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Fintech Predictions: 2023
Speculation on the next year of finance and technology
Disclaimer: This is not investment advice. These opinions are mine and mine alone. They do not reflect that of my employer or former employers. Also, I’m definitely going to be wrong on some of these so read them with a healthy dose of skepticism. 😬
I previously wrote about how Fintech recently got wrecked and, while I ended the article rather optimistically, I didn’t elaborate much on specifically which areas of Fintech I think will be exciting in the near and medium term.
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So I wanted to spend today’s article on some predictions of things that I think will be successful in 2023 (and maybe even a little after).
Consensus in Fintech
I find myself often disagreeing with many consensus opinions in Fintech—largely because they are pinned to a current point in time and because both venture capitalists and founders are not immune to whatever is trendy this week (*cough* NFTs *cough*).
A couple of years ago the industry was raving over consumer Neobanks and e-commerce, then B2B fintech/corporate credit cards, and then Web3/Crypto/DeFi. Money 20/20 was, apparently, quite heavily representative of B2B Fintech.
So consumer has gotten a lot less excitement. In the wake of public consumer Fintech companies taking a beating, I understand…but that doesn’t make it rational. It’s worth remembering that all of these B2B companies will need to have a consumer Fintech customer that reaches sufficient scale to make themselves VC worthy.
I think much of current consensus is based on the learnings from the last 2 years of IPOs and acquisitions, which is useful information but the businesses that had successful exits weren’t launched recently so taking the learnings from the exits and applying them to the current selection of startups doesn’t make sense.
To be explicit: the companies that are successful today from an IPO or major acquisition were built years ago under extremely different technology and market conditions—in many cases when no one was paying attention.
So, it seems that the Twitter consensus isn’t very tempered with its thinking, which is good news because that means people are missing out on an opportunity.
Natural question: where’s the opportunity?
Opportunity in Context
To identify opportunity in startups I like to contextualize the company and the macroeconomic environment, which will drive incentives and aggregate consumer behavior.
With respect to the company, it’s important to know: (1) what product offerings exist in the market today, (2) which products are missing or underdeveloped, (3) which products are novel to the target consumer, (3) which products have significant market penetration, and (4) if the company can create barriers to entry in the medium term.
These components will dictate how impactful a startup can be in the face of incumbents.
Then you need to consider the broader macroeconomic environment which, in the near term, means there will be reduced consumer spending, a preference for saving money and investing in lower risk assets, and a rise in consumer delinquencies.
This does not mean that the economy is shutting down but it does mean the aggregate macroeconomic trends will move slower than before.
People will still spend money, just not as much on leisure goods but technology will continue to permeate throughout our society, and there will be growth in many sectors—just not on average.
So with that context, here is my evaluation of some of the areas in Fintech and what I think will have successful business outcomes in the years to come.
Ah, the excitement for Neobanks seems to be dead, which feels rather short-lived.
My honest opinion is that it’s silly for people to pull too far back from them, which effectively represents a direct relationship to the consumer. But in a high interest rate environment where cost of funds provide margin pressure, I certainly understand this reaction. But looking at interchange as the only revenue source is the mistake here.
Neobanks need to innovate because offering a PFM, debit card, or credit card won’t be enough if all you’re doing is adding a different colored UX and some emojis on top of your BaaS provider.
Neobanks that solve a hard problem for their customers (e.g., offering a bank in another language, which is surprisingly challenging) will thrive. Anyone who doesn’t do anything novel will probably explode, unless their marketing is truly legendary (since acquisition costs are notoriously high in Fintech).
In Fintech Reckoning I wrote about how great lending businesses are built during downturns but it really depends on your portfolio mix (because math, lol).
If you’re a new lender with few loans on book or have a short average loan duration and loan size (plus thoughtful underwriting obviously), you’ll be in a great position. But if you have a long loan duration and high average loan size, you will probably be in for some terrible vintages.
If you’re a lender without great distribution, no product novelty, or deposits reducing your cost of funds, I’m skeptical you’ll do very well in this environment.
So the opposite obviously applies; i.e., if you have cheap costs of funds (via deposits and a banking license) or product novelty and utility (e.g., BNPL—note that I have a clear bias here), you’ll probably do well.
