Google the term “fintech bubble” and you’ll find a slew of recent articles on the topic with titles like:
- Is the fintech bubble bursting? This Financial Times article discounts the likelihood that we’re in the “midst of peak fintech-mania” be citing data from The Disruption House that shows that “after a huge increase in the number of fintech start-ups founded between 2004 and 2015, there has since been a rapid decline from 390 in 2015 to just 71 in 2018.”
- Fintech Bubble Implodes And Nobody Even Noticed. Referencing the Financial Times article, Zero Hedge write “FT makes an intriguing point that the problem for fintechs is that anything they can do; traditional banks can copy, and can throw more resources at. And with that being said, it seems that another bubble has imploded, and barely anyone has noticed.”
- The Fintech Bubble Floats Toward a $64 Billion Pin. This Washington Post article references a study commissioned by Stripe that estimate the potential hit to overall economic activity from new Payments Services Directive (PSD) regulations at 57 billion euros (or $64 billion).
These examples of fintech bubble babble contain questionable assumptions:
- The FT article’s data source only looked at capital market—not retail—startups, making the claim of a downturn in startups suspect.
- Zero Hedge’s claim that “traditional banks can copy anything fintech startups do” lacked concrete examples, and the claim that an exploded bubble has gone “unnoticed” is hardly true.
- The Stripe-sponsored study has nothing to do with a fintech bubble.
How Can We Talk About Something Without Agreeing on its Definition?
The blurbs from the articles cited above should lead a rational person to ask: “Are those people all talking about the same thing?”
At the root of the issue is a lack of common definition of what a “bubble” is. According to Investopedia, a financial bubble is:
“An economic cycle characterized by the rapid escalation of asset prices created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior. When no more investors are willing to buy at the elevated price, a massive sell-off occurs, causing the bubble to deflate.”
By Definition, There is a Bubble
By virtue of the first part of the definition—an “escalation of asset prices created by a surge in asset prices unwarranted by the fundamentals of the asset”—there is a bubble.
To the question How does an early-stage investor value a startup? Seedcamp responds:
“When an early stage investor is trying to determine what [an] appropriate valuation should be, he basically gauges the likely exit size for a company of its type within the industry, and then judges how much equity his fund should have in the company to reach his return on investment goal, relative to the amount of money he put into the company throughout the company’s lifetime.”
In other words, pre-IPO fintech valuations have nothing to do with the “fundamentals of the asset.” Therefore, there is a fintech bubble.
By Definition, There is No Bubble
But wait. Another part of the definition refers to a surge in asset prices driven by “exuberant market behavior.” And the latter part of the definition talks about “…a massive sell-off, causing the bubble to deflate.”
There is no “exuberant” market behavior because there is no market for pre-IPO fintechs (unless we’re talking about VCs as the “market,” because they’re the only ones in it).
And there’s clearly no sell-off because, well, there’s nothing to sell—practically none of the highly-valued fintechs have gone to IPO.
And it doesn’t appear that the industry is moving in that direction. A Seeking Alpha article titled Why Fintech May Not Be Fit For Public Consumption stated:
“The year 2019 seems set to be a record-setting one for venture capitalist exit value capture by means of tech IPOs. But fintech doesn’t seem to be a part of this picture. [As] Pitchbook says, ‘not one of the most valuable fintech companies in the world seems particularly close to an offering.’ ”
Nothing to sell = no sell-off = no bubble.
Forget the Definition: The Case For a Bubble
Forgetting the definition for a moment, the underlying question surrounding the bubble babble is whether or not the industry should be optimistic about fintech startup prospects (irrespective of certain firms’ valuations).
A pessimistic view would hold that the prospects for future fintech investment is limited. There is a case to be made there.
Challenger banks, while boasting of large numbers of customers, have revenue, profitability, and sustainability challenges of their own. For example, as I wrote in The Warning Signs Ahead For Chime:
“Chime’s success has been predominantly with lower-income consumers. While these consumers are drawn by early wage access and no fees, that leaves the challenger bank with a challenge of its own–how to make money.”
With trading fees at zero, where’s the opportunity for another fintech brokerage (or robo-advisor) to come into the market? Most of the ones already launched are making a bee line into banking. Good luck with that.
And in the lending space, prospects for an economic downturn don’t bode well for new lending fintechs in the market—unless, of course, they don’t care about the profitability of their loans.
Finding Good Fintech Opportunities
Ignore the pessimistic view. Dismissing opportunities for further fintech investment is short-sighted.
The reason can best be understood by recalling the words of Amazon CEO Jeff Bezos: “Your margin is my opportunity.”
The margin opportunity in banking today isn’t necessarily coming up with a “better” bank, but instead, helping to improve banks’ profitability. Opportunities for fintech startups abound within banks’:
- Business functions. Functions like fraud and risk management, account opening, marketing, small business banking, payment processing, and commercial lending are ripe for new players who can attack the economics (i.e., margins) of the current technology providers in those areas.
- IT departments. Opportunities for fintech startups abound regarding core applications, cloud computing (and the migration to it), API development and deployment, and other areas.
Bottom line: While an argument can be constructed that we’re living in a fintech bubble, don’t believe it. Opportunities for fintech disruption abound—but maybe not in the obvious places.