Finding Genius

by Kunal Mehta

  THE FUTURE OF FINANCIAL TECHNOLOGY

  Nitya Rajendran, Tribeca Venture Partners

  SECTION I: INTRO TO FINTECH

  Disruption is a word we hear a lot these days. Netflix is disrupting Hollywood and video content consumption. Airbnb is disrupting travel and hospitality. Amazon is disrupting retail, grocery, cloud storage, and maybe even pharmaceuticals. While not as immediately obvious, finance is another industry that impacts everyone and is undergoing massive disruption. In fact, venture capitalists invested $12.3 billion into US fintech startups in 2018 alone to further fuel this disruption.1

  What’s causing this recent surge of disruption? The short answer: an increasing amount and variety of data coupled with cheaper and more accessible technology. More data enables companies to better understand consumers and market conditions to optimally price their products. Lower technology costs enable companies to extract more insights from their data and empower more of the population to engage with technology and incorporate it into their daily lives.

  Brian Hirsch, a partner at Tribeca Venture Partners whose investments include CommonBond, ShopKeep, and AppNexus, believes that the vast amount of consumer data that companies own has created a shift in the relationships between companies and their consumers. Before globalization and mass markets, banking was localized and largely based on trust and personal relationships. As globalization set in and companies started to reach immense scale, they lost this intimacy because it became impossible to know and track all the nuanced preferences and behaviors of customers across the country and globe. However, in recent years, as data flows more freely and technology is more accessible, businesses have the ability to deeply understand their customers again and reclaim that customer intimacy.

  Due to these shifts in the last decade, the financial industry has witnessed an emergence of startups. The fintech startups that will succeed and survive various economic conditions are those that build themselves up as data-centric from the beginning, build more efficient and accessible technology, and appeal to a new generation of financial consumers through transparency and purpose. However, these traits alone will not be enough — the fintech startups that thrive long term will be those that partner with financial institutions in some capacity to give them scale, data, and financial ammunition. Though not impossible, fintech startups that try to go it alone the entire way will be much more susceptible to falter.

  Opportunity after the 2008 Financial Crisis

  The Atlantic’s “The Never-Ending Foreclosure” profiled the Santillan family, who has felt long-term repercussions of the 2008 financial crisis. They refinanced their home in 2003 and 2004 and took on an adjustable rate mortgage, exposing them to the risk of fluctuating interest rates. During the recession, both parents saw their paychecks decrease while their monthly mortgage payment increased to $3,000 from $1,200. As a result, they began to fall behind on payments and by 2009, they were told they would have to pay nearly $450,000 to keep their house. They lost their home to foreclosure that year. The Santillan family also lost out on economic opportunity as they focused on surviving and trying to find places to live, with the family of six often living in hotel rooms or their car. At the end of 2014, the family was able to rent a single-family home. Their oldest son could not afford college after graduating high school in 2009 and finally enrolled in film school in 2017. Although they are on the path to economic recovery, the Santillan family lost nearly a decade of economic opportunity, an incredibly difficult obstacle to overcome.

  People everywhere felt the recession’s catastrophic impacts in their daily lives, whether with suddenly unemployed family members, houses going under, or less discretionary spending. These scars run deep, leading to distrust and disdain of legacy financial institutions for many, but particularly for millennials who were in their formative years during this period.

  The 2008 financial crisis had disastrous consequences and is still fresh in many people’s minds, if not still a dark presence in their lives. In the first two and a half years after the recession, 55% of those in the labor force found themselves unemployed or with a pay cut or reduced hours.2 By February 2010, 8.8 million jobs had been lost since the pre-recession peak.3 In the year following the crisis, the United States’ stock and home values dipped by trillions of dollars, equating to each US household losing on average approximately $66,200 in stock wealth, $30,300 in real estate value, and nearly $5,800 in income.4

  Following the 2008 recession, the financial industry underwent two major changes: increased regulations and a growing focus on the end consumers’ experience.5 The crisis wiped out many financial institutions and the survivors were increasingly subject to stricter regulations and stress tests. As a result, these surviving institutions turned inward as they were no longer focused on growth but on survival. As The Economist wrote in “A Decade After the Crisis, How Are the World’s Banks Doing?,” “sluggish revenues, combined with the competing demands of supervisors and shareholders, have forced banks to screw down their costs and to think much harder about how best to use scarce resources.” For example, The Economist notes that after Citi spent 20 years dramatically expanding its offerings, it withdrew from many of them post-crisis and re-focused on its primary corporate and investment offerings. Banks also focused on ensuring they were financially sound and could comply with new regulations. Prior to the recession, banks used to conduct their own internal stress tests which would analyze a few thousand data points. Now, banks analyze millions of data points.

  This environment created an opening in which new fintech startups could emerge and scale. When speaking with Brendan Dickinson, a partner at Canaan which has invested in companies such as Lending Club, Ebates, and Instacart, he said, “over the past decade, a lot of incumbents pulled back from the market. It created a great opportunity for lots of new brands to get off the ground where it might have been harder years before.”

