After the fintech bloodbath – what comes next?

The last eighteen months have seen fintechs and blockchain companies take a hammering. As the dust settles, Managing Editor James Wood asks what comes next.

 After the fintech bloodbath – what next?

First, the stark facts. Last year, funding for fintechs fell by a third to $63 billion world-wide, according to Standard and Poors.

Of this $63 billion, there was a massive deceleration from October to the end of 2022, with just $8 billion of new money invested in fintechs in the last quarter.

This slowdown has hit the whole industry.

Massive layoffs in London, New York, Silicon Valley and elsewhere; and a concomitant drop in the number of investment bankers, intermediaries and other professionals servicing the sector.

One senior banker speaking off the record told Payments Cards & Mobile at the end of June that, “they are still cutting fat and not muscle … we’re still above our 2019 headcount.

To be frank, we were expecting things to be worse.”

As we’ll see later, their hunch may be right – but any fintechs looking for new money will have a whole circus-full of new hoops to jump through.

For all that, some of the cuts we’ve seen so far have been dramatic.

Swedish neobank Juni laid off a third of its staff just weeks after raising $206 million last autumn, while international corporate card company Brex laid off 11 percent of staff and one-time investor darling Klarna has seen its valuation plummet by 80 percent and suffer two rounds of lay-offs.

Industry commentator Chris Skinner says, “We’ve seen very heady times, such that some companies became unicorns with no substance. For years, the valuations of fintech firms have been a little bit mad, to be frank.”

And so far in 2023, the beat goes on.

According to layoffs.fyi, a financial industry job-cutting tracker, 212,000 jobs have been lost in global finance so far this year, with the bulk of these losses in fintech-heavy areas such as New York, LA, San Francisco and London.

Where are we now?

Getting to an understanding of where fintech stands today isn’t easy – firstly because we’ve seen the reversal of a trend towards fintech which has been around for almost fifteen years.

But the rapid change in macroeconomic conditions hasn’t helped the sector either.

Rising interest rates and soaring inflation have made some categories of fintech less attractive as investment propositions – especially buy-now-pay-later (BNPL) and the online mortgage sector, both of which now face rising costs and potentially higher default rates.

Likewise, companies that relied on people having spare cash to invest, such as the crypto exchanges and Robinhood.com, are also likely to suffer as trading volumes collapse.

As long ago as 2019, a survey from Banking Circle said that more than a third of fintechs were focused on payments.

As the current investment cycle comes to a firey close and we look to the future, we should not expect that focus to continue.

One school of thought suggests we’re seeing a “dot com” moment, in which overinvested propositions crash and burn, leaving a few survivors to hoover up market share.

However, other industry experts don’t see it that way. Prakash Pattni, Global Financial Services Lead at IBM, isn’t wholly on-board with the dot com analogy.

“It feels different to the dot com era: things aren’t as hyped”, he told Payments Cards & Mobile.

“To start with, we’ve seen a lot of new technologies appear since the start of the fintech cycle: smart phones, 5G data networks and blockchain have all emerged since 2010.

And although payments has been a huge draw, more recently it seems to have gone quiet on that front.”

What happens next?

Pattni sees a number of vectors manifesting as we roll into a new investment cycle.

The first – unsurprisingly – is a toughening of investor conditions. “Investor rigour when it comes to examining propositions has definitely gone up a notch”, he says.

“Investors are making subsequent rounds contingent on customer sign-ups and other metrics.”

By itself, this represents quite a change from the former lassitude by which companies such as N26 could airily declare that “profitability isn’t necessarily one of our key metrics”, and stories of companies burning through their capital four times faster than they were making income would reach this correspondent from the bars and pubs of London.

Something we can expect to see is an increase in mergers and acquisitions as investors with cash to spare look to snap up good propositions at low valuations and founders look to salvage value from their operations.

There are signs that this is already happening: Edgar, Dunn and Company report that a third of the fintech deal flow seen in the first half of 2023 has been in the B2B payments sector – in other words, the automation of back-office functions.

