Heading into 2023, the outlook for financial technology (fintech) companies wasn’t especially bright. Rising interest rates and inflation had ended the pre-pandemic era of easy money, making it more difficult for fintech startups to raise capital.
Regulators were pressuring fintechs, particularly in the cryptocurrency space, to adhere to more conventional know-your-customer protocols. And a number of high-profile failures, including the spectacular implosion of Sam Bankman-Fried’s FTX crypto exchange, were making investors nervous. Then, in March 2023, the collapse of Silicon Valley Bank sent shivers of dread throughout the entire tech sector.
These converging factors generated a considerable amount of skepticism about the future of fintechs, particularly among under-capitalized startups. A brutal market shakeout was inevitable, the thinking went, and — in the great Darwinian tradition of entrepreneurial capitalism — only the strongest would survive.
Have these fears about fintech’s future materialized?
Looking back, it’s apparent that some skepticism about fintechs was warranted, but the situation heading into 2024 isn’t nearly as dire as many had predicted. In fact, some indicators are quite promising.
A funding rebound?
First, it is true that overall funding for fintechs has cratered, but signs of a turnaround are starting to emerge.
According to KPMG, overall global funding activity for fintechs — including venture capital (VC), private equity, and mergers & acquisitions (M&A) fell to $17.9 billion in Q2 2023, from $34.5 billion in Q1 2023 and down from its peak of $103.2 billion at the beginning of 2022. Also, global M&A activity also dropped to a paltry $2.8 billion in Q2 2023 from $21.2 billion in Q1 2023. During the same period, however, VC funding appeared to be rebounding (from a low of $11.9 billion in Q4 2022 to $14.8 billion in Q2 2023) — so it’s not all bad news.
The fundamentals of failure
And yes, there have been a number of high-profile failures in the fintech space over the past couple of years. Among them:
- CommonBond — A student-loan lending service that saw its core business crumble during the pandemic
- Ribbon — An all-cash real-estate service hit by rising mortgage interest rates; acquired by EasyKnoc
- Fast — An online checkout provider that burned through its funding too quickly
- Nuri — A German neobank that fell along with the collapse of crypto
- Bank North — A United Kingdom neobank that ran out of funding
- LendUP — A loan service that was shut down for “repeatedly lying and illegally cheating customers,” according to regulators
- Plastiq — A banking-as-service provider tied to the Silicon Valley Bank collapse
- Rize — Another banking-as-service provider acquired by regional bank Fifth Third
- Daylight — A digital bank serving the LGBTQ community
Dozens of other fintechs have called it quits as well, but it’s worth exploring why so many have failed before making any grand generalizations about the overall health of the fintech market.
Indeed, failing fintechs tend to succumb to one or more of the following forces:
- Financing issues — Capital drain due to investor pullback, higher interest rates, poor management, an inferior product, inability to grow, or some combination thereof
- Regulatory hurdles — Lack of attention to compliance and other regulatory issues
- Saturated markets — The product itself isn’t unique enough to differentiate it from competitors offering similar services
- Poor data security — Operations compromised by inadequate security and control measures, eroding customer confidence and allowing possible breaches
- Not enough customers — Projected customer base fails to materialize, calling all valuations and growth assumptions into question
- No clear path to profitability — Good idea maybe, but a bad business plan
- Staffing issues — Inability to hire enough people with the skills necessary for the product to succeed
- Poor execution — The product itself does not work as advertised or expected
- Pandemic fever — Many startups that counted on low-interest financing during the pandemic saw their business models crumble as interest rates rose
Half-empty or half-full?
Now, according to the Wall Street Journal, 75% of venture-backed fintechs eventually fail no matter what, so there is a certain amount of built-in churn in this space. Success also looks different for different companies. After all, there are many types of fintechs — such as neobanks, e-money services, digital wallets, banking-as-services, stock-trading apps, as well as those serving various sectors like insurance, regulatory, lending, payments, wealth management, personal financial management, and more. Lumping them all together as fintechs does not do the overall sector much justice.
In the current economic environment, for example, many payment and insurance fintechs (such as PayPal, Kin Insurance, or Sure) are holding their own, while some involved in real estate and wealth management are indeed struggling. But even within the spaces that are struggling, pockets of resilience can be found. For example, Altruist, a California-based fintech startup in the wealth management area that provides analysis software to financial advisers, has seen nothing but solid growth since its founding in 2019.
The brighter side of fintech
Overall, what’s really happening to fintechs going into 2024 is that the return of higher interest rates, inflation, and greater investor scrutiny has re-introduced the overheated fintech sector to some uncomfortable market realities — ones that don’t support wild bets and hopeful speculation. Of course, this leaves the door open for fintech solutions that have a compelling product story, meaningful differentiation from competitors, an identifiable market segment, and, most important of all, a realistic path to profitability.
The market’s new normal has also spurred a great deal of re-positioning and innovation. Faced with consumer markets that are too competitive, for example, some fintechs are pivoting to enterprise or business-to-business services. Others are scrambling to figure out how they can incorporate generative artificial intelligence (AI) capabilities into their products, or invent new products based around AI. And those fintechs that are partnering with more established financial institutions are successfully insulating themselves against the risks of going it alone, and even flailing fintechs that get acquired are finding new life under the umbrella of their parent companies.
So, the truth is that yes, some fintech froth has been skimmed over the past couple of years, but those fintechs built on solid fundamentals — as with any other business model — are weathering the storm just fine and have plenty of reasons to be optimistic in 2024.