The internet revolutionized the financial services industry and today new technologies and innovation continue to shake things up. Consumers now expect better user experiences, higher levels of personalization, faster service, and more options. And the industry is racing to deliver.
Some of the innovations include payments using blockchain—including micropayments and cross-border payments—as well as personalization and automation using artificial intelligence and machine learning.
Financial giants and startups
While nimble startups have continued to push the boundaries on innovation, the behemoths of the financial world are not staying stagnant. Instead they are often early stage investors in new companies—which gives them insights into what's up-and-coming and opportunities to acquire some smaller fish. Established brands are also investing heavily in innovation and technology—and hiring just as many technologists as traditional staff.
"Some could say that financial services companies are morphing into tech companies to stay competitive and create new markets for opportunity and growth," says Camille Carlstrom, managing director of research and co-portfolio manager for the Fidelity® Disruptive Finance Fund (FNTEX).
"M&T Bank (MTB) is a good example here. They created a tech innovation center, the ‘Tech Hub,' recruited from tech-savvy companies to build its own teams, applied agile software programming, and improved their own operations quite a bit."
As startups, financial technology (fintech) offerings tend to be initially narrowly focused and expand over time. Square's Cash App started as a simple peer-to-peer (P2P) payment service, but has grown to offer trading for cryptocurrency, payment processing for retailers, and payroll. SOFI, another fintech company, started with student lending services in 2011 and has expanded to personal loans, stock trading, and banking.
"But many fintech's have difficulty providing products and services that are truly differentiated, especially since new products or services can be copied quickly by others," Carlstrom says. "This highlights the need to identify the new fintech companies with unique and defendable products and processes."
Whether innovations come from brand-new companies or decades-old institutions, consumers stand to benefit from the developments reshaping the field of financial services. Here are 2 of them.
1. Blockchain as a game-changer
Blockchain is perhaps the biggest potential disruptor to traditional finance companies—and also the biggest opportunity. Many people have heard of blockchain—it's the technology that allows cryptocurrencies to exist.
Blockchain is a digital and, in some cases, an immutable ledger. Almost anything of value can be tracked and traded on a blockchain network. The blockchain can bring more accuracy and information sharing into the financial services ecosystem, enabling new ways to audit systems and verify transactions. It's also created an alternative to traditional methods of financial transactions.
"Blockchain removes the intermediary," says Carlstrom. "This enables transactions to be done more quickly and cheaply and with clearer transparency. It offers the opportunity to recreate traditional processes and may make it easier to create new businesses and applications by removing some barriers."
Blockchain underpins the tokenized economy, which allows for a new form of money movement. It also offers the ability to exchange value with settlement finality. In other words, as soon as money is transferred via blockchain it's typically available to be used within minutes.
"My team members see attractive investment opportunities in companies that are utilizing blockchain technologies and that are moving fast in adding digital assets and digital asset capabilities to their product suite. In my view, the tokenized economy and demand for digital assets is a key opportunity to watch," says Carlstrom.
Tokenization: Buying memes is just the beginning
NFTs, or non-fungible tokens, have gotten a lot of attention recently. On the surface it sounds silly to buy a meme or a famous internet picture or video. But tokenization is here for the foreseeable future—and it's likely that more assets will be tokenized. Tokenization refers to the creation of cryptographic tokens that are minted and managed using blockchains.
"And they can represent tangible or intangible assets—companies are already tokenizing houses and real estate. Tokenization of assets may help make transactions more transparent, and make buying and selling easier with higher liquidity and easily verified ownership," Carlstrom says.
Companies that have benefited from blockchain technology
Signature Bank (SBNY) is one of the first banks to offer 24/7 fund transfer capabilities on a blockchain platform, via its SignetTM platform. Commercial or institutional clients are able to make real-time payments all day, every day, 365 days a year.
It's designed for institutional clients looking for options to transfer US dollars to digital currency exchanges.
"The digital deposits vertical is nascent for SBNY but offers a growth opportunity not necessarily available to peers at the current time," Carlstrom says.
Only a handful of banks currently accept cryptocurrency as digital deposits, but it could gain traction as regulators determine how to regulate crypto.
Mastercard (MA) has one of the world's largest blockchain patent estates and has been working on tools and products that leverage their blockchain research. This is a natural extension of their current business where Mastercard is a global arbiter of identity and authenticity in payments.
MA also sees potential to bring their blockchain research to nonpayments use cases, including areas like cross-border supply chain where MA can help to connect parties across countries and continents.
Coinbase (COIN), one of the leading cryptocurrency exchange platforms is helping to foster growth in cryptocurrency by providing a platform for buying, selling, and spending digital currencies. After all, without a place to trade it or use it, there would be no market.
COIN's mission is to create a whole new banking system, the "cryptoeconomy," in which a person or business can borrow, save, and spend using only cryptocurrency. COIN is supporting those who are building public blockchains by providing a venue for their currencies to trade. Finally, COIN has a large venture portfolio of investments in innovative crypto companies—any number of which have the potential to become meaningful one day.
2. Autonomous finance—delivering exactly what you need
Autonomous finance uses artificial intelligence and machine learning to help you make financial decisions—or even to make them for you. Robo advisors are a great example of autonomous finance. By providing a little bit of information about yourself, your financial situation, and your goals, your investment choices and management can be almost entirely automated.
But that's just one example—AI can potentially make other financial decisions for you and help make better customer experiences with more personalization.
"The use of artificial intelligence/machine learning and data analytics to improve financial decision-making continues to be a key area of investment opportunity," says Carlstrom. "For example, using AI/ML in underwriting allows companies to offer more customized financing solutions as well as expand into niches not historically serviced by traditional players. AI/ML also allows for leaps of improvement in customer service, creating a relationship with the client at a more efficient acquisition cost for the institution and a better satisfaction level for the client."
Companies leveraging AI
Capital One (COF) is one of many key players in the banking market using artificial intelligence (AI) as a result of their focus on technology and innovation. The company has a Machine Learning Center to develop AI tools and by the end of 2021, Capital One plans to hire 3,000 additional machine learning specialists and software engineers in an effort to improve their machine learning acumen.
"It's really a fintech within a traditional bank," Carlstrom says. "They are trying to build relationships with customers by using artificial intelligence and machine learning. Algorithms allow the experience to be customized to you for higher customer satisfaction and potentially greater share of the client wallet for COF."
Arch Capital (ACGL) is ready to embrace digital disruption in the insurance industry by taking steps to fold in data technologies, automation, and machine learning.
Arch Capital is one of the world's largest mortgage insurance companies and is using data science along with artificial intelligence to improve their companies' risk management and insurance underwriting process and effectiveness. In April 2021, Arch teamed up with Delos, a company that uses satellite imagery and proprietary modeling technology to quantify a home's wildfire exposure. The ultimate goal was to increase insurance capacity for California homeowners in areas prone to wildfires.
The company's risk management sets the bar for US insurance, Carlstrom says.
By using data analytics, Arch Capital has been able to price and manage risk effectively. They're also committed to creating innovative solutions themselves: The company has a defined data science track to hire top talent to address the intersection between machine learning and insurance.
Fidelity® Disruptive Finance Fund (FNTEX) held securities mentioned in this article as of its most recent holdings disclosure. For specific fund information, including holdings, please click on the fund trading symbol above.
Camille Carlstrom is the managing director of research and co-portfolio manager of the Fidelity® Disruptive Finance Fund (FNTEX). Her passion for solving puzzles and digging into how things work led her into financial services. "Equity research rewards you for asking questions and finding the better mousetrap," she says.