9 August 2022

The Rise Of Fintech 3.0

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For the past decade, the financial services sector has made great strides toward innovation. We have seen technologies move more services to digital channels. Artificial intelligence and smart algorithms today power services ranging from robo-advisors that nudge consumers toward better financial behaviors to analytics that help retirees withdraw their nest egg more effectively—and everything in between.

While this period—which I call Fintech 2.0—has immensely benefited people all over the world, helping them connect to the digital economy and improve their financial health, a lot of the innovation we have witnessed so far has been incremental. In other words, they have been more on the “fin” side of the house than on the “tech” side. In practice, this Fintech 2.0 approach mostly repackages a financial service in a way that improves usability, such as adding a behavioral economics aspect to it, for example—or functionality, by integrating a service that was previously siloed into a seamless flow.

Don’t get me wrong; there are exceptions. Many “digitally native” fintech startups have delivered nicely on their goals and disrupted traditional players successfully. For example, some clever entrepreneurs found out that nonfinancial data can be more predictive than past financial data to risk-assess consumers—powering big FI and changing how credit scoring works everywhere.

But for most of those who are in the business of incremental innovation, the hype seems to be ending. Recent consolidations, lower valuations and scarcer capital mean that several Fintech 2.0 are scaling back, laying off staff or shutting down altogether.

Big FI Is Still Winning 

One of the reasons why Fintech 2.0’s allure is fading is that big FI is still winning. Despite some disruption here and there, large firms still enjoy well-established relationships with their customers and deep regulatory clout. Additionally, because a lot of the innovation happens at the edge of their businesses, they continue to maintain and profit from core services. This, in turn, allows them to more frequently than not grow by partnering, acquiring or building solutions in-house following another innovator’s blueprint. All of this is relegating more and more Fintech 2.0-type solutions into the commodity category instead of the compelling innovation one.

More Tech Than “Fin” 

The rise of what I like to call Fintech 3.0 will spotlight those platforms that effectively leverage major technological shifts to expand the market, enhance use cases—and break off from legacy technologies that have reached their limits. The shift to software-defined trust (SDT) is a good example.

Up until now, Fintech 2.0 solutions have relied on hardware to secure sensitive data and authenticate whoever needs access to it. This has kept the market shackled to costly, slow-moving infrastructure anchored on security chips—like the ones you see on your payment card, inside your phone and on the terminals and dongles merchants use to accept digital payments. Replacing this antiquated model, which is susceptible to shortages like the one we are facing today, with a software-based model can motion the market to a renewed period of innovation and expanded gains—a space ripe for more tech than “fin.”

The big push to tap-to-pay by the card networks, which focuses on devaluing and ultimately removing this anchor at the endpoint, and the entry of Apple into this space—which never does anything casually—is writing on the wall that we are entering a new era in the financial services space.

A New And Improved Anchor 

While Apple’s payment acceptance efforts seem to be moving forward despite renewed regulatory scrutiny, one cannot but wonder what Samsung’s next step will be. I predict that very soon Samsung will find a new way to join in on the fun—I say “new” because Samsung was one of the early investors in Mobeewave, the startup that Apple snagged to create its own tap-to-pay solution. I believe they will probably build their own solution to compete with Apple for the payments’ acceptance market—and with device prices way lower than Apple’s, they might as well have an advantage.

What nobody is talking about, however, is that these efforts are just a new and improved anchor. While Mobeewave’s solution attracted both heavy hitters, its technology is still grounded on hardware—a chip inside the device houses the logic needed to process a transaction. In Apple’s case, this is a solution available only on phones and not even all models.

While a good nudge for the softPOS industry, these types of solutions are not a leap forward, but a sidestep that transfers endpoint control from one device maker (the payment terminal manufacturer) to another (the phone manufacturer). Heck, in the backend, banks still use big boxes called hardware security modules to hold keys. The real leap will only come from replacing these last hardware bastions with software.

By no means getting to Fintech 3.0 will be an easy undertaking. I should know, MagicCube’s software-defined trust environment took several years to develop and prove. Getting certified by the necessary industry bodies seemed never-ending because the standards and financial regulations don’t move at the same pace as technology innovation. Even when entrepreneurs overcome these hurdles, being a category-creating business means being met with skepticism on the daily.

Nonetheless, transformational innovations win in the end: Look at what happened to the EMV chip or NFC. In the words of Victor Hugo, “Nothing else in the world... not all the armies... is so powerful as an idea whose time has come.”

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