Fintech Forecast: the Digital Dance of Disruption

2023 has been a wild one for the financial sector. Between the collapses of Silicon Valley Bank (SVB), Silvergate, and Signature - along with the acquisition of troubled Swiss lender Credit Suisse - the events that transpired resemble that of the 2008 financial crisis. The most highly coveted crisis involved SVB, a bank at the heart of the venture capital and tech ecosystems. SVB had a large portion of customer deposits loaned out in long-term securities. As the Fed rapidly hiked interest rates to curb inflation, the value of its loan book took a massive hit, forcing it to either 1) sell assets at a loss or 2) raise capital in the equity markets.

Where there’s smoke, there’s fire. VCs got word of trouble brewing with SVB, advising portfolio companies to withdraw their cash quickly. A bank run ensued as a result, and SVB failed as it did not have the liquidity needed to cover depositors.

I’m not here to debate where the blame resides - the lack of oversight by regulators, the mismanagement of assets by bankers, or the rapid burn rates by startups - but rather discuss what it means for the financial sector (and fintech) moving forward. The stress in the regional banking sector certainly bodes well for the bulge brackets - JPM, Bank of America, Citi, Wells Fargo - as depositors turn to “too big to fail” institutions for financial safety. We saw this play out in their Q1 earnings, as these banks reported record revenues and profit growth.

And the recent fallouts highlight the benefits of decentralized finance (DeFi), where blockchain technology removes intermediaries, smart contracts dictate lending and liquidity, and the risk of bank runs are mitigated. DeFi is built on peer-to-peer networks, meaning no single entity controls the system and therefore no central point of failure exists. Furthermore - unlike the issues that plagued Credit Suisse - DeFi platforms are open-source and auditable, promoting transparency and trust. This likely explains why Bitcoin and Ethereum have soared to start the year, up 85% and 75%, respectively.

But what about broader fintech? And what does it mean for other players moving forward? Following the collapse of SVB, I was impressed by the speed at which neobanks, like Brex and Mercury, moved to accommodate clients needing new banking relationships. Through seamless onboarding and enhanced FDIC deposit protection, these fintechs added thousands of customers relative to other players.

Now I don’t see neobanks replacing legacy institutions, as the diagram above may suggest. The last decade was dominated by agile startups stealing market-share from banks, but these incumbents have woken up to the threat and have three powerful advantages: economies of scale, low cost of capital, and brand recognition.

But I do expect to see bank/fintech partnerships grow - partly due to the cost of buying and building, but also the macro environment. Fintech finds itself in a turbulent economic landscape inherited from a disruptive 2022. The war in Ukraine, inflation, labor market challenges, supply chain disruptions, and environmental pressures will continue to play out in the year ahead. However, as fintech opens up the world for business, technology will continue to play a leading role. Let’s dive into some of the key trends shaping the sector and the opportunities that exist for startups.

Cross Border Payments

The payments landscape is already diverse, with traditional financial institutions competing with fintech startups for a share of the market. However, we can expect to see more disruption in the space as the macro landscape unfolds, especially in emerging markets.

Supply chain issues and geopolitical tensions have spurred debate around the future of globalization and the impact that re-shoring will have on the United States economy. Current legislation certainly supports this shift, as the IRA and CHIPS Act will provide financial incentives for companies sourcing and manufacturing goods domestically. These trends impact the payments space because, ultimately, the movement of people, goods, services, and funds will dictate where growth lies. For instance, in the remittance industry, the displacement of individuals due to conflict will influence how those services are utilized. And from an enterprise standpoint, many argue that independence is making a comeback at the expense of global interdependence.

But I have my doubts. Consumers have long demanded customized goods at low prices – entrenching globalization in the worldwide economy - and that relationship should continue between developed and developing nations. Capital will continue to flow across borders – if not to Russia and China, then to Latin America and Europe - and fintech will play a critical role in facilitating that. Emerging markets are already seeing the benefits of frictionless payments – mobile banking, embedded finance, and biometric authentication - that reduce friction and provide seamless experiences. Digitally native Gen Zers will continue adopting financial technology, so long as proper fraud and security measures are in place. They are the first generation to see the rise of frictionless payments and are thus more comfortable with these innovations.