Meanwhile, dealroom.com say the total number of fintech exits edged down only marginally in Q1 2023 and is expected to stay flat or rebound slightly in Q2.

Most recently, Visa’s purchase of Brazilian fintech Pismo for a billion dollars at the end of June 2023 was a signal that the bad times may be stabilising after more than a year of negatives.

In sum, we’re going to see massive consolidation in the industry, expressed through wide-ranging M&A in 2023 and 2024.

Backing winners

When it comes to banking infrastructure, debate has focused not around banks should modernise their systems – they have to – but whether this should be a step-by-step approach or a “rip and replace” change.

Conventional wisdom says the longer a bank waits to replace its infrastructure, the more outdated it becomes – and that full-on replacements are the only option for those who stall too long.

However, IBM’s Pattni disagrees, saying the gradual modernisation of banking processes is now a lower-risk and often more rapid means of getting to digital than the “rip and replace” method.

As a result, we can expect fintechs that focus on fast API integrations, multi-cloud and hybrid cloud solutions to flourish in what we might call “fintech 2.0.”

Artificial Intelligence as applied to payments is another area of serious interest. In particular, AI’s role in protecting data and securing transactions seems to hold a lot of promise, even if some CEOs Payments Cards & Mobile spoke to have expressed doubts about the real value of AI as applied to fraud – chiefly because by the time a system learns to identify one form of fraud, criminals have moved on to exploit a different weakness.

Finally, there’s the intriguing area of partnerships that help grow revenue – whether that’s API integrators enabling travel companies to sell insurance, or the wide range of open banking plays coming on-stream in parts of Europe that let supermarkets, telcos and utilities companies offer financial products.

This is an interesting area, not least because it’s the most complex to pull off.

While there’s no doubt banks need to improve their tech stacks and firms of all sizes want to cut the cost and time of paperwork, investing in new revenue streams in a challenging environment also makes sense – but it might be a harder sell.

What happens next?

If we’re currently still in a time of lay-offs, consolidating M&A activity and raised investor expectations, then there are faint signs of better times ahead.

While no-one should expect investors to suddenly become easy to deal with, D.A. Davidson’s 2023 edition of “The Fintech Herd” shows record amounts of private capital ready to be invested, with the amount looking for new opportunities down only slightly between 2022 and 2023.

The Davidson report also records that the number of fintech initial public offerings (IPOs) waiting for the right market conditions has never been higher than in January 2023.

At some point these firms will either do their IPO or merge with other players – another sign of necessary consolidation in the fintech sector after more than a decade of heady expansion.

That said, Davidson themselves caution against too much optimism, soberly noting that “profitable companies with scale and an established, proven proposition will be more attractive both to investors and to the wider public market.”

In other words, the days of huge funding rounds for ideas that sound great on paper and might work as software code are long gone.

These days, investors are looking for proof of customer appetite and engagement, established revenue flows and – whisper it – evidence of profitable operations.

And that’s backed up by the average size of funding round this year – Series A, or first-round deals, are $12 million on average, whereas average Series F deals – typically given to companies with more than six years of trading and an established proposition – stand at around $170 million.

Where it ends

As a mafia war erupts in Francis Ford Coppola’s The Godfather, Clemenza tells Michael Corleoni that, “this kind of thing has to happen every five or ten years … it’s good for the blood.”

No-one will have taken any pleasure from the rafts of lay-offs and closures that have besieged fintech companies in the last eighteen months and yet – at so many levels – this kind of purging was necessary.

Necessary because it helps to strengthen investor confidence in those propositions that survive, separating the wheat from the chaff, and necessary because it helps everyone in the industry focus on what matters – delivering value to customers, investors and staff in that order.

It remains to be seen whether the job of transforming retail and wholesale payments is complete – current evidence would say it has not.

If that’s the case, then let’s hope that conditions improve sufficiently for investors to return in areas such as crypto and A2A payments, since they show considerable promise in solving long-intractable problems for the payments industry.