Crashing into a New Era of Financial Services

Click here to download the full report

The Next Era of Fintech

The last several years have been a whirlwind for fintech. When we began our careers, fintech was a specialized corner of venture. It is now a dominant market force within not just venture but the entire global economy. It went from having just a few IPOs per year prior to 2020 to having over 30 in 2021. Investors flocked to the category, dragging fintech from a subcategory to the hot, burning center of venture.

And then, as fast as fintech’s star exploded, it seemed to collapse. Valuations cratered. Previously lauded private companies turned out to be terrible public stocks. Frauds were uncovered. According to some, and perhaps many, in the traditional financial services industry, Fintech was over. 

The idea that the period of rapid innovation in financial services has ended is short-sighted. Market forces are never static. And while many of the dynamics that came to represent “fintech” over the past decade have become more commonplace in the market, they now join a long list of technologies, new business models, and regulatory innovations that have propelled the financial services industry forward for generations.

The idea that fintech has run its course ignores broader changes in our economic environment, a shifting outlook among regulators and policy makers, generational preferences in how consumers engage with technology, and radical improvements in the utility of technology for users. Together these waves of change will usher in a new era in financial services, one that will reward startups that can take advantage of this new environment and build the businesses that will come to represent the next generation of fintech.

The Economic Wave: The Emergence of Volatility‍

While our most recent economic era was defined by increasing globalization and low interest rates, we expect the next few years to be defined by volatility. We have already seen it play out in 2022 and 2023 with the most rapid increases in interest rates in modern memory. This shift has had profound effects on the financial services industry, which was best represented by last year’s banking crisis. We expect more fallout to come. Other formerly “stable” areas of the economy, ranging from supply chains to socio-political conflict to climate, are trending towards increasing volatility in the years to come. 

While this volatility will create chaos in some markets, we expect it to be a period of continued investment in the U.S. financial services industry. Investors and capital markets engage in a flight to quality during turbulent times, and even if the U.S. is chaotic, it is still the most stable market for global capital. We subsequently expect more money to flow into the U.S. economy and by extension the financial services industry, and also drive continued dollarization of commerce and global business.  

However, at an individual and firm level within financial services, this volatility of interest rates and financial markets will lead to more conservative strategies. They are likely to focus on their most important markets, hold on to cash, and keep spending in check. In short, they’re unlikely to innovate into new markets and are less likely to defend “marginal” and small “niche” markets from upstart competition. 

This is a dynamic that nimble startups can exploit: shifts in markets just do not matter as much to small growth-oriented firms. With incumbents distracted by the volatility of markets, politics and, in turn, regulation, we expect startups who can stay focused, while building capital-efficient and high-growth businesses, will grow at unprecedented rates.  

The Regulatory Wave: Putting a Thumb on the Scale

The decades that followed the 2008 Global Financial Crisis were notable in that most regulators and policy-makers generally took a favorable view of technology and startups. This permissiveness was partly rooted in a belief that startups and technology would play a catalytic role in expanding access to the financial services ecosystem while bringing additional competition to the largest banks, the shrinking of which was a stated goal of many policy makers. That goodwill has been completely eroded by the high profile collapse of a number of fintech and crypto startups, several fueled by outright fraud. Further, the regional banking crisis of 2023 seems to have marked the end of the post-financial-crisis regulatory ambitions of limiting the big banks. This sea change in the regulatory posture will have profound implications on how regulators treat fintech startups. 

Going forward, we expect regulators to pay very little positive attention to startups: the days of sandboxes, no-action letters, and roundtables with innovators are likely over. Instead, we can expect additional enforcement and investigative activity as regulators increasingly view startups as a relatively high risk industry. However, those startups that can build the appropriate risk and compliance functions are likely to enjoy a relatively hands-off approach from regulators, given this general lack of attention. Those that can not are unlikely to survive.

Meanwhile, regulators are increasingly preoccupied with their core responsibility: overseeing banks. We believe the regulators are pushing the industry toward a future with fewer players. We see that playing out both with consolidation among that long tail of community banks and credit unions but also effectively creating a separate class of “super banks” that will be able to retain the advantage of their regulatory moat. Perhaps counter-intuitively, and related to the point above on greater economic volatility, we expect this period of consolidation to create large gaps in the market that startups will be well-suited to exploit. This race to beef up balance sheets is also likely to result in less organic investment in technology over the coming years. 

The increasingly insular focus of regulators will open more paths for technology companies to grow share from the more heavily regulated firms. In addition, this dynamic will continue to create lucrative acquisition opportunities for startups that are able to develop scale-ready technology with lean teams. 

