Fintech, the (faintly uncool) term for financial technology, is booming these days. But it’s wrong to think of fintech as a single sector. There are two very distinct types of fintech innovation that entrepreneurs, consumers, investors and regulators need to be able to tell apart.
To understand the distinction, it’s helpful to take a look at venture-backed innovation in general. Modern venture investing has its roots in two very different kinds of businesses: computer technology businesses and health-science businesses (stereotypically, drug development).
What those two businesses have in common is massive scalability once an effective solution is found. But where those two businesses look incredibly different are their development life cycles. Part of that is regulation — health science is heavily regulated; software generally isn’t. But there’s a much deeper distinction — the role of time in the product.
Particularly when dealing with software, when a computerized product works, it works fast. Emails get sent, documents get saved, data gets analyzed, chats get snapped, machines get learned… Computers can respond within a single Bergsonian moment — the passage of time isn’t an intrinsic part of the user experience.
Medicine is different. There, the passage of time is core to the product experience. Health is intrinsically intertemporal; weeks, months or years are needed to fully gauge the impact of a course of treatment on a patient. As a result, the product development life cycle is necessarily extended, with accompanying effects on business life cycles.
Upfront investment amounts have to be larger, earn-back periods have to be longer. And that makes sense — it would be hard for a biotech startup to declare victory anywhere as quickly as a software startup might (which isn’t to say markets don’t jump to conclusions).
These two models can be applied to fintech, or really finance in general, in a very natural way. Finance is about transporting value, and that can either be transactional (i.e., payments, settlements and exchanges, including the provision of data) or intertemporal (i.e., investment, insurance and borrowing).
Transactional finance is about enabling or facilitating value exchanges between parties and has been the site of fintech’s earliest and clearest victories. Transactional innovations meet their users’ needs immediately, often with very transparent benefits over incumbent business models. Once the innovation was the credit card; now it’s PayPal, Stripe and other payment solutions (and even bitcoin, as far as that has gone).
Marketplaces emerged, from eBay to electronic securities trading: Mint.com, Yodlee, Addepar and other data innovators — even the Bloomberg terminal. It shouldn’t be surprising that some of the more software-like financial innovations have been relatively quick to establish an advantage over the traditional way of doing business.
In contrast, intertemporal finance is about moving value across time. (And that’s usually where financial risk gets taken.) Savers invest now in order to retire later. Borrowers spend money now but have to service their debt into the future. Insured parties buy policies now to manage risk later.
There is a terrible danger when intertemporal finance gets mistaken for transactional finance.
But innovations in intertemporal finance take longer to prove their value to users, just as it takes a while for clinical trials to validate the value of a new medical compound. Do the savers get to retire? Do the borrowers pay back their debt? Are the insured protected from risk? As a result, these types of businesses frequently require more resources to build. That said, that’s where some pretty large rewards lie for both innovators and society; investing, financing, capital markets and insurance are some of the largest markets in modern commerce.
There is, however, a terrible danger when intertemporal finance gets mistaken for transactional finance, and transaction volume overshadows the final outcome. This is essentially the underlying story of every financial crisis, large or small. In the subprime crisis, I saw firsthand how mortgage originations and securities issuance overshadowed the final outcomes for the borrower or the mortgage owner. In the late-1990s tech bubble, IPOs overshadowed the prospects of the offered companies. In the Savings & Loan crisis, balance-sheet growth overshadowed balance-sheet soundness.
So what’s the point? Here are three takeaways for anyone involved with an “intertemporal” fintech venture.
Know What Success Looks Like
Is it fair to judge Stripe by its transaction volume? Absolutely. Is it right to judge peer-to-peer lenders by their origination volume or roboadvisors by new customers onboarded? Not really. Like a newly discovered drug compound, the real benefits of these innovations need to prove out over time. “Loans funded” or “assets under management” might be business milestones, but they’re not success. Success might look a bit more like “minimal borrower defaults” or “client returns over the cycle.”
Ugly things happen when you’re keeping your eye on the wrong ball.
Frustratingly for today’s startup zeitgeist, those measures resist easy quantification as weekly KPIs, but ugly things happen when you’re keeping your eye on the wrong ball. It’s hard to imagine now, but there was a time (2006?) when it was thought Bear Stearns and Merrill Lynch might leave Wells Fargo and Chase straggling behind, given the growth they were achieving in the structured finance market. No need to finish that comparison.
Actually, Growth Isn’t King
Obviously, growth is key to great business outcomes. But biotech investors looking at pre-clinical ventures have to focus on other things. The team. The science. The need. So when looking at fintech innovation that needs time to show its value, those criteria have to be just as important as early growth rates.
Just Because You Can Do It, Doesn’t Mean You Should
Some industries, like payments, are largely regulated today for compliance and interoperability reasons. In contrast, healthcare, investing, insurance and lending are heavily regulated for a different reason. That reason is because it’s awfully hard for users to know what’s best for them because it may be months or years before a patient or client or borrower can understand the consequences of their choices.
So there, regulations exist to provide protections. But regulations are deeply imperfect. On one hand, they can stifle innovation. But on the other end of the spectrum, weaknesses in the regulations can permit problems to slip through — witness the approval of Vioxx or the horrific outcomes of day traders in foreign exchange (technically not a security). So the onus is on those of us building innovations to consider the full implications of what we’re doing, not just to satisfy regulators or fit a marketing story.
When those innovations earn their stripes — and I’m confident many of today’s “intertemporal” financial innovations will — the benefits will be significant. But participants have to remember that not every fintech business should be modeled on a software business, and for financial products that benefit from “clinical trials,” there’s just as much to learn from health-science innovation (and venture investing).