Consumer Real Estate
The obvious conclusion is that “interest rates go up, housing go down” is a little too simple in my opinion.
That said, Fintechs in the real-estate business have faced significant pain as interest rates increased, one may argue a little too extreme, but as home prices cool and the economy stabilizes I actually think mortgage buyer activity will start to grow as homes become more affordable from a price perspective (though this means consumers with more cash will have an advantage).
It’s worth remembering that the majority of Americans became priced out1 of homes in the most recent home pricing chaos (heavily driven by investment homes). Middle and lower income groups have seen a strong labor market and increases in wages, which reinforces my belief that they will do better than consensus suggests, so I’m slightly optimistic here and I really hope consumers are able to afford homes as prices finally decrease.
Commercial Neobanks (aka Corporate Cards)
This space was quite exciting before and it will certainly get more competitive but is there an opportunity for new startups? I’m not so sure but I think the market will continue to get competitive for scale-ups (e.g., Ramp, Brex, Mercury) as they look to compete with the giants of the world (e.g., AmEx). So I’m optimistic for the scale-ups but less so for the startups.
One interesting and exciting change about this area is that some of these players (e.g., Ramp) have begun to introduce vertical products that are eating into other parts of the industry (e.g., expense management). This makes me especially optimistic for scale-ups as they continue to innovate against the established behemoths.
Consumer Trading, Investing, and Asset Management
We are in a post-meme stock era and I think that’s probably healthy. Meme-stocks and Reddit’s Wall Street Bets will probably still stir the pot with some occasional chaos in public markets but I imagine traders and quant-shops will incorporate this chaos into their models and that the frequency will be far lower.
Beyond the obvious, retail investors are moving away from equities as rates rise, so my advice to startups working in retail trading is to offer the ability to buy bonds and other low risk assets, because consumers are going to want them. So, while I have been impressed by the innovation in this space, I’m a little more pessimistic because of the current incentives in the market.
Historically collections has been an underfunded area of Fintech but during economic downturns it becomes increasingly important.
To elaborate, as people go delinquent (i.e., don’t repay their loans) lenders have to handle it with some process, this is called collections.
For many lenders it’s often done in-house poorly, or in predatory ways by existing shady third party providers, but TrueAccord (and some places that I’ve worked!) are much more consumer friendly.
TrueAccord gives dignity and control to their customers and offers an incredible service for those managing debt (full disclosure: I’m a proud investor). For those unfamiliar, I highly recommend Packy McCormick’s incredible piece on TrueAccord.
There are two reasons I think this space will be big in the years to come: (1) as mentioned, delinquencies, unfortunately, will increase and consumers will need a way to manage their debt and (2) most of collectors have notoriously lacked compassion when working with consumers in delinquency which means the space is especially ripe for disruption.
Most consumers aren’t taking out loans with the diabolic intention of charging off or going delinquent (outside of fraud of course), they just end up in challenging circumstances and make hard choices about who they can pay back. So empowering the consumer to manage their debt better and increasing repayments is a win-win, so I am optimistic on this space in general and TrueAccord in particular (okay enough plugging).
Two things can be true: (1) there are lots of scams in crypto (*cough* Sam Bankman-Fried *cough*) and (2) there’s a lot of incredible opportunity/innovation in the space.
I’m not an expert in crypto, there are far smarter people that I’ll trust to give insights here but I will say people who think crypto is going to die after the latest fiasco will probably be wrong as that’s a pretty extreme view.
Consumer and Commercial Insurance
The insurance business is great because you end up cash rich as your customers pay their premiums (excluding your reserve requirements), which performs favorably in a high interest rate environment but if you can’t underwrite well you will surely be in a bad place.
Hippo and Lemonade Insurance, like other public Fintechs, have taken a colossal beating in the market.
Hippo operates within the commercial market and Lemonade in the consumer. I spent the early part of my career working at AIG building machine learning models to underwrite commercial businesses and I can say it’s an extremely challenging problem, one I’m not entirely confident Hippo will be able to manage.
I am much more enthusiastic about consumer insurance because the volume of policies and data tend to be higher and the claims tend to be smaller (at least compared to commercial), which lends itself to benefiting significantly from the advances in software and machine learning.
I think startups can be disruptive in commercial insurance too but I’m much more bullish on consumer.