  For consumers, the financial crisis led to a massive loss of trust in financial institutions, leading them to be more interested in companies whose core missions more closely resonate with them. The issue of distrust rings especially true for millennials, who have already been through two recessions in their lifetimes. Because of this issue, millennials are open to trying new and different solutions. Fintech startups have recognized this underserved, unsatisfied market and are working to fill the gap. Startups are employing a myriad of strategies to win over millennials and eventually gain their trust, but a few methods are common: sophisticated technology coupled with an intuitive, easy-to-use interface; social networks serving as trusted sources that amplify word of mouth; and a clear social mission. Matt Harris, a partner at Bain Capital Ventures, has invested in fintech for a long time through Bain’s investments, such as Acorns, OpenFin, and SigFig. He told me he has found that people have “a surprising level of willingness to trust new brands that show themselves to be technologically sophisticated and elegant even if they’re unknown brands. People are getting their cues from the app’s design and from referrals. The way trust is manufactured is a little different for a growing segment in the population, primarily youth and the digitally native.” A millennial data scientist echoes Harris’ sentiment, saying “I don’t really care how well known a brand is. If it has the features I need and everyone seems to like it, it will probably be a good option.” However, sometimes the desire for and willingness to try something different can be detrimental to consumers if startups have not followed the proper regulations and do not deserve their customers’ trust (I discuss regulations more in depth later in the chapter.)

  A primary undercurrent propelling the finance industry forward is the “socialization of finance,” which the Goldman Sachs report The Future of Finance Part III: The Socialization of Finance defines as “the impact of technology and changing behavior on the financial services markets.” The report explains that “the financial services industry is becoming increasingly social and democratic as it continues to move online and becomes more au
tomated, at once empowering consumers, disrupting existing banking and credit systems, and creating new markets.”

  Technology coupled with changing consumer behavior is enabling efficiencies in the financial industry, creating an opportunity for fintech startups to build innovative products that reach more people. A wider swath of the market is gaining access to financial tools: people who have subprime credit scores, people whose bank accounts typically would not meet the minimum threshold to be managed by professional wealth managers, and people burdened with high student loans, as examples. In addition, increased amounts of data extend access of financial products to more people. For example, credit card companies can now price products, such as credit card rates, to people with no credit history using alternative data sources that are now available. Brian Hirsch sees the socialization of finance as one of the most important themes in fintech today as he believes that there are “lower income people around the world that don’t have access to the same services that the middle class and wealthy do.” Startups that provide money management solutions or access to capital at reasonable rates offer an immense opportunity to provide financial tools and ultimately more financial freedom and power to more people.

  The Goldman Sachs report suggests that social networks have acted as a catalyst for the socialization of finance as people are actively sharing their financial experiences on social networks, helping fintech startups gain users through significantly lower customer acquisition costs. Additionally, fintech startups are able to scale rapidly and reach many people using social network constructs. For example, Venmo differentiated itself in the world of payments through the social network they built for users. Venmo allows users to pay or request money from contacts and include a note similar to a check’s memo line. Venmo’s primary value proposition is the instantaneous transfer of money, a more efficient solution than writing and cashing checks. Another difference from checks is that users can make these payments public to their network so friends can see who is interacting with whom and what activities they are engaging in based on their payment history. Venmo created a sense of virality through its social platform where friends can see their contacts’ social activity through the previously boring lens of payments. One of the co-founders, Andrew Kortina, told Fast Company that he and co-founder Iqram Magdon-Ismail wanted to “build a version of [a payments service] that feels more like the apps we’re used to using with our friends, like Twitter and Facebook. It became this record of all the things that we were doing — the people we were hanging out with, the places we were going — and it started to look a lot like a news feed. Many think payments are a private thing, but if you think about it, the things you spend money on with friends are: going to restaurants, concerts, ski trips, birthdays. These are the things you would actually talk about the next day over the water cooler at work, so it’s natural people want to share.”6

  The memo line has become a fun, interactive space. Users can write straightforward notes such as “Utilities” but many users write more creative notes, employing emojis or jokes. In the Fast Company piece, Austin Carr suggests that “the social aspect of Venmo makes the services feel more authentic and personal — terms rarely used to describe the payments space.” Or as The Atlantic notes in “Why the Venmo Newsfeed Is the Best Social Network Nobody’s Talking About,” “Due to its incredibly intimate look at how your friends spend their money, the Venmo newsfeed has become one of the most interesting, informative social networks out there. But don’t say that too loud, or you’ll feel like a creep.”

