Two thousand fifteen was the year fintech – including blockchain technology – entered the “mainstream,” signified by a groundswell of venture capital (VC) investment.
More than $13.8 billion in venture capital (VC) was invested in a variety of fintech companies globally, more than twice the amount invested in 2014, according to “The Pulse of Fintech 2015 Review,” a global analysis of fintech venture funding by KPMG and CB Insights. VC deal volume also jumped, from 586 in 2014 to 653 in 2015.
A key to fintech’s growing prominence in the VC community is the diversity of interests the segment encompasses. Fintech companies are targeting nearly every major banking and insurance process, disrupting the incumbents or enabling them to serve customers better or lowering costs.
Fintech’s scope and evolution make it critical for VC investors. This report examined global and regional trends. It also focused on blockchain.
Blockchain Investment Soars
VC-backed investment in bitcoin and blockchain companies jumped from $3 million in 2011 to $474 million in 2015. The number of deals rose from two in 2011 to 75 in 2014 and 74 in 2015.
The leading bitcoin and blockchain deals were: 21 Inc., $111 million; Coinbase, $75 million; and Circle Internet Financial, $50 million. The top cities for this investment were: San Francisco, 13 deals, $261.7 million; New York City, five deals, $26.3 million; and Austin, five deals, $3.3 million.
“Blockchain is a notable example of an emerging technology that offers enormous potential to the financial services industry, however this needs to be balanced with the reality that substantial barriers must be overcome in order for this potential to be realized,” said Ian Pollari, global co-leader of fintech at KRMG International and a partner in KPMG in Australia.
Why VC Interest Surges
nterest in blockchain is gaining momentum. A wide range of companies are exploring blockchain as a solution to challenges inside and outside the banking sector.
During 2015, Santander, Citibank, HSBC, Wells Fargo and other banks announced partnerships with fintech companies to leverage blockchain to make banking processes more secure, efficient and timely.
In addition, IBM has launched an open source blockchain initiative with partners including the London Stock Exchange, Cisco and Intel. Such organizations believe the potential disruption blockchain could create can’t be ignored. The disruption will be caused by lower transaction costs, decreased transaction times, minimized fraud, self-automated smart contracts, and opening the door to micro-transactions.
The expanding investment in blockchain is expected to continue in 2016. But there are barriers to be overcome in order to implement blockchain successfully within banking and capital markets.
Regulatory and market changes could hinder blockchain’s use on a global scale. Some analysts say excessive investor expectations have hindered blockchain.
At the rate investment is expanding, investors looking for immediate, short-term success could be disappointed.
Practical Approach Needed
Corporate investors have to qualify their expectations. To get the most value from blockchain, corporate investors need to be pragmatic. They must encourage industry-focused engineers to define the problems blockchain can help solve, find the most cost effective technology solutions, and address limitations to scalability, scope, velocity and usability.
Blockchain is presently not scalable to a degree that it can fundamentally replace high-availability, large-scale platforms. Nor does it deliver the ubiquity, speed, APIs, or controls environment required by banks to conduct daily activities.
Many banks continue to work with outdated legacy IT systems which may not be able to support blockchain initiatives. The technology usually consumes more computing power and resources than status quo solutions that banks and related vendors use in areas such as payments.
Such issues could affect plans to move to distributed ledger platforms. In addition to these and other challenges, there is a long way to go to gain widespread regulatory acceptance for blockchain.
Despite these challenges, there are many reasons to support innovation in distributed ledger technologies.
One short-term benefit is digital identity or a digital financial passport. Many banks see improvements related to how digital identity is facilitated. Such improvements could provide better choice and portability and ultimately higher customer satisfaction as individuals can control their own identity.
Beyond digital identity, there are other niches where blockchain can make a difference. Corporates that encourage use-case testing – whether for the processing of loans, securities trading lifecycle, or digital identify verification – and who can learn from this experimentation can be positioned to change course and gain the most value.