Vertical SaaS

Payment diversity will pave the way for vertical software solutions in emerging markets. In the past, we’ve seen vertical SaaS companies in the United States provide a suite of services to their merchant customers to operate more effectively. These platforms are designed specifically for a particular industry or niche market, offering custom products, integrations, and domain expertise that are not found in general purpose or horizontal software. Some examples include:

• Toast: combines many services needed to run a restaurant, including point of sale, online ordering, and payment processing

• AppFolio: provider of management solutions (accounting, sales, marketing) for real estate companies

• Ironclad: contract management platform for the legal industry

The list goes on and on. Vertical SaaS offers faster implementation, enhanced alignment with workflows, and cheaper growth (as their audience is known, every lead is cheaper). And they increase in stickiness over time. They may start with the basics for their industry - CRM, workflow, and communication capabilities - and include more breadth to their solution over time. Add-on services such as payroll, compliance, and finance can strengthen the relationship with merchant customers, reducing churn and increasing average contract value (ACV) over time. This, in turn, allows merchant customers to better serve their own customers, as the diagram below shows.

Software adoption has been slower in emerging markets, but I predict that trend to change as merchants see the value that software can have on their business. And when that time comes, payment processing infrastructure will be needed. A white label solution can quickly find product-market fit in Latin America and challenge legacy tech. There are several companies currently doing so - such as Kushki in Ecuador and Klar in Mexico - but they focus on mature software companies, leaving plenty of opportunity to serve high-growth SaaS players.

In addition, by taking advantage of new technologies such as near-field communication (NFC) - which turns cell phones into point-of-sale terminals - startups can increase their margins and cut the high cost of hardware that is usually required by incumbents. If you’re building in this space, please don’t hesitate to reach out and connect with me on Twitter.

Of course, we must first educate and democratize access to financial services. According to Forbes, 70% of LatAm’s population remains unbanked, and nearly 60% of point-of-sale purchases are still made in cash. Vexi, a Mexico-based startup, is solving that problem by offering credit cards with non-predatory rates. Providing access to financial services – such as wealth management and fair credit – can help drive economic output and SMB activity.

But offering financial services is not enough - educating customers is equally important. In 2023, I expect new products and offerings to be introduced to engage clients. Onboarding them was just the start; next will be offering 24/7 educational opportunities.

The Enterprise Stack

In the past ten years, much of the progress and money was directed towards consumer facing apps and the front-end of transactions. Venmo is a leading player in P2P payments, Chime is gaining recognition as a distinguished digital bank, and Coinbase is a reliable platform for crypto investments. But the uncertain macro environment will drive a new shift: digital transformation across enterprises. Accounting, treasury, and corporate finance departments continue to rely on outdated processes and workflows. B2B payments are still largely manual and processed through checks, wires, and ACH. Financial reporting and ledger reconciliations are performed in Excel and subject to human error. In a world where success is defined by agility and speed - and a company’s competitive advantage can seemingly evaporate over night -modern software that enables predictive analytics, cross-functional collaboration, and automation can provide value. Ledge is a seed stage startup that offers accounting and bookkeeping services to small businesses. The New York based company uses AI and ML algorithms to automate various accounting tasks, including categorizing transactions, reconciling accounts, and generating financial reports. The software integrates with various accounting and ERP systems, acting as a command center across the finance department. Solutions like this can be vital for managing back-office functions, saving time for CFOs to take on more strategic roles.

Plus, as the ‘growth at all costs’ mindset ends, finance leaders will emphasize operational efficiency and cost control. The era of discipline is upon us, and companies will adopt new tech to better manage their financial health, as opposed to focusing on top line growth. Expect fintechs to support this shift, offering better services for customers to manage cash and working capital, optimize spending, and earn yield on excess cash.

I spoke with a childhood friend last week who previously worked at Truebill, the personal finance and budgeting app acquired by Rocket Mortgage. Truebill analyzes user subscriptions and spending patterns, gathers insights on behavior, and even negotiates better rates for customers. I wonder if a similar solution could work for early-stage startups. I admire every founder, but many have technical backgrounds and lack experience when examining a business with a financial lens. A platform that gives advice for where costs can be reduced - without impacting the core business - could be extremely useful. Bonus points if it allows benchmarking across industries and competitors.

