The intersection of financial services and technology, or fintech, is where many people will now spend, lend, borrow, invest, and trade. And they do it like his second nature. Fintech is making financial services more efficient and adaptable, and more personal and inclusive. From buying coffee with a credit card stored on a mobile device to splitting a dinner bill with Venmo, fintech apps are transforming the way businesses and consumers interact with their finances.
We expect that as technologies like these mature and their adoption increases, the importance of the Fintech mega theme in investment portfolios should increase, and for good reason. Exciting opportunities continue to emerge as Fintech, including the Blockchain theme, increasingly overlaps with emerging themes such as the Internet of Things (IoT), cloud computing and video games.
Key points to remember
- We expect digital transformation to bring financial services, including mobile payments, online banking and alternative lending platforms to previously unbanked and underserved populations.
- The pandemic has accelerated fintech adoption, with digital payments shifting to 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 make significant investments in fintech as consumer demand for the ease and convenience of fintech increases.
Fintech adoption is gaining momentum and becoming the norm
Fintech adoption has increased dramatically in recent years, and we expect innovation in the field to continue to increase access to the global financial ecosystem. Global fintech investment activity, including through venture capital, private equity and mergers and acquisitions, grew from $148.6 billion in 2019 to $124.9 billion in 2020 to $210 billion in 2021.1
For consumers, the ease and convenience of purchasing goods or services by touching a device at a point of sale makes digital payments Fintech’s most recognizable segment. For businesses, beyond the initial costs of developing the program and the infrastructure to conduct transactions, mobile payment technology is a user-friendly way to keep ongoing and variable costs low. With consumers more able and willing to buy online, more integrated shopping ecosystems are developing. The success of Fintech’s fastest growing segment, BNPL, is the result of the continued growth of online shopping.
Overall, US consumers using Fintech grew from 58% to 88% between 2020 and 2021.2 By comparison, it took 20 years for the refrigerator to reach a similar adoption rate, while the computer took 10 years and the smartphone 5 years.3 Notably, adoption is increasing across all 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 some demographics, fintech usage has 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 marketplaces can integrate the latest technologies without forcing an old business model to become obsolete. Among emerging markets, China and India have the widest adoption to date, reaching 87% in 2019.6
The chart shows the trend of fintech adoption around the world across different traditional financial services before the pandemic. And it’s reasonable to assume that since the pandemic, adoption has increased across all 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 properties stem from its decentralized approach. The data is recorded in blocks on a digital register. Participants, called nodes, are the computers and network-connected devices that distribute and validate the ledger over a peer-to-peer (P2P) network. While anyone can create data on public blockchains by creating a new block and chaining it to a previous block, the consensus approach to validation means no one can alter or tamper with data after received a sufficient number of block confirmations. The result is a structure that generates trust without the need for a third party.
Since participants do not need to trust a government to back a currency or to manage the money supply, it is conceivable that blockchain networks will eventually integrate into the financial ecosystem. This technology provides a mechanism for financial inclusion, especially in countries struggling with political instability, corruption or high inflation.
A February 2021 survey found that the top 10 countries with the highest frequency of cryptocurrency use among their population were all emerging market 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%.seven In the United States, an estimated 16% of adults own cryptocurrency.8 We expect this number to increase over time, but investors should be cautious in the crypto space as regulation remains light and illicit activity common. Consumer risk is likely a barrier to adoption. Scams, theft and volatility are risks. In 2021, $7.8 billion in value was scammed and $3.2 billion worth of cryptocurrency was stolen.9.10
Beyond financial use cases, the applications of blockchain technology are vast, touching supply chains, healthcare tracking, and smart contracts.
Fintech is a crossroads of thematic disruptions
A key advantage of fintech platforms over their more traditional financial competitors is their ability and willingness to integrate new approaches at scale and change their business models as new technologies emerge. The merger of blockchain and fintech to form decentralized finance (DeFi) is a prime example. As a result, fintech is a natural crossroads for disruptive themes including the Internet of Things (IoT), cloud computing, and video games.
Fintech platforms combined with IoT technologies can transform everyday services. For example, insurers generally operate with incomplete information, which increases the cost of P&C insurance policies. But if they were able to use telematics sensors to track GPS and in-vehicle diagnostic information, they could get more accurate information for underwriters and potentially cut costs and speed up resolutions.
Cloud technology can streamline previously cumbersome processes for banks, such as onboarding new customers, opening accounts, and managing regulatory compliance. Globally, cloud IT spending by the banking industry is expected to grow at a CAGR of 16.2% between 2019 and 2024, to reach approximately 25% of IT budgets.11
Another new frontier for Fintech is play-to-win with non-fungible tokens (NFTs). According to one estimate, more than one million digital wallets connected to decentralized gaming applications per day in October 2021, representing 55% of overall blockchain industry activity.12 These blockchain games allow the ownership of playable objects, and therefore the possibility of selling, exchanging, using and lending these tokens.
Putting Fintech and Blockchain Themes in a Portfolio Context
Fintech will continue to make financial services more digital and scalable. The transformation is obvious, but it also has significant leeway to execute globally, as no use case exceeds 70% penetration.13 Critically, as blockchain technology moves out of its infancy, we expect the reach of end-user and institutional applications to grow exponentially and potentially disrupt traditional finance.
In our view, thematic stocks should be targeted, using screens to ensure that the underlying companies provide the desired exposure. This focus on pure gaming minimizes overlap between themes while differentiating the exposure provided by the theme versus broad beta products.
Companies operating in the fintech and blockchain spaces are global and positioned to benefit from increased thematic adoption across the globe. We believe there is a lot of innovation outside of the US and that limiting exposure to the US will exclude key players, to the detriment of long-term investors. The charts below break down the geographic exposure of the largest fintech and blockchain themed ETF products.
Note: Includes the Big Five Fintech ETFs and Big Five Blockchain ETFs according to our thematic classification. All thematic ETFs have the same weighting.
Because blockchain remains in the innovation phase, the number of pure play blockchain companies is limited. Therefore, many ETFs include large semiconductor manufacturers that design and build crypto-mining infrastructure. These companies are also included at a relatively high level in market-cap-weighted large-beta ETFs and technology-sector ETFs. Over time, we expect overlap levels to decrease as the space matures and the number of pure play businesses increases.
Conclusion: the Fintech revolution is on the right track
Real paper money transfers could approach relic status as fintech changes the way the world accesses and interacts with money. As the space progresses and adoption grows, we believe blockchain-based digital ledgers will likely become the dominant way to 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 the risk for investors is not being exposed to the fintech mega theme and the many investment themes it connects.
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