  Sharing financial experiences has become a natural part of consumers’ financial journeys and purchases. The Future of Finance Part III report notes that in a 2015 survey Goldman Sachs conducted, 84% said that reviews of financial tools played a role in their decision-making process. NerdWallet, another post-recession startup, aims to fill the gap of providing transparent evaluations of financial products. According to Inc.’s piece “NerdWallet Weathers Its Growing pains,” NerdWallet’s mission is to be a “curated ‘Yelp for finances,’” with an “approach [that] certainly fits a post-financial crisis world facing demands, particularly from Millennials, for financial transparency.” NerdWallet CEO and Co-Founder Tim Chen founded the company out of his own frustration to try to find unbiased reviews of financial products when trying to help his family members find new credit cards and evaluate mutual funds. NerdWallet seems to have resonated with users as its content and tools received more than 140 million visits in 2018.7

  In addition to post-recession factors, perception of the financial industry has also proven to be essential in boosting its startup ecosystem and attracting talent. The financial industry was not always an attractive market to entrepreneurs, but Matt Harris believes that the 2009 founding of Square changed the game. Harris explains, “Jack Dorsey started Twitter and amazingly, what he decided to do next was a payments company, Square. I think for a whole generation of entrepreneurs and venture capitalists, that made fintech something the cool kids do.” Square’s genesis came from one of Dorsey’s friends, James McKelvey, who was unable to accept credit cards at his faucet studio. Dorsey and McKelvey came up with Square as a way to help merchants seamlessly accept credit cards through a mobile credit card processor and eliminate the middlemen. Square went public in November 2015, six years after its founding, and as of publishing has a $33 billion market capitalization. Seeing an already successful entrepreneur build a huge fintech startup inspired many others to start their own.

  This confluence of post-recession factors has led to a surge of fintech startups in numerous subsectors of the financial industry. Given the breadth of the industry, I will focus on only a few (blockchain is covered in another chapter): student loans, wealth management, and insurance.

  The Emergence of Fintech Startups

  By looking at post-recession startups such as CommonBond and Ellevest (discussed later in this chapter), it is clear that the new class of fintech startups tend to share four characteristics: 1) a technology-first approach; 2) big data as a strategic imperative to better understand customers and run more efficiently; 3) hybrid model combining online automation and the ability to access to humans; and 4) a clear mission that resonates with consumers.

  1) A Technology-First Approach

  Millennials are accustomed to interacting online or on mobile, so companies are meeting customers where they are and striving to create positive online experiences. Shivani Siroya, the CEO and founder of startup Tala, which underwrites loans to consumers not covered by credit bureaus in emerging markets, said she built the Tala app to “meet our customers where they already are. We’re not asking them to meet us in person or through the phone. All the interactions are through digital mechanisms, in-app chat, etc.” As cell phones become the primary way people interact with the web, many startups begin as mobile apps before launching websites. Startups are focusing on design and ease of use, making everything seamless and intuitive for new users. David Klein, CEO and co-founder of student loan refinancing company CommonBond, believes taking a technology-first approach has been incredibly important because, “as technology has continued to improve, it allows you to do things online that you weren’t able to do before or enables you to do things much more quickly than you were able to do before. You can make your products stronger. You can make your customer experience faster and more personalized. Your ability to innovate in general is exponentially higher. And it’s constant.” Employing a technology-first approach enables companies to move many processes online and make them more streamlined, which are beneficial to both companies and their customers.

  2) Big Data as a Strategic Imperative

  This second characteristic is enabled by startups’ strong focus on technology. Fintech startups are employing the latest big data, artificial intelligence, and machine learning technologies to better understand their consumers, predict behavior, and optimize their businesses. Increasing amounts of data to run algorithms on and faster, more accessible techn
ology are pushing artificial intelligence and machine learning forward. The amount of data is growing exponentially and is coming from a wide variety of sources, providing companies the opportunity to analyze customers more fully. For example, robo-advisory startup Betterment tries to understand its customers by taking into account data such as their retirement plans, zip codes, expected growth rate of expenses, social security benefits, spouse’s income, and assets at and outside of Betterment. This data allows Betterment to provide personalized solutions tailored to its users.

  Another example is Tala, which uses alternative data sets to determine consumers’ credit worthiness. Siroya recounted to me that when she worked at the UN and traveled to different countries, she realized “banks in these countries didn’t understand how to assess the risk of customers who did not have credit history. They didn’t understand their daily lives and it was costly to underwrite them. I could prove they were creditworthy through daily life data and create more customized products for this segment.” She built Tala so that it uses behavioral and device data to assess customers’ credit worthiness, such as device type and ID, how users engage with the Tala app, and if they read Tala’s Terms and Conditions. Opening up the types of data Tala can use to evaluate its consumers creates opportunities to build customized loan products for a massively underserved segment of the population. Siroya was also adamant about using transparent, fair data practices, writing on their website, “Tala is committed to fair lending practices that do not discriminate based on gender, race, ethnicity, religion, national origin, or sexual orientation. As such, we shall seek to follow guidelines that ensure that we do not build any features based on these data points and consider and mitigate if possible the implicit algorithmic bias that might arise with regards to these categories.” When employing many data streams and feeding them into machine learning models, potential biases can arise; however, Tala has taken steps to mitigate and eliminate any traces of discrimination in their credit worthiness machine learning models both through the data they ingest and their algorithms.