The Generational Wave: New Consumers, New Preferences 

Every cycle, new generational trends impact consumer preferences and buoy new companies and business models. The previous environment was one in which consumer relationships were “optimized”: centralized content hubs served users with fine-tuned algorithms, the best brands became adept at sucking money out of customers, and employers focused on minimizing short-term labor costs, often at the expense of long-term outcomes. 

But we believe that consumers are driving a more authentic, empowered relationship with technology and brands. While this optimization was once seen as magical, it now feels a lot more invasive.   

Gen Z has shown distinct proclivities around how they buy and spend their time, and these behaviors are spilling over into the mainstream. Consumers are now more social, activist, and more likely to crave authenticity in their engagements with brands and with one another. They are demanding more from brands, and with the rise of the influencer economy, are incentivized to make their voices heard. 

Consumers are also becoming fatigued with traditional SEO and advertising, impacting the main way that internet companies make money: ads. The rise of AI risks even further weakening the credibility of ad-based models. As this model starts to break down, brands will need new ways to position for discoverability, engage prospective consumers, and sell their products. This change in content consumption has the potential to create entirely new modes of commerce, payments and credit. 

Finally, within fintech, we expect to see unprecedented levels of talent spin out of the last era of fintech companies and create new startups. Tens of thousands of people, (and founders), entered the fintech workforce over the past few years. Many were focused on delivering exceptional products to end-businesses and consumers, and building in the most modern architectures at the time. Infrastructure that was innovative at the start of the last cycle, like banking APIs, are now commonplace. The existence of this infrastructure now is forming the foundation of new and creative business models. The next generation of fintech founders will not only benefit from seeing age-old and bleeding-edge problems first-hand but also have the ability to leverage a wealth of knowledge, talent, and infrastructure from this past era.

The Technological Wave: New Protocols Emerge, and APIs Become Standards

We spent the 2000s gathering data, leveraging the vast storage capabilities of systems like AWS. The 2010s–especially in fintech–were defined by innovative products built on top of increasingly open access to these data (e.g. banking-as-a-service APIs). We are now entering an era defined by our ability to manipulate data in ways that return control to end-users. 

The clearest example is, of course, AI. The fuel for these LLMs has, to date, been huge swaths of the public internet. As the technology matures, though, innovators will train these models on private data sets, which will open up new frontiers in the application of this technology. We expect the most significant near-term disruptions to be in the professional services industry, especially in relation to lower-level tasks. While AI tools will make senior personnel vastly more productive and result in substantial cost savings, the generally risk-averse nature of large firms, coupled with the unpredictability inherent in LLM technology, will cause them to shy away from making truly transformational investments.

The walled gardens that grew up over the past couple decades placed heavy limitations on innovation by hiding data and interactions behind proprietary platforms. In recent years, partly because of consumer demand and partly because of regulatory attention, momentum has shifted towards more open and accessible protocols such as ActivityPub, which underlies Mastodon, and BlueSky’s AT protocol. Even at this early stage, millions of people are using nascent platforms based on these protocols. We expect to see these concepts applied to financial products and marketplaces as entrepreneurs sink their teeth into these emerging opportunities. 

Similarly, despite the challenges of the last couple of years, developers in the crypto ecosystem have continued to advance the technology. As one specific example, several of the Layer-2 protocols that were first introduced during the last era are now widely used to increase the scalability, stability and security of crypto transactions. The crypto ecosystem is now faster, more secure and more transparent than at any other time in its evolution. 

Finally, quantum computing continues to advance. While the technology is still under development, and hardware has yet to perform at a commercially viable level, the technology has demonstrated that that theory is correct: at a minimum, future highly parallelized simulations will be run on quantum hardware, and many existing encryption technologies will be rendered useless. We are at the beginning of a true “quantum leap” in our ability to run financial simulations of everything from derivative pricing to overall market returns, and the opportunity to build new technology is just beginning. Our ability to use quantum to dramatically accelerate the compute power of data both public and private will truly be a breakthrough in data manipulation. 

The important point is that these technologies exist. Whether in commercially viable form or not, they are not going away and cannot be ignored. Regardless of how much widespread attention they are receiving, entrepreneurs are looking to build the solutions that will create the demand that, in hindsight, will seem to have been inevitable.