Because to have control over spend, companies first need to have visibility into where costs are incurred and where cash is spent. And that alone may not be enough, as time lags in reporting can falsely portray a company’s liquidity. I picture a future of ERP 2.0 systems - where payments and transactions are recorded in real-time, accounting ledgers are automatically updated, and financial statements are reconciled and prepared. All in real-time and without manual labor, allowing executives to make informed decisions based on the most accurate data available. I have no doubt an infrastructure like this is possible, especially as real-time payments (RTP) become increasingly adopted.

Wealth Management & Personal Finance

Historically, the growth in personal finance companies (e.g. Robinhood, SoFi) has been driven by marketing spend. Startups allocate large sums of capital towards customer acquisition - either through paid ads on FB/Google, or through influencer campaigns. In a world where privacy rules have increased CACs and fundraising is difficult to obtain, this strategy proves too expensive for most startups.

Furthermore, most fintechs have operated in a period of rising equities, low interest rates, and low inflation. Customers are now seeing these trends reverse and realizing it doesn’t take a genius to make money in a bull market. Amidst the uncertainty, retail investors are trading less frequently and handling their assets with caution - this impacts fintechs relying on trading fees, AUM, or payment for order flow.

So in a saturated market, successful companies will be those that leverage new enabling technologies to drive value for customers. There’s massive opportunity to use generative AI and financial APIs to disrupt wealth management and personal finance for millions of people. Imagine a GPT-like model trained on decades of financial information and data points - one that can optimize a portfolio’s Sharpe Ratio and gather research in seconds. Streetbeat is an investment app that leverages AI to analyze financial information, earnings reports, and technical indicators to maximize returns and manage volatility for investors. Streetbeat’s flagship strategy outperformed the S&P 500 by a wide margin last year, and the startup is on a mission to level the playing field for retail investors.

I imagine similar technology can be implemented at the stock exchange level to modernize the trading desk and streamline equity research. Morgan Stanley has already experimented with AI, helping investment professionals dig through detailed analyst reports, social sentiment, and market research in seconds. The use cases for AI in asset management can expand beyond that.

While language models can address some low-hanging fruit, more complex use cases will require a clear regulatory framework and flawless accuracy. When dealing with, for instance, fully automated investment decisions, companies will need to balance these new services with potential skepticism from customers. After all, this is people’s money we are dealing with. And in an industry defined by relationships, there is value in human judgment and trust.

Risk Management: Fraud & Digital Security

Navigating the fintech frontier goes beyond innovation and digital dexterity - it is about keeping bad actors at bay and playing by the rules. According to Plaid, businesses are projected to lose over $300B globally due to digital payment fraud in the next four years. As transactions and banking increasingly move online, the potential for fraud and data theft grows. And given that the financial sector houses a wealth of valuable data, hackers have shown the ability to weaponize this data in more aggressive ways. Fraudsters stole personal identifiable information (PII) from millions of people through pandemic-related scams. They normally wait several years before using stolen identities, giving them time to create synthetic IDs, which are used to open accounts, falsely build credit, and steal funds. This year, I expect much of the stolen PII to be used against financial institutions - and for companies that lack strong internal controls, these attacks will be devastating.

Fortunately, the industry has some weapons of its own. Founders have deployed novel technologies around self-sovereign identity, cryptography, and biometrics in customer onboarding. I also see opportunity in one-stop solutions that leverage AI to automate complex data processes, streamline governance reporting, and gather intelligent analytics. At the transaction level, purpose-built solutions can predict whether an ACH payment is likely to be returned without friction to users. Neuro-ID is a promising platform that does just that - the company has raised $42M since inception and is experiencing rapid growth. I expect similar companies to emerge and offer expansive fraud detection services, even blending into areas like onboarding and credit monitoring. The market is too saturated for narrow-minded tools.

All in all, risk management will make or break fintechs in 2023. Finding ways to build security and trust for consumers is critical - there is too much operational and legal risk otherwise. Given the interconnectivity of the entire ecosystem, this is an area of finance that should be collaborative, not competitive.

