Fintech Newsletter: June 2019

Fintech’s Cambrian Explosion

542 million years ago, in perhaps the most important evolutionary moment in history, complex biological life emerged in an event known as the Cambrian Explosion. We believe fintech is in the middle of its own “Cambrian Explosion.” For decades, almost all financial services were tightly bundled inside a bank. At the data layer, the only way to have granular access to transactional information was to be a bank. At the services layer, the only way to move money was … to be a bank. And at the product layer, the only way to offer a deposit account was … you guessed it, to be a bank.

That is no longer the case. The basic digital building blocks are now in place so that fintech entrepreneurs can have access to data, services, and products without being a bank. Today, if you want access to transaction data you can integrate it with tools like Plaid and Yodlee. If you want to move money, you can, with Stripe, Dwolla, etc. And now, with new tools like Synapse, if you want to offer products once the exclusive domain of banks—like a deposit account and debit card—banking as a service (BaaS) providers can help you integrate that as well.

This latest development—the unbundling of financial services at the product layer—is very exciting, since it allows entrepreneurs to integrate various building blocks previously unavailable to them to create new financial experiences and products. In short, it marks a rich explosion of complexity in the evolution of fintech—and we will see whole new categories of companies evolve to occupy specific ecological niches in ways the were previous untenable. Welcome to the Cambrian Era of Fintech.

Are ETFs Facing Mass Extinction? (TL;DR: yes, and ESG is kinda the asteroid)

Exchange Trade Funds (ETFs) are the biggest trend in the investing world today—but their rapid ascendency was far from obvious. In the 1980s, the argument that investors would be willing to accept ‘average’ returns was a heresy; surely no one would want to be average! Fast forward to 2019, and most investors feel accepting “average returns” is the smart thing to do. It turns out that paying a professional manager to pick stocks on your behalf, net of fees, more often than not actually underperforms the market. So investing in low fee baskets of stocks that sought to be delightfully average (ETFs) became increasingly popular.

But the things that made ETFs convenient and worthwhile—the expense and time each trade cost—are no longer true today. Trades are essentially free, and can be executed more easily than ever with software. Client demands for ESG, essentially ethical investing (no carbon, no guns, no cigarettes for example) are also creating an increased demand for customization. If you approach your investment advisor today and ask, “Am I invested in oil companies?” that advisor might have to sheepishly acknowledge that yes you are, because you own an ETF that tracks US equities and that ETF includes oil companies, and so sorry, but it’s hard to change, since they don’t control the ETF. In short, tech is now making it increasingly easy for you to have your own basket of individual, customizable stocks for almost nothing—your own personal little ETF. Joshua Levin from OpenInvest calls these customized baskets Dynamic Custom Indices (DCIs), and OpenInvest has created software to allow financial advisors to build bespoke DCIs for their clients.

It’s a little glib to call ESG the asteroid that will kill ETFs, since the story of DCIs is part of a larger one around better automation, lower transaction costs, and lower friction unlocking new products and financial services. But new products are only adopted if consumers want them and in this case, ESG -> ETF -> DCI seems to be a thing that consumers increasingly want.
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Infrastructure goes international

The idea of a single integrated global, seamless financial infrastructure today feels like science fiction. Moving money between accounts you own is hard enough, let alone sending money across borders—which can be a herculean effort. Today, the fragmented, highly local nature of the financial system for consumers is just as true for developers: If you want to develop a global financial application, you very quickly run into the stark realities of geography.

But the same way we are beginning to see early signals that global finance will one day be attainable—Transferwise, for example, makes international transfers doable with your fingertips, from your phone—we are starting to see early signals of global shifts for fintech developers, as well. Before Plaid launched, developers struggled to get data from any bank to verify account ownership. A few years in, they supported only the biggest banks. This March, a full six years after they were founded, Plaid announced coverage for 100% of all banks (as any software developer knows the last 1% is the hardest!), and this month, they announced they will be expanding to now cover UK banks. A thousand little stories like this show the small steps we are taking towards building a better global financial infrastrastructure. Developers (and consumers) should rejoice, but mostly they should get back to work, since there is plenty more to be done.
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Back to the future: the return of community banking

Community banks are getting hammered—their numbers have declined from over 10,000 in 1997, to fewer than 6,000 today. The ones that are left are, well, having to figure some shit out. Meanwhile, as the fintech startup space explodes, those startups need access to regulatory infrastructure (but usually don’t want to become regulated entities themselves). This report from CB Insights link (paywall) describes some of the interesting partnerships that can arise from the meeting place of this existential angst plus the need for access—such as turning them into APIs, with Synapse or Cambr. Through these new partnerships, community banks in turn get access to more deposits, more customers, more business, and more innovation. There’s a karmic beauty to the fact that many of the coming exciting developments in the world of fintech infrastructure might not have been possible without the willingness of small, local banks to experiment.
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