The Landscape of the Next Era of Fintech

So, what does this mean for the companies and inventors that will take advantage of these trends? While there are countless potential implications, we believe the next era of fintech will be marked by the following dynamics:

1. Leaner & meaner companies. We are seeing a generation of founders who, burned from VC hype and having seen what happens when capital dries up, want to avoid the mistake of raising too much and burning too quickly. Add to that capital constraints from a broader VC pullback and the ability to amplify a workforce with AI, and we could realistically see companies that never have to raise or take meaningful dilution after their first round of funding. 

2. A focus on “predictable” revenue models. In an economic era marked by volatility, business leaders will do all they can to prioritize predictable income. Although the CAC/LTV ratio will always be important, running a business with broad swings in expected revenue tied to things like interest rates (even indirectly) makes planning difficult. At a minimum, founders should plan for variability. From a business model standpoint, expect to see SaaS continue to dominate, a swing towards annual and multi-year contracts, and business models that incorporate more “hedging” built into the product (i.e., volume-based pricing with contractual floors). 

3. Technology or business model is key. As a consequence of both economic volatility and the significant technological breakthroughs on the horizon, we expect funding will follow either very strong business strategies built on increasingly commonplace tech platforms, or founders’ introducing truly breakthrough technologies (AI, crypto, quantum, etc.). The era of raising significant capital after building an incrementally better product on top of existing banking APIs, for example, has likely come to a close.

4. Increasing regulatory sophistication for startups. As regulators become more emboldened and the regulatory environment continues to tighten, companies in the financial services space will need to develop a sophisticated approach to compliance management. One obvious implication is that companies that focus on building tools for managing regulatory overhead will be more valuable. But a less obvious implication of the changes in the regulatory dynamic is that the most sophisticated actors may follow the lead of some crypto firms and start pushing back against regulatory enforcement actions. Even minor successes in fighting the regulators could have profound impacts on how fintech is regulated over the coming decades and ultimately provide fintech startups with significant competitive advantages over regulated entities.

5. The consumerization of everything. As everyone, even enterprise customers, have become attuned to excellent user experiences, the line between corporate and consumer products is blurring. In order to succeed in both the enterprise and consumer space, founders will need to focus on building delightful and intuitive tools while acknowledging that the days of pleasing the IT department while ignoring the end-users are coming to a swift close.

6. Professional services companies beware. Professional services are uniquely suited to AI technologies, as LLMs excel at tackling the kinds of repetitive, data-driven processes often found in these fields but with access to encyclopedic, cross-domain troves of information. Historically strong margins, stable salaries, and protection from “tech” has resulted in little innovation in the field. We expect to see a wholesale shift here. Tech companies that are able to incorporate the “relationship” aspect into interactions with clients will be able to compete more head-to-head. We also expect lower costs to open up new segments of these markets and grow the pie overall.  

7. Escalations in security whack-a-mole. Most security breaches are the result of vulnerabilities that have been announced but which have not yet been patched. As LLMs are able to ingest these vulnerabilities and generate exploit code faster than humans can patch vulnerable systems, we are likely to enter an era in which solo attackers are able to mount attacks that, previously, have been the province of dedicated, criminal syndicates and nation-states. Breakthroughs in quantum computing also will inevitably render much of today’s encryption systems insecure. The required degree of sophistication for sysadmins at both startups and legacy firms is increasing by orders of magnitude.

8. Technology marches on. Founders have a once-in-a-generation opportunity to build upon massive technological innovations in AI, decentralized protocols, blockchain, and even quantum. All of these domains have direct applicability to fintech. Coupled with new consumer preferences, each of these technologies could, on its own, herald a new era of technology. But we are experiencing all of them coming together practically simultaneously. It has never been a more exciting time to build a business, and we expect founders to discover new and innovative applications among all of these currents and many others we have yet to predict.

Building in this New Era of Fintech

There is no doubt that we are in a phase of great uncertainty, but along with that comes opportunity. We expect that some market participants will look back on the last few years in fintech and exit the market. The greatest returns, however, will be generated by those who look forward and see the promises of a new market, build well-run (and compliant) businesses, and develop products that push consumers and businesses forward. The businesses that can do that will be primed to move faster, be more disruptive, and create far bigger outcomes for founders and investors than anything the industry has seen to date.

We at Restive Ventures are wholeheartedly embracing a future of swing-for-the-fences fintech companies. We believe in the future of this industry and the arrival of a new set of conditions that will unlock the next generation defining companies and technologies. We pride ourselves on working alongside the most ambitious founders tackling problems within financial services and helping to catapult them forward at the earliest stages. If you’re getting restive to build the next generation of financial services, reach out. We’re ready to help.

‍