Welcome to my series on fintech’s evolving role in finance! If you missed part one, you can find it here.
Fintech is tangibly changing the industry, through new payment systems, new financing methodologies, and changes in asset allocation. I’ll discuss the issues and uncertainties of these innovations, their potential for disruption, as well as how the industry is presently adapting to them.
New financial technologies, and the companies that produce them, are rapidly reimagining finance, and one major development is the emergence of new payment systems. PayPal, launched in the 1990s to provide a payment system for online purchases, was incredibly innovative for its time, and serves as an early example of fintech’s disruption of traditional payment systems. Since then, new payment systems have emerged, such as payment by mobile smartphones, digital wallets and pre-funded eMoney. Key players currently reshaping payment systems include M-Pesa by Vodafone, Apple Pay, and Alipay by Alibaba. Apple’s upcoming iOS 11 update will allow users to send money directly through iMessage.1 These are just a few of the ways financial technologies are impacting payment systems.
Cryptocurrencies, like Bitcoin, are also disrupting payment systems. These currencies use blockchain technology to combine a number of mathematical and cryptographic techniques to maintain a database between multiple participants without the need for third party validation or reconciliation, effecting a secure and distributed ledger. Cryptocurrencies can be used for international payments and trading; transfer, clearing and settlement of digital assets without the need for an intermediary (like a clearing house); and automatic execution of “smart contracts” once pre-agreed upon conditions have been met. A number of consortia, namely R3 Corda, Ethereum, and Digital Asset Holdings (DAH), as well as the Linux Foundation’s open-source project Hyperledger, have emerged to explore these capabilities.
“Cryptocurrencies use blockchain technology to combine a number of mathematical and cryptographic techniques to maintain a database between multiple participants without the need for third party validation or reconciliation, effecting a secure and distributed ledger.”
Firm financing has also radically changed. Crowdfunding through online platforms allows individuals and businesses to lend and borrow between each other or invest in the capital of companies (private equity). There are over one hundred lending platforms in the US alone, such as Lending Club, Prosper, Funding Circle, OnDeck, Avant, Kabbage, SoFi, Square, etc. With lending innovation, alternative credit models have emerged, including automated loan approvals.
Fintech is also upsetting traditional modes of financial advisory and portfolio management, essentially changing the conventional customer relationship as we know it. Robo-advisors, companies offering automated investment advice, use algorithms to place investments into various buckets, usually low-cost ETFs. In return, the platform charges a management fee plus fund expenses. The platform routinely rebalances the portfolio to stay in-line with set allocations and can offer other services, like automatic tax loss harvesting. Robo-advisors present a huge potential for investment; some notable companies include Wealthfront, FundShop, Marie Quantier, Yomoni, and WeSave.
“Fintech is upsetting traditional modes of financial advisory and portfolio management, essentially changing the conventional customer relationship as we know it.”
New technologies come with new risks and uncertainties. Fintech poses new cybersecurity risks, such as the threat of infiltration of payment and settlement systems as well as the theft of identities and financial information. Cryptocurrencies can, and have been, used to support criminal activity through identity concealment. The field of risk management needs to evolve in conjunction with fintech.
“Fintech poses new cybersecurity risks, such as the threat of infiltration of payment and settlement systems as well as the theft of identities and financial information.”
Banks have responded to the challenge by creating new C-positions (i.e. Chief Digital Officer, Chief Data Officer, Chief Information Officer, etc.) and by developing new partnerships with fintech companies. In 2015, robo-advisor FutureAdvisor announced its agreement to be acquired by BlackRock, the world’s largest asset manager.2 Not only does fintech pose a challenge for industry leaders, fintech also raises conduct and public policy issues, like questions of client suitability, Anti-money Laundering (AML), and Combating the Financing of Terrorism (CFT). The twin imperative of inclusion and increased competition point to the value of “digital identities”; biometrics and cryptography are being used to validate customer identities.
Fintech is reforming the financial industry, most notably by reshaping long-established payment systems, financing methodologies and the conventional company-client relationship through the development of digital wallets, cryptocurrencies, peer-to-peer lending and robo-advisory. Forward-thinking industry leaders and legislators are already adapting. To stay abreast of these developments, aspiring financiers need to learn new skills - which we’ll explore in the next part of this series.