the identity documentation market is projected to be valued at $9.7 billion by 2021. Identity documentation is a cornerstone of the client verification and onboarding process of every regulated financial institution. Yet, decentralized identity platforms have the potential to remove the creation and verification of identity documents from the hands of financial institutions and even governments.
These platforms have already moved well beyond the development stage. Microsoft and the United Nations High Commissioner for Refugees have already used ID2020, a sovereign identity system based on a private version of the Ethereum blockchain, to create identity documents for 1.3 million refugees in 29 countries.
A Powerful Equalizing Benefit
The 1.1 billion people globally, many of whom are women, who don't have the means to obtain a national identity document can be brought into the world economy, bringing huge new markets to financial institutions that embrace decentralized identity platforms as a solution in the Know Your Customer (KYC) space. Sovereign identity systems can have a powerful equalizing influence, ultimately simplifying how we cross borders and move globally.
The Flow of Capital
Global fintech investment in 2017 remains historically strong, matching the $31B invested in 2016. But in 2017, investment from Asia was down while U.S. investment surged, following a strong Q4 totaling $8.7B, for a total of $15.2B for the year. Total 2017 annual investment from Europe was $7.44B while Asia saw investment drop to $3.85B for 2017, after more than $10B in funding in 2016.
PE deal values were up over 2016 to $17 billion across 139 deals globally, according to KMPG. As investments from Asia declined in 2017, strong U.S. based investment of $15.2 billion made up the difference, amounting to nearly half of the $31 billion invested globally.
What's slowing in Asia? The relative drop in 2017 investment actually keys on a single record-breaking funding round from 2016. More than half the region's total 2016 investment came from a single deal: China's Ant Small and Micro Financial Services Group's $4.5B funding round.
Look for Ant Financial to again impact Asia's totals dramatically for 2018, with the completion of an unprecedented funding round of $14B in the first half of this year.
Where are the Opportunities?
With investment continuing to the tune of $31B annually, where is fintech likely to create investor returns? The most powerful opportunities are those that directly address operational and cost inefficiencies, lack of transparency, and poor customer service experiences. With customers in the driver’s seat, financial service providers who make accessing their products faster, easier, and cheaper will win the race.
Here’s where change is happening:
* There is a rising demand for robust digital banking services.
* Insurtech is driving pent-up demand in the insurance industry for more efficient operations and more customer centric offerings.
* The application of machine learning will drive profits for hardware manufacturers, data analytics firms, and companies that apply machine learning to enhance existing processes like fraud detection.
* Crowdfunded investments may come of age as a way for smaller investors to enter the commercial real estate market through investment in major projects in places like New York City or Tokyo.
* More efficient effective mortgage platforms represent an investment opportunity, as millennials finally move into the real estate market.
The payments industry is not offering strong returns as payment services like Stripe and Square are overvalued, even though payments processing remains a powerful cash-generating business.
Investors should also be wary of the buzzwords. The presence of machine learning or blockchain technology in a platform provides little guarantee of a return. What companies are actually doing with these technologies is crucial to finding investment opportunities.
Foregrounding Customer Experience in Banking and Insurance
Unencumbered by legacy IT systems and brick-and-mortar infrastructure, digital banks are providing ease of access and powerful banking tools for a much more responsive customer experience. Incumbent banks’ competitive vulnerabilities are spread across their operations including:
* Alternative assets
* KYC/ID management systems
* Portfolio management
Traditionally cumbersome client onboarding, application, loan, and banking processes represent ground zero for disruption and decentralization. To stave off upstart digital banks like the U.K.’s Monese and Atom Bank, Belgium’s Hello Bank, and Germany’s N26, incumbent banks in the U.S. and Europe are buying digital banks outright; partnering with them to create new offerings; or hiring fintech innovators to speed new services to market.
Friendsurance has developed the first peer-to-peer insurance model worldwide, rewarding customers with a claims-free bonus if there are no insurance claims in their peer-to-peer network on common coverage including car insurance, home insurance, legal expenses, and private liability insurance.
Lemonade is focused on renters and homeowners insurance, offering instant coverage, claims, and payment. Lemonade touts its charming artificial intelligence bot's ability to help you craft the perfect insurance. Its powerful customer-facing model is designed to create a sense of transparency in an industry with historically low customer approval ratings
The demand for more agentic, empowered customer experiences in banking and finance is a global phenomenon. Regulators are being pressed to adapt to new technologies and expectations, but there are limits. While blockchain, cryptocurrencies, and some level of decentralized systems will see growth over the next decade, regulation will need to be enforced.
As client facing interactions are changing, the back office function of securely being able to take deposits and provide custodian services will continue to be a need for clients and new client-facing fintech companies alike.
In the future, we could see each one of us being custodians of our own money enabled by mobile wallets and a decentralized blockchain systems and cryptocurrencies. It is a very real possibility, but one that will require a fundamental shift from the “social contract” with which we now live whereby government and centralized institutions are at the core of our financial systems.