The scene occurs at a San Francisco coffee bar in late 2014. She asks, “And what do you do during the day?” He calmly says, while tucking his plaid shirt in and rubbing his fully-grown beard, “I work in a fintech startup.” “Me too,” she replies giggling. “Are you in payments or digital wealth management?”
The story draws a smile. Two years ago, few millennials in San Francisco knew what fintech (e.g. financial technology) was, but now they all see it as their ticket to fame and fortune-via-IPO. Move over social networks and micro-blogging; the next innovation frontier lies at the crossroad of Wall Street and Silicon Valley.*
Just in the month of October 2014, fintech companies in the US have raised more than $1B, including the $75M IPO of valley-veteran Yodlee, the $64M raised by digital wealth management fintech poster-child Wealthfront, and the $150M raised by payment darling Square. The capital flows and the hefty valuations don’t lie: fintech is on fire, and that fire is not only burning in the US; fintech ecosystems are flaring up in Singapore, London, Frankfurt and Paris, and many other technology centers in the world.
It was not always like this. If you tried to raise money in fintech during the years that followed the fall of Lehman Brothers, most venture capital and private equity firms would have gently pushed you out to the curb with a polite “We are not investing in fintech right now,” but today money is gushing out of their funds faster than their fledgling startups can spend it, and they are briskly updating their websites to make you believe they were in fintech all along.
So what has changed since the doom-days of finance?
The first change is economical: The markets are back in the saddle. As proof, the Dow Industrial has broken its all-time record high 79 times in 2013 and 2014 alone, and it closed on October 13, 2014 at its highest value in history. As a rising tide lifts all boats, the bubbling markets have boosted financial services and yanked financial technology in their trail. One thing that stands out in the growth of the markets is the meteoric growth of Exchange Traded Funds (ETFs)—which has exceeded every other asset class since their inception 20 years ago. Assets in ETFs now exceed 3 trillion dollars. Their inherent ease of use (as they combine the passive investment convenience of mutual funds with a level of trading ease that was previously only found in equities) could certainly explain some of the rebirth in the markets. In any case, finance is hot again. God bless America.
The second change is technological: It’s been almost 20 years since the Internet revolution began on August 9, 1995 (the day of the Netscape IPO), and technology has matured tremendously in many areas. Those concurrent evolutions have combined to create a cradle of innovation which is fueling the Fintech Fire:
- The scaling of the public cloud (e.g., Amazon Web Services) which not only lets startups rev up on a dime, but also confers them a significant long-term cost structure advantage.
- The maturing of app development via open source, re-usability and tools has reduced costs and timelines to hours or days. Imagine holding up a weekend-long hackathon in 1992; it just would not have worked.
- The coming of age of social networking and search engine optimization (SEO) that have automated go-to-market strategies and slashed customer acquisition costs. With social contacts, adoption can go viral. Virality was not conceivable 10 years ago. It is not even a valid word in my spell-checker.
- The dawn of APIs (whether used for trading via FIX or for market data consumption, as with my company Xignite) enables true end-to-end automation of processes that used to be complex and human-intensive. Fifteen years ago—without easy trading, market data and account funding APIs—digital wealth management companies like Wealthfront, Personal Capital or Betterment could not have existed.
The convergence of those trends is allowing startups everywhere to reinvent every vertical segment of financial technology with a new angle and with solutions that are easier, faster and better. This is hitting traditional financial service institutions like a high speed train. Most of them have had their heads buried in the sand focused on regulation and cost savings since the days of that infamous Lehman Brothers bankruptcy. Wall Street is now petrified that Silicon Valley is about to eat its lunch, and it is scrambling to catch up. But once you see that most large banks still twitch when one whispers the word cloud, you realize that the technology and cost advantage of the fintech revolutionaries is significant indeed. God bless APIs.
The third change is social. It has to do with a generational replacement of a population that has grown up with the Internet, surrounded by mobile devices, and used to instant gratification and levels of ease-of-use never experienced by humanity before. That generation could not care less about traditional investment and advice models. They would not think twice about banking with Google, Starbucks or Facebook if it were available. They are not worried about security on the Internet, and the last thing they want is to have to talk with someone to get anything done. They are ready to use Siri to place a trade and expect an investment account to open and be funded instantly.
According to a survey conducted by eTrade, the majority (72%) of millennials want a financial advisor like R2-D2— “a copilot with diverse skills who helps you when you need it and offers a variety of tools you can use yourself.” Only 28% of them are looking for a friend like C-3PO (i.e., “a constant companion focused on your money who will always tell you what to do”). If you are betting that millennials will reverse their habits to that of their parents once they hit the age of 40, you may lose.
One may look at the mortgage crisis and think that because of it, financial services will never be the same. But the impact of the financial mortgage crisis is negligible compared to what millennials will have on the industry as they grow up. God bless our children.
So the fintech fire is being fueled by three deep-seated technological, social and economic transformations that are catalyzing to create an innovation bonanza that is turning the industry upside down. Of the three, only the first one is cyclical, and even if a bear market could put a cold shower on the whole phenomenon, the lasting characteristics of the two other trends allow us to safely predict that financial services and financial technology will never be the same.
* Technically a bit north of that, since Wall Street is now lined-up with condos and neglected for hip neighborhoods uptown by New York startups, and since Silicon Valley has been displaced by San Francisco as the startup capital of the world.