A number of the major financial institutions have blockchain proof of concept (POC) and prototype initiatives underway. Institutions such as JP Morgan Chase are considering how to validate hypotheses, test for scalability, build longer-term target operating models, and enhance business cases based on their POC/prototype results.
Work is also needed in enhancing international payment capabilities and applying distributed ledger principles to identity management and other areas. The move to experiment with distributed ledger technologies is well under way in financial services.
Investors must take a balanced approach to blockchain investment strategies. Blockchain solutions, to be the disruptor investors envision, must evolve to support the efficiency, reliability, and scalability requirements.
Blockchain also needs to be a differentiator instead of simply an enabler. And it has to be adoptable by all parties in the banking supply chain.
Blockchain investment has expanded, but relative to other fintech areas – such machine learning, robo advisory, and alternative lending – the scale of investment remains modest.
For blockchain to become a true game changer, more progress is needed. Investors have to ensure that any technology solution is supported with a full understanding of the barriers, exceptional learning, and clear economics on the cost and benefits. Many organizations are now undertaking deeper analysis of blockchain, and a more pragmatic view is emerging.
Andreessen Horowitz, a major bitcoin investor, has been the most active investor in North American fintech companies since 2011, followed by SV Angel, 500 Startups, and Google Ventures.
Fintech: Disruptor Or Enabler?
Investors globally have noted fintech’s potential, not only as a banking industry disruptor, but as an enabler to allow banks to kickstart their own innovation.
The fact that millennials seek more personalized and convenient services alarms banks which recognize the challenge of establishing trust with millennials.
Trust is an important competitive advantage banks have over new market entrants. To fully become the trusted adviser, they must be willing and able to work with fintech companies to provide customers with secure, personalized, easy and inexpensive experience to manage their financial lives better.
Banks Partner With Startups
Many banks and insurers have established their own fintech funds, but they’ve also looked to partner with fintech companies seeking a competitive edge.
While big banks have viewed fintech firms as competitors, they have started to see them as enablers. Technology giants like Apple and Google are becoming more of a threat to banks than fintech startups. Hence, corporate participation in global agreements to VC-backed companies accounted for a quarter of fintech investment.
Geographic diversification has resulted in fintech hubs in London, Singapore, Sydney, Hong Kong, Tel Aviv and elsewhere. The different geographies are creating sub sectors.
The growth of mobile in Asia supports efforts to serve the unbanked and underbanked while in Europe, fintech focuses more on creating cost effectiveness and just-in-time services.
The majority of VC-backed companies focus on lending technologies or payments processing. On the payments side, companies like SoFi and Stripe lead in attracting VC investment.
Interest is rapidly growing in insurance–related startups like Oscar, Zenefits and Gusto, which address new models of payroll, insurance or benefits provision.
VC Plays Bigger Fintech Role
VC-backed fintech firms are grabbing a bigger share of overall fintech investment. VC-backed firms accounted for 55% of fintech investment funds in 2014.
North America and Asia witnessed major growth in fintech investment in 2015. After taking less than 10 $50 million-plus deals from 2011 to 2014, Asia posted 17 $50 million-plus deals to VC-backed fintech startups. North American witnessed nearly 40 $50 million-plus deals in2015 after taking 29 in 2014.
Fintech companies include several key verticals:
- Lending tech: These are primarily peer-to-peer lending platforms, in addition to underwriter and lending platforms.
- Payments/Billing Tech: These companies include payments processing, payment cards and subscription billing software tools.
- Personal finance/Asset management: Such companies help individuals manage bills, accounts and/or credit, assets and investments.
- Money transfer/remittance: Money transfer companies include peer-to-peer platforms to transfer funds between individuals across countries.
- Blockchain/Bitcoin: Such companies include software or technology firms in the distributed ledger space, such as bitcoin wallets, security providers and sidechains.
- Institutional/Capital Markets Tech: These companies provide tools to financial service companies.
- Equity crowdfunding: These are platforms that allow individuals to provide monetary contributions for projects or companies in the form of equity.
- Insurance Tech: These companies create online carriers, brokerage and distributional platforms.
Featured image from Shutterstock.