Editor’s note: Alston Zecha is a Partner at Eight Roads, a global venture capital firm backed by Fidelity that partners with game-changing technology and healthcare companies in China, Europe, India, Japan, and the United States. At Eight Roads, Alston is focused on assessing early-stage investment opportunities in fintech and enterprise software, and advising portfolio companies on strategic, financial, and operational issues. Prior to joining, he co-founded the mobile payment startup SumUp.

Fintech is a massive sector and one that’s getting a lot of attention. How do you think about it?

The term fintech means different things to different people. To me, fintechs are companies that use core technology to take an innovative digital-native approach to delivering financial services. The services they provide often map to the traditional categories you’d find at a universal bank, including transaction banking, lending, capital markets, and asset management, as well as to adjacent categories like alternative investments. Beyond that, there are technologies that cut across these areas such as cryptocurrencies or digital assets, as well as a wider tech enablement layer called techfin that, as the name implies, is technology for financial services. 

Since all of this tech is really the backbone for where the entire financial services industry is headed, in my view fintech is financial services.

How has the sector evolved throughout your career?

When fintechs first started emerging in the early and mid-2010s, the big question was whether they would eat away at the different universal bank subcategories I mentioned before and effectively unbundle traditional financial services. By the late 2010s, however, a number of super apps and other platforms had emerged that were actually doing the opposite. They rebundled financial services, but did so by taking the most profitable and interesting parts of multiple categories and mixing and matching different business models. 

Since then, it has become clear that there are many different possible approaches to a fintech business. I mention that because while mapping fintech to universal bank functions is a useful mental model, trying to shoehorn fintechs into fixed buckets doesn’t always work anymore. Instead it’s about recognizing the different functions universal banks serve and how they can be mixed together into new and innovative configurations. 

That’s how you end up with payments companies, for example, that evolve into data companies thanks to their proximity to the transactions they handle or into lending companies thanks to the transaction insights they have and the fact that they are close to the money. So it’s not uncommon for the ways fintechs provide value and generate revenue to evolve from one category of financial services to a very different part over time.

What does the rise of fintech mean for incumbents?

Contrary to what you might think, many established financial institutions are actually doing just fine. I’ll give you an example from the world of payments processing, where there’s a massive incumbent called FIS as well as disruptors like Stripe and Toast. Between 2017 and 2022, Stripe and Toast went from processing roughly 3% of FIS’s volumes to nearly 40%. At face value, you’d think it’s a classic case of disruption with two newcomers taking considerable market share away from an established player. 

But during that same period, FIS’s payment processing volume increased from $1.7 trillion to $2.2 trillion, or in absolute dollar terms a similar amount to the disruptors. You could argue that without companies like Stripe and Toast, FIS would have maintained more market share. But you could also argue that because of the innovation that these fintechs are driving throughout the ecosystem, the overall pie is growing to the benefit of the entire ecosystem. To my mind, this is just a natural side effect of the modernization, expansion, and financialization of the global economy. 

What has investment activity in fintech looked like in recent years?

The numbers vary pretty dramatically depending on how you cut it. One source I’ve seen put the global peak at nearly $200 billion back in 2021, but included established businesses that have been around for 20 or 30 years. Another source pegged VC investment at around the $120 billion mark that same year. Regardless of what the true number actually is, I think the more compelling stat is that between 20% and 25% of all VC investments were in fintech companies during that peak in 2021.

And while fintech investment has shrunk by between 30% and 60% over the last two years, depending on the data source you’re looking at, so has VC and growth equity investment overall. In spite of the recent decline, fintech has become a core pillar of the innovation economy. A good case in point is a recent study that noted that 31 of the 100 fastest-growing companies in the UK are fintechs. There were more fintechs on that list than any other type of company, including B2B SaaS.

As the economy continues to financialize and digitize, it stands to reason that fintech will remain one of the main sub sectors that VC and growth equity investors are focused on.

What subcategories within fintech are particularly hot right now?  

Payments is an area where there’s always a lot of activity. It’s also become particularly interesting because of the growing popularity of real-time account-to-account payments, which are paving the way for new business models as they continue to displace cards, cash, checks, and other bank-based payment methods. As an ex-payments operator and an all-round payments geek, this is the first fundamentally new payment method to emerge in over two decades, so it has tremendous potential.

Another area we’re really interested in is alternative assets. Beyond overall massive growth over the past decade, there’s also a lot of opportunity there because these categories are earlier in their adoption journeys for technologies that are commonplace elsewhere in tech, like the use of mobile, cloud architecture and SaaS, not to mention huge future potential from AI.

Let’s unpack both of those areas a bit more. Can you start by telling us more about the current payments landscape?

Sure, activity in payments is perennial because it’s such a core pillar of global commerce. At the large cap level, there are multi-billion-dollar M&A transactions every couple of years with plenty of small bolt-on acquisitions happening in between in the $10 million to $100 million range. Every year or two there are also a handful of exits in the few-hundred-million to low-billion-dollar range. And then, once a decade or so there’s a behemoth exit like Adyen’s €7.1 billion IPO back in 2018. We anticipate even bigger IPOs from Klarna and Stripe, potentially with $20 billion and $50 billion valuations, respectively.

In talking about the payments landscape, I think it’s also important to note that one of the challenges for VCs is valuing companies correctly. Because payments is a high volume, low margin business, payment companies have traditionally traded at a discount to pure software. And yet as payments took off and investors started becoming enamored by the seemingly infinite possibilities associated with the globalization of commerce and the digitization of payments, that began to change. During the 2020-H1 2022 bull run, payments companies were trading on par with or even at a premium to pure software, with fintech equity indices increasing more than 1.5x compared with software. 

Not surprisingly, that wasn’t sustainable