Reg Tech & Compliance

As digital services expand, so do the regulations governing them. The financial sector is one of the most regulated industries in the world, but there is still uncertainty around the ‘technology’ aspect, especially as companies becomes globally intertwined. In the past, banks had to establish a connected network of financial institutions to move money across borders. Neobanks can now just turn to payment processors like Stripe or Airwallex, along with banking as a service providers (BaaS) and avoid the complexity of maintaining an entire infrastructure. In other words, it has gotten easier to provide financial services to customers by reducing the time to market.

And this growth has woken up regulators. With the European Union - the ever present guardian of regulatory wisdom - taking on a global role, fintech faces ambiguity and uncertainty. Emerging products and services may not seamlessly align with existing frameworks, and people may question which regulatory bodies have jurisdiction. Each time you venture into a new country, you'll encounter unique rules and regulators who require guidance. While entering individual countries might not be overly demanding (emerging markets often present fewer challenges than established ones), keeping up with evolving regulations can accumulate and become a headache. Many aspects of BaaS, such as technology and product, scale easily. But compliance doesn’t.

This is where regulatory technology plays a role. RegTech aims to streamline compliance processes for businesses, helping reduce operating costs and ensure adherence to changing rules. There’s demand for this because of the nature of the space - compliance is boring manual work, subject to document retention and loads of audit oversight. Any technology automating these tasks will save time and improve the bottom-line. ClauseMatch is a good example - the U.K. based startup is closing this gap in RegTech with smart document management. Through centralized, automated policy and regulatory change solutions, ClauseMatch can help its users take the busy work out of compliance. The platform’s features include an online editor, a regulatory portal, AI-enabled content mapping, and more.

Companies that leverage this technology to automate data processes throughout the lifecycle will separate from the rest. From how data is gathered and checked for quality, security, and compliance, to how it is presented in business intelligence dashboards, automation tools can speed processes, reduce human errors, and increase visibility.

Speaking of visibility, I see potential in expansive Know Your Customer (KYC) and KYB products. For fintechs relying on partner banks for infrastructure, the question of data ownership is an important one. Who is liable for customer oversight, the fintech offering add-on solutions, or the partner bank providing the charter? In 2023, I expect to see more demand for tools that help sponsor banks in dealing with third parties, especially with the Treasury Department and the Office of the Comptroller of the Currency (OCC) breathing down the neck of the BaaS model.

With regulatory scrutiny increasing around bank-fintech partnerships, embedded finance, and more, being compliant will be a key aspect of a company’s success. As non-compliance penalties grow steeper, banks will be increasingly dedicated to upholding the highest compliance and regulatory standards for themselves and their fintech partners. Compliance isn't just a checkbox; it's a key component in protecting consumers and borrowers and preserving a robust financial ecosystem. And the companies that build it into their infrastructure early will have an advantage over those that don’t.

Key Takeaways

There is much more I would like to write about: the impact of FedNow and real time payments, how lending models may change in a rising rate environment, and the potential demand for super apps. Which is why I’ll likely write a second part.

If there is one thing to take from this, it’s that the financial world will no longer be composed of just banks and customers. Through open banking, customers have greater control over where they store their financial data, while being able to quickly transfer it between different organizations or allow third-party providers access to their data when necessary. Meanwhile, embedded finance has made it easier for non-financial businesses to integrate financial products or services into their offerings - we are seeing this with BNPL, Apple Savings, and Elon’s new version of Twitter. These are early signs showing every company will become a fintech company.

“Most companies will become fintech companies in some way, shape, or form.”

Zach Perret, Co-founder & CEO, Plaid

While these advancements allow for infinite levels of customization and personalized offerings for users, 'humanising' banking should remain a priority. We have used AI and automation to build scale and efficiency, but how do we take the technology and keep the human element? In a time where trust is low and many people remain financially illiterate, I hope we keep the human piece that was once the backbone of traditional banking relationships.

I hope some of you found this piece to be insightful and intriguing. As always, please collaborate below or connect with me on Twitter. I’m always happy to have thoughtful conversations with those who want the same.

Cheers for reading.