This is a broad space with lots of sub-areas (from payments, core banking, servicing, rules engines, and more) and lots of money recently.
I think so long as each company is able to empower their customers to grow during these turbulent times it will be a successful space. But if their consumers’ business (i.e., the customers of their infrastructure) aren’t thriving it’s unlikely they will too.
So I’m excited for some new companies in the space but skeptical on some of the older players that are notorious for failing to innovate and moving like a sloth.
Plaid, Argyle (disclosure: I’m an investor), Pinwheel, and others will continue to flourish because, in general, you need good data to send money on the internet.
As Alex Johnson excellently pointed out, Fintech needs to aggressively defend itself from fraud. As profitability and sustainable growth becomes a greater focus for the entire industry, fighting fraud becomes increasingly more important (and it’s quite hard!). So I’m especially bullish on this area.
Banks that take this time to double down on technology, acquire startups at bargain prices, and hire top talent looking for stability will do well. I cannot scream this next point loud enough, so let me bold it and italicize it for emphasis.
The world is changing, technology will not go away. Every piece of the banking interaction will be run by some piece of technology and the worse you are at the software, the more likely your customer will churn. Be warned.
Banks holding off on their technology investments will regret it.
Lastly, it really isn’t enough to buy tech startups and try to internalize them and make them good products, you have to invest in the people and culture of innovation. Goldman Sachs did this and pretty much ruined the products they bought (lol).
Some clear word for startups:
If you do not solve a hard problem you will die. The End.
That’s a little dramatic but it’s actually the truth in my opinion. There’s a lot of competition in the market these days and many companies look very similar under the hood, whether it’s from having the same BaaS, underlying data for underwriting, or sharing a bank partner. All of that similarity to me means that the companies are exchangeable and if they’re exchangeable then there’s little incentive for a customer to prefer one company over the other.
Capitalism tends to be unforgiving when companies lack a competitive advantage, which is why I emphasize solving a hard problem. Companies that successfully IPOd in the early 2020’s all focused on and solved hard problems many years ago, which gave them their moat.
Having a provider solve most of your problems for you is great but it means you don’t have a business that is well differentiated and that’s really not sustainable for long term success, so make sure your work is hard! Plus that’s the only work worth doing anyways. 😉
I know it’s a challenging time for many of us working in this area but, as I said before, it’s an exciting time to build. So I’m sending everyone best wishes and I’m rooting for you to launch amazing stuff.
Thanks for reading and Happy Thanksgiving. 🤠 🦃
Happy Turkey Day!
I wanted to take a moment to say thank you to everyone who reads this newsletter. I find it brings me lots of joy to scribble my thoughts down and I’ve received a shocking amount of support from the Fintech community and people that I don’t even know so I wanted to express my gratitude to all of you that read and share this newsletter: sincerely, thank you. I’m blown away by how fast this newsletter has grown. 🙏
Some Recommended Readings
Reggie Young at Fintech Law TLDR wrote a terribly thoughtful piece on the CFPB’s recent Open Banking proposal. I cannot recommend reading it enough.
I cited Alex Johnson’s article above but I wanted to call it out explicitly. He wrote about the Fintech Steroid Era and discussed the recent history of lots of capital incentivizing fraud in consumer banks. As always, it’s just great writing.
Jason Mikula at Fintech Business Weekly covered the latest startup (Tellus) taking on more UDAAP risk than they should as well as Nirvana Money and Stilt’s shutdown 🙁.
Alex Xu wrote a short and intuitive post on how gRPC works, it’s a web framework that has been growing in popularity since Google open sourced it and it’s just so well done (I’m a big fan and I think it’s exceptionally cool).
Ron Shevlin’s Digital Banking Didn’t Kill Bank Branches but Chatbots Will is excellent. A bold and accurate statement “…Digital banking isn’t that good.” Which is implicit in what I’ve tried to say above but I’m optimistic that we can continue to improve it and I think chatbots actually will play a huge role in that. Maybe I’ll go over why chatbots have failed in a separate article.
Did you like this post? Do you have any feedback? Do you have some topics you’d like me to write about? Do you have any ideas how I could make this better? I’d love your feedback!
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Though I will note, if prices fall and we see significant spike in unemployment then the homes will obviously not be affordable.