Looking Ahead: FinTech
The views in this Global Market Outlook report are subject to change at any time based upon market or other conditions and are current as of January 6, 2020. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed.
Before we look ahead to potential 2020 trends in Venture Capital, we believe it would be useful both to quickly review the "why venture capital" question discussed earlier, and then to take a look back at 2019, which was certainly an interesting year for the industry!
On the "Why venture capital" angle, this is a question we have discussed in more depth, but for reader convenience, a few key points include*:
Historically low correlation to equities and fixed income, offering diversification potential in the context of the investor's overall investment portfolio
Even if individual VC investments may be volatile given the nature of the business, the overall early-stage portfolio may still be stable
Given the high growth potential, early-stage may offer an inflation hedge, particularly in a low interest environment
While perceived as risky, VC also has outsized growth potential that is difficult to find with larger stock or fixed income opportunities
In fact, many of the world's largest corporations such as Apple, Google (Alphabet), and Facebook derived large growth from initial VC investment
While we do not focus on nor invest in FinTech at the moment, it is hard to ignore the major traction and media attention the sector has seen in recent years. Some examples include (again, please note each of these could easily merit multiple articles on their own, but our focus here is on a broad overview):
Blockchain: While cryptocurrencies like Bitcoin receive much of the attention, the underlying decentralized technology of blockchain may end up being even more transformative
Online banking: We do not feel traditional banking will disappear overnight, but the rapid, massive rise of companies like Ant Financial (Alipay) shows that this is a market that will only grow over time
Crowdfunding: While traditional funding sources have not gone away and in fact still dominate the market, crowdfunding has emerged as useful tool for many entrepreneurs
Lending: Similar to crowdfunding on the equity side, FinTech has helped democratize lending on the debt side
Blockchain. A full blockchain is well beyond the scope of today's focus, but this is also not an area we can ignore. As mentioned, bitcoin has received and continues to receive much of the media attention, particularly during its meteoric rise in 2017 when it went from trading around $200/BTC, to $2000, to a peak of $18,000. While the price has significantly retraced, it has stayed comfortably over the $3,000 level and is currently trading around $7,000, thus reflecting a market cap over $100B. If we compare this to the public markets, Bitcoin's market cap would be in the top 75 of all companies, which is astounding for a technology released to the public 10 years ago, that has no revenue, and no hard assets. We do not invest in cryptocurrency as the lack of data and underlying value (whether asset or revenue driven) makes it hard to value, but on the latter, there is certainly objective demand for the broad category due to its decentralized nature, and perhaps even more so in an era where central banks play a very active role in the financial marketplace and have kept interest rates low.
With that said, bitcoin is just one part of the broader decentralized technologies under the blockchain technology that uses a distributed rather than centralized ledger. More specifically, each block stores details about the date/time/amount of a given transaction, transaction participants (using a digital signature rather than actual name), and a unique identifying "hash" for each block. With this technology theoretically being applicable to nearly every industry involving multiparty transactions, the applications are immense. The linked Investopedia article provides a great overview that is very easy to understand, with a few key examples outside of cryptocurrency including:
Banking: Rather than being limited to regular banking hours, transactions can be processed continually, allowing for faster settlements
Financials: Similarly, financial instruments could theoretically be processed via blockchain rather than a centralized clearinghouse
Healthcare: As a means to provide safe, secure storage of patient records
Smart contracts: This is a fascinating concept where the contract is automatically carried out only if mutually conditions mutually agreed to are met, for example a security deposit for an apartment rental
Supply chain: This allows companies to track the origin of their products, and even traditional companies like IBM have been involved in the space
Online Banking: Similar to bitcoin, Ant Financials’ Alipay has had a meteoric rise, with over 1.2 billion users in just over 5 years. While still privately held, the company has a valuation around $150B, which when combined with its dominant market position in Asia and rapid growth, makes it a very important market player to watch. Of note, they do not offer solely simple balance inquiries or transfers, but instead a broad range of services such as handling e-commerce for retailers, digital payments, private credit, and business lending. As mentioned, we do not think traditional banking will disappear, but do expect to see even more traditional banks offer more services online to compete for customers.
Crowdfunding: Like our other topics, this could certainly merit a much longer discussion on its own but is certainly worth discussing here. Traditionally, entrepreneurs and small businesses had limited options to raise capital, whether through a bank loan, friends & family, or accredited investors, and often faced onerous regulatory requirements. The 2016 Jumpstart Our Business Startups (JOBS) Act greatly streamlined this. First, it allows companies to raise up to $1MM via crowdfunding, in which many smaller investors pool their resources (we should also note similar yet different platforms like Kickstarter, but with crowdfunding giving equity to investors and Kickstarter being more of a donation platform where donors may receive incentives if goals are met) to help meet the company meet its funding goals. In addition to giving entrepreneurs the ability to find many smaller investors, this also allowed them to target nonaccredited investors (investors defined by a certain threshold of assets or income). Finally, the JOBS Act Regulation A allowed companies to raise up to $50MM without having to register with the SEC. While we certainly want potential investors to conduct proper diligence on any investment regardless of the means of investment, we do believe the greater democratization of the investment process that opens up high-potential growth companies to investment by a broad range of people is a good thing by allowing more people to help fund great companies.
Online Lending: On the debt side of the financial landscape, FinTech has created major opportunities for lenders and borrowers to connect online, rather than borrowers having to borrow from a bank. Lending Club is one particularly interesting example, as they allow for direct peer to peer lending for amounts up to $40,000. By leveraging technology, Lending Club is able to connect lenders with borrowers based on criteria such as loan size, borrower information, credit scores, and loan purpose. The company has facilitated over $54B of loans, with a default rate around 3%, Other examples include Y Combinator alum Avant, which also offers consumer credit cards in addition to online lending, and LendingTree, which can cover areas as large as home and student loans. Further, these companies also aim to offer transparency in borrowing options, rather than being the "take it or leave it" approach that may have been dominant in older years. Like online banking this area was highly concentrated, but FinTech has played an invaluable role in democratizing the process and bringing potential opportunity to more people while also reducing costs.
In summary, while we are not currently focused on FinTech ourselves, we do find it a fascinating area that has the potential to improve people's lives. Whether the decentralized currency via cryptocurrency, crowdfunding, or online lending, FinTech has already showed how it can create positive impact, and the excellent potential benefits of the still-nascent blockchain industry may end up being the most intriguing of all given the broad applications across major areas like medical, financials, legal, and supply chain that affect nearly everyone, especially with the increased transparency and cost savings.