Fintech: a recent concept, but not so much
The creation of financial institutions dates to the earliest times of society as we know it. Banks, credit unions, and similar organizations have always exercised a structural role in our history, supporting crucial evolution episodes such as the industrial revolution and winding up toxic events, such as helping dictators hide their fortunes. Regardless of how these entities have benefited society or not, the fact is that they have consistently played an essential role in humankind’s history.
As financial institutions evolved, they have naturally specialized in different matters, engendering a wide range of segments within the financial market. One of the most recent categories of financial institutions is the so-called fintech, a term first coined in 1993 to refer to those financial institutions that use technology to enhance financial processes. However, only more recently, when the internet banking system became mainstream, this expression started to be widely adopted and devoured a stake in the venture capital market. As one may induce, fintech is nowadays not a segment on its own in the financial market, but companies that adopt processes powered by technology and that may be present in every part of the financial industry.
In contrast with what most of us may believe, fintech already exists for quite a while, probably for much longer than one believes technology would enable them to be conceived. In 1866, a device called Pentelegraph was created to verify signatures by banks, which may be considered the first adoption of technology to enhance financial processes. Such initiative, among several others until 1967, comprises what we know as fintech 1.0, consisting of the initial experiments that put together the latest technological findings and finance to streamline financial bureaucracies. From 1918 to 1967, professionals started using the Telegraph and Morse Code to digitalize money. Transfers no longer demanded money to be physically moved from one place to the other, and one’s wealth would mainly consist in a register of the wealth across several financial institutions rather than a pile of cash and gold stored in a bank’s safe.
In 1967, the concept of fintech, as we know it today, was revolutionized when Barclays created the first ATM, spiking the beginning of the fintech 2.0 era. The year before, Telex replaced the Telegraph and enabled the connection of financial institutions and communications that characterized this period in financial history. In 1971, Nasdaq was created, and in the decade following, electronic trades and online banking systems emerged.
However, after the financial crisis of 2008, the financial market was once again revolutionized, delivering what we currently consider fintech 3.0, those financial firms that, among other aspects, developed their own ecosystems to involve users. Some already speak about fintech 3.5, created from 2014 onwards and which may replace more prominent players, but the definition behind this last category still lacks content.
All that said, fintech already exist for quite a while, and the definition behind them (financial institutions that use technology to automate financial processes and unlock new possibilities) has stayed the same. Since 1866, technology has evolved and, consequently, how financial institutions have used it to enhance their processes and solutions. Thankfully, we see no signs of deceleration in how technology has evolved, so it is hard to believe that fintech will reach an evolution plateau in the foreseeable future.
Not surprisingly, a huge market with strong perspectives
Every sector in the economy is inevitably transformed as technology evolves. The financial segment is not an exception and has been improving and expanding dramatically as digitalization unlocks more efficient and effective financial processes. What currently is the most profitable sector of the global economy, with an average margin of 18%, representing a $2.3 trillion profit pool, should become even more representative as technology is used to refine its activity, consequently boldening the importance of fintech in the venture capital ecosystem.
Technology in financial services has been disrupting traditional banking services on almost every front, ranging from improving customer experience to using data analytics to enhance accuracy in financial institutions’ internal processes. The improvements brought by innovation were so sharp in the financial market that, according to the US Net Promoter Rankings as of 2022 by Forrester, people became more loyal to fintech than to banks in the US, a major disruption compared to not long ago.
Among the fintechs of our portfolio, we carry a great example of a company that has been thriving in maintaining a brilliant connection with its customers. PayJoy, which provides microcredit using the debtors’ smartphones as collateral, adopted a unique stance during the pandemic and took the chance to retain many of its customers by providing its clients with more flexibility to pay the installments instead of following every contract to the letter in such a delicate moment. With that, the startup exponentially improved its customer experience and propelled its reputation among its target audience.
Future Family, another portfolio company of ours, has also captivated clients through another way: instead of just providing credit for egg freezing and in-vitro fertilization procedures, the firm also provides a world-class digital health experience for patients who are mostly overlooked by the specialized clinics after the procedure is concluded. This way, one would hardly opt to take a loan from a bank and face potential post-treatment issues, given the better option offered by the startup.
The fact that fintech has been positively revolutionizing the financial market at a tremendous pace doesn’t mean we are about to reach the market’s capacity in this regard, though. Currently, around a quarter of all adults worldwide are still unbanked, mostly concentrated in the Middle East, Africa, and Latin America. In other words, given the massive potential consumer market yet to be explored for digital financial services, the already extremely relevant and profitable financial industry should become even more relevant through fintech development in the next few years.
