Conversational Alpha®: Fintech is revolutionizing money

The intersection of financial services and technology, or fintech, is where many people now go to spend, lend, borrow, invest and shop. And they do it like its second nature. Fintech makes financial services more efficient and adaptable, and more personal and inclusive. Whether buying a coffee with a credit card stored on a mobile device or sharing a dinner bill with Venmo, fintech applications are changing how businesses and consumers interact with their finances.

We expect that as technologies like these mature and their adoption increases, the Fintech mega-theme’s prominence in investment portfolios should increase, and for good reason. Compelling opportunities continue to emerge as Fintech, including the topic of Blockchain, increasingly overlaps with new topics such as the Internet of Things (IoT), Cloud Computing and video games.

Important takeaways

• We expect the digital transformation to bring financial services, including mobile payments, online banking and alternative lending platforms, to previously unbanked and underserved populations.
• The pandemic kicked fintech adoption into overdrive, with digital payments moving into mass adoption. Key avenues for future growth include buy now pay later (BNPL), cloud banking and blockchain-based segments.
• Traditional financial services companies continue to invest significantly in fintech as consumer demand for the simplicity and convenience of these technologies increases.

Fintech adoption gains momentum, becomes the norm

Fintech adoption has increased dramatically in recent years, and we expect innovation in the space to continue to increase access to the global financial ecosystem. Global investment activity in fintech, including through venture capital, private equity and M&A accelerated from $148.6 billion in 2019 and $124.9 billion in 2020 to $210 billion in 2021.¹

For consumers, the simple and convenient purchase of goods or services by tapping a device at a point of sale makes digital payments into Fintech’s most recognizable segment. For businesses, beyond the upfront costs of developing the program and infrastructure to execute transactions, mobile payment technology is a consumer-friendly way to keep ongoing and variable costs low. With consumers more skilled and willing to shop online, more integrated shopping ecosystems are developing. The success of Fintech’s fastest growing segment, BNPL, is a result of continued growth in e-commerce.

Overall, US consumers using Fintech grew from 58% to 88% between 2020 and 2021.² In comparison, it took the refrigerator 20 years to achieve a similar adoption rate, while the computer took 10 years and the smartphone 5 years.³ In particular, adoption is increasing across user demographics. Millennials lead with 95% overall adoption, but Baby Boomers are the fastest-growing group, with their usage doubling from 39% to 79%.⁴ For certain demographics, fintech usage approached and even surpassed traditional banking usage in 2021.

Based on available data, the global adoption rate of fintech solutions reached 64% in 2019.⁵ Innovations in mobile payments, online banking and alternative lending platforms can bring financial services to previously unbanked and underserved populations in developing and emerging markets. Without existing infrastructure in place, such as traditional bank branches and credit cards, these markets can integrate the latest technology without forcing an old business model into obsolescence. Among emerging markets, China and India have the widest adoption so far, reaching 87% in 2019.⁶

The chart shows the trend in fintech adoption globally across different traditional financial services before the pandemic. And it’s reasonable to assume that since the pandemic, adoption has increased across categories.

Blockchain can be a gateway to financial inclusion

In its most basic sense, a blockchain is a type of database focused on recording and maintaining data. Its unique characteristics stem from its decentralized approach. Data is recorded in blocks on a digital ledger. Participants, called nodes, are the computers and devices connected to the network that distribute and validate the ledger on a peer-to-peer (P2P) network. While anyone can create data on public blockchains by creating a new block and linking it to a previous block, the consensus-based approach to validation means that no one can edit or falsify the data after receiving a sufficient number of block confirmations. The result is a structure that creates trust without the need for a third party.

Because participants do not need to rely on a government to back a currency or to manage the money supply, it is conceivable that blockchain networks will eventually become embedded in the financial ecosystem. This technology provides a mechanism for financial inclusion, especially in countries struggling with political instability, corruption or severe inflation.

