After a banner year in 2020 and 2021, fintech companies and startups are now feeling the pressure of macroeconomic problems, as many organizations have seen their funding shrink and employee headcount decrease over the last few months.
Challenging economic conditions, including skyrocketing inflation, aggressive monetary tightening by central banks, and a slowing economy, have led investors and venture capitalists to withdraw their excitement from the market, for now at least.
Much like the once-booming tech sector, financial technology has seen its fair share of public and announced staff layoffs throughout the year. During the first half of the year, 4,189 fintech employees were laid off, representing around 11.2% of the more than 46,700 startup employees who were let go during this time.
Fintech, which still managed to enjoy significant growth in 2022, has seen some pushback from portfolio founders and venture capitalists in recent months, as many are now encouraging startups and related establishments to prepare for the worst as a recession looms on the horizon.
A decrease in funding, against the backdrop of employee layoffs, is a sign that conditions have been deteriorating at a faster pace through the later part of the year. During Q3 2022, global funding in fintech fell to $74.5 billion, indicating that some fintech and startups are looking for new ways to cut costs and delay expansion until the economic activity has returned to normality.
Ongoing economic and financial headwinds have created an air of doubt for many investors and VCs, despite a report by The Brainy Insights revealing that the global value of fintech is on track to reach a value of $936 billion by 2030.
While the sector does have some innovative and positive prospects, some underlying risks are often overlooked when investors or venture capitalists look to diversify their portfolios.
Growing Competitive Market
The number of new fintech and startups has grown at a stratospheric rate in recent years, more so during the onset of the pandemic. Financial businesses and traditional financial service providers have in recent times realized the capabilities and opportunities embedded within fintech and have gone to expand their service and product offering to help dominate the market.
Industry leaders such as Visa, Mastercard, and insurance tech company Lemonde, who already enjoy a strong consumer following are not simply changing the pace of financial technology but are now dominant players in the ecosystem.
It could mean that although some smaller startups and organizations are enjoying steady cash flow from investors, the overall success rate or market penetration can easily become deterred by bigger institutional competitors in the long term.
Poor Forward-Looking Strategy
Although the fintech ecosystem has been booming in recent years, disrupting the pace of financial service adoption among developed regions, companies that lack proper guidance and a forward-looking strategy could find themselves being outpaced by larger and more established competitors.
As the opportunities in the marketplace grow, so will the competition to constantly innovate and provide consumers with next-generation financial services. Yes, it’s possible to say that small startups might have the creative drive to push the boundaries of the industry or offer consumers more affordable pricing structures – who’s to say that other corporate giants can’t do the same?
Without a sustainable strategy, fintech will find it increasingly challenging to retain consumers. Even in developing regions where fintech firms are seeing widespread adoption among consumers, it’s only a matter of time before other competitors enter the market on a larger scale than what existing companies can cover.
The Threat of Cybersecurity
According to The State of Email Security Report around 96% of surveyed companies and organizations have been victims and targeted by an email-related phishing attempt. These attacks have resulted in data leaks and business email attacks, leaving companies vulnerable and exposed to financial threats.
As more consumers move online, along with the adoption of fintech products and services, the more there is the possibility of fintech being exposed to cyber-based attacks. Given the nature at which these companies operate, and the frequency of funds being moved and transacted via their online platforms, digital fraud or theft is a direct threat to consumers and the organization.
Though cybersecurity is crucial, it can be expensive for smaller fintech firms to implement. The growing demand for cybersecurity protocols has meant that it has become increasingly expensive to utilize reliable and credible software, something which smaller startups often lack during the early phases of their founding.
Lack of Innovation
Fintech firms are often considered some of the most innovative companies and startups in the digital economy, as it helps to provide ordinary consumers with basic products and financial services an innovative and creative display.
From fast-thinking Artificial Intelligence (AI ) and deep machine learning, fintech can understand consumer needs and financial behavior on a more profound level. This does mean that newer, younger, and lesser-known fintech firms could lack this type of technology that looks to help improve systems, increase customer retention and lead to more innovative products.
In a growing competitive market, it could mean that for some fintech companies that their technology may already be considered outdated, whereas companies that enjoy steady cash flow and funding year-round can constantly innovate and develop newer more advanced services and products.
Investors and VCs will need to consider how fintech is pushing the boundaries with the technology and software they offer consumers. Not only this but how more advanced features will enable the company to grow its competitive influence and provide a more profitable forward-looking strategy.
Economic Cyclicality
Some industries are more sensitive to changing economic activity than others. Cyclicality refers to how businesses operate during times of economic fluctuations such as recessions. As consumers start to pull back on spending, businesses that are sensitive to these types of changes can find it harder to expand or grow.
In the case of financial technology, fintech can often be somewhat cyclical in the sense that if consumers are unable to spend money during a recession or macroeconomic slowdown, the harder it can be for people to pay their bills. This is a common occurrence among credit card issuers who often see a higher number of consumers unable to repay their debt due to slowing economic activity.
Fintech firms that provide these sorts of services will find it a lot harder to continue expanding if consumers are unable to utilize their services. Often traditional financial institutions can provide consumers with more affordable offerings than what newer fintech companies have.
Regulatory Concerns
An aspect of fintech that’s often missed is regulatory expansion, which has, in recent years, taken more form as the industry grows. A good example is the recent collapse of the global crypto trading platform, FTX, which has now sparked lawmakers to further tighten regulations on crypto and digital assets due to the high risk the industry poses to the direct economy.
The problem is not the lack of regulations but rather the pace at which these laws and policies are being changed and updated to accommodate an ever-growing industry. New companies and startups will need to constantly ensure that they are up to date with the most recent regulations and that their business model can accommodate a changing environment.
On top of this, fintech will need to consider how they can operate and expand in regions that have differing regulations, not only for financial services and products but more so in terms of consumer privacy and cybersecurity among others.
It can be hard for startups to keep up with changing regulations, not only in their domestic marketplace but in international territories as well.
The Bottom Line
Fintech provides consumers and businesses with innovative financial solutions that help to push the boundaries of traditional finance and technology at the same pace. Though the market has seen positive growth in the last few years, underlying risks, ranging from marketplace competition, cybersecurity, cyclicality, and regulatory factors, can influence investors and VC preferences.
While it’s important for any investor or venture capitalist to continuously research and monitor the performance of a potential investment opportunity, it’s just as crucial for them to consider the underlying risks that can tarnish fintech innovation and future expansion.
For investors and VCs, it’s often considered desirable to scope out fintech firms that are pushing the boundaries of the industry while at the same time establishing a sustainable business strategy that can help influence the market while proving to have a competitive edge. Fintech companies will continue to be a forward-looking part of the everyday consumer, yet for investors and VCs, these companies can either be a fruitful investment or a wolf disguised in sheep's clothing.