The fintech segment holds a 2% share of the $12.5 trillion in revenues generated by financial services annually. This sector is estimated to grow up to 7% of the entire financial services industry by 2030 and reach $1.5 trillion in revenues when banking fintech is expected to constitute almost 25% of all banking valuations worldwide, according to BCG’s Reimagining the Future of Finance report. By then, despite the exponentiated capillarity of fintech in Latin America, Africa, and the Middle East, the fintech market in the Asia Pacific should become even more representative than the one in North America, the currently most representative region in this field.
The Latin America’s growth should be led by Brazil and Mexico. Brazil´s fintech market is growing rapidly, seen an example by other countries given the technological development it has already reached in a wide scope of financial activities. ranging from consumer credit and open finance to digital payment. With the emergence of big players such as Nubank, the currently largest neo-bank in the world with more than 75 million customers, local regulation had to keep up to date with such an exponential evolution becoming one of the most advanced among the emerging markets without lagging behind the ones adopted by the most financially sophisticated first world countries. According to Distrito’s 2023 Fintech Report, Brazil currently has more than one thousand fintech startups, which represents the largest tech market in the country. Such segment may become even more representative as the recently created Pix (an instant payment system that revolutionized the entire Brazilian financial system) should be the starting point for the creation of uncountable new ventures in the short-term.
As expected, the number of fintech deals worldwide has been growing simultaneously with the importance that this market has been gaining. From 2014 to 2022, the number of deals closed in this segment increased by over 8 times, a volume possibly suppressed by the recent market downturn, and that should continue to grow drastically throughout the next few years. The volume directed to investments in fintechs has also been gradually increasing, confirming the importance that the segment has been gaining in the venture capital industry.
Despite the seemingly accurate predictions of how the fintech industry should grow in the next few years broken down by geography, it is hard to predict how each fintech sub-sector will evolve by then. Until not long ago, the payments industry was responsible for most of the funding absorbed by fintech. However, in 2021 crypto-related startups became exponentially more relevant to the point that, in the year following, they surpassed payment-related firms in funding. Regardless of the tremendous attention that crypto and blockchain have attracted in the past couple of years, most of what we have been living in this segment are merely the first few trials of what these technologies are capable of. The possibilities offered by blockchain structures may, in not too long from now, revolutionize how financial transactions are executed and attract even more investments than we currently imagine.
However, if such an abrupt change took place in just a couple of years, who knows what type of compelling fintech sub-segment will emerge in the next few years and attract more investments than any other niche?
As a matter of curiosity, you can find below some of the most successful fintechs categorized by segment through CB Insights perspective. In a few years, we should see not only more names joining this list, but also new segments comprising the map. Nowadays, for example, earned-wage-access companies such as Rain, one of our portfolio companies, have been attracting increasingly more attention from investors and do not comprise a separate category themselves yet. Rain has already onboarded nearly half a million eligible employees in its platform, demonstrating the potential that this segment has to be put under the spotlight in the coming years.
The future: integrated financial services
With the staggering growth of the fintech segment throughout the past few years, this market has become one of the most relevant venture capital sectors to invest in, attracting attention from some of the largest VCs out there, many of which have created funds to invest exclusively in this type of company. In 2022, fintech investments dominated the allocation of major VCs such as A16Z and Sequoia Capital, representing nearly 25% of their deals overall. But venture capitalists are not the only ones behind investments in fintech — Big Techs realized they were missing uncountable opportunities in the financial market as well, especially retail companies, which are now broadly launching financial solutions related to their core business or absorbing synergic startups to propel their operations. At the beginning of 2023, for example, Apple introduced the “buy now pay later” solution in partnership with Goldman Sachs to allow users to pay for their Apple products over time, boosting the company’s stock price. Thousands of similar examples could be discussed as solutions embedded into virtually any business are becoming increasingly more frequent and accessible.
The frequency with which financial services have been added to industry-related services has grown to a point that, nowadays, cybersecurity and compliance-related problems have started to emerge. With such a growth in the number and variety of digital financial transactions being executed, consumers are almost inadvertently becoming more vulnerable to personal data leaks and cyber-attacks to the point that even blockchain-based transactions are no longer completely safe in certain circumstances. Synergies between industry and financial solutions evolved so much that, in some cases, when one is applied to the other, it gets hard to define whether certain companies should be categorized as a fintech or another type of firm. For example, Future Family, previously described, could be considered both a fintech and a healthtech. With that in mind, it is inducible that financial services will be increasingly embeddable into other core solutions in the near future, sometimes becoming the core itself and other times providing support for the core business to operate properly.
At the end of the day, defining whether a company is a fintech or understanding how its core business relates to finance may be irrelevant, though. The technological evolution we are currently living in is providing us with ample opportunities to rethink financial services and add them directly to virtually any business model instead of detaching them into traditional financial institutions. And, with so much space yet to be explored, given the number of adults still unbanked, it is hard to contest the seemingly astonishing potential perspectives of the fintech market for the next few years.