A February 2021 survey revealed that the top 10 countries with the highest frequency of cryptocurrency use among the population were all emerging countries. Nigeria led the way with 32% of respondents indicating they use bitcoin or cryptocurrency more widely, followed by Vietnam at 21% and the Philippines at 20%.⁷ In the US, an estimated 16% of adults own cryptocurrency.⁸ We expect these numbers to rise over time, but investors need to be cautious in the crypto space, as regulation remains light and illegal activity common. Consumer risk is likely to be a headwind to adoption. Fraud, theft and volatility are risks. In 2021, $7.8 billion in value was defrauded and $3.2 billion in cryptocurrency stolen.^9,10

Beyond financial use cases, the use of blockchain technology is extensive, touching supply chains, healthcare and smart contracts.

Fintech is a crossroads of thematic disruption

A key advantage of fintech platforms compared to their more traditional financial competitors is their ability and willingness to integrate new approaches at scale and shift business models as new technologies emerge. The fusion of blockchain and fintech to form decentralized finance (DeFi) is a good example. As a result, fintech is a natural crossroads for disruptive topics including the Internet of Things (IoT), Cloud Computing and video games.

Fintech platforms together with IoT technologies can transform everyday services. For example, insurance companies usually operate with incomplete information, which increases the cost of property and casualty insurance. But if they were able to use telematics sensors to track GPS and on-board diagnostic information, they could get more accurate information for underwriters and potentially lower costs and faster resolutions.

Cloud technology can streamline previously cumbersome processes for banks, such as onboarding new customers, opening accounts and managing compliance. Globally, the banking industry’s IT cloud spending is expected to grow at a CAGR of 16.2% between 2019 and 2024, rising to approximately 25% of IT budgets.¹¹

Another new frontier for Fintech is non-fungible tokens (NFT) monetization games. By one estimate, more than 1 million digital wallets were connected to decentralized gaming apps per day in October 2021, representing 55% of the blockchain industry’s overall activity.12 These blockchain games allow ownership of playable items, and thus the ability to sell, trade, spend and lend these tokens.

Putting the Fintech and Blockchain themes into a portfolio context

Fintech will continue to make financial services more digital and scalable. The transformation is readily apparent, but also one that has significant room to run globally, as no single use case exceeds 70% penetration.1. 3 Critically, as blockchain technology grows out of its infancy, we expect the scope of end-user and institutional applications to grow exponentially, potentially outstripping traditional finance.

In our view, thematic equity should be targeted using screens to ensure that the underlying companies provide the desired exposure. This pure play focus minimizes overlap between themes, while differentiating the exposure provided by the theme versus broad beta products.

The companies operating in the fintech and blockchain spaces are global and positioned to benefit as thematic adoption increases worldwide. We believe that there is plenty of innovation outside the US, and that limited exposure to the US will exclude key players, to the detriment of investors in the long term. The charts below break down the geographic exposure of the largest fintech and blockchain-themed ETF products.

^{Note: Includes the five broad Fintech ETFs and the largest five blockchain ETFs according to our thematic classification. All thematic ETFs were equally weighted.}

Because blockchain remains in the innovation phase, the number of pure blockchain companies is limited. Therefore, many ETFs include large semiconductor manufacturers that design and build infrastructure for crypto mining. These companies are also included at a relatively high level in market capitalization-weighted broad beta and technology sector ETFs. Over time, we expect overlap levels to decrease as the space matures and the number of pure play companies grows.

Conclusion: The Fintech revolution is well under way

Actual transfers of paper currency may be approaching relic status as fintech changes how the world accesses and interacts with money. As space expands and usage increases, we believe blockchain-based digital ledgers are likely to become the dominant way people send, manage, invest and lend. The rise of the digital payments segment to mass adoption levels illustrates the willingness of consumers to embrace these new technologies. Given the enormous growth potential of fintech applications, we believe that one risk for investors is not having exposure to the Fintech mega-theme and the many investment themes it links together.

Image taken from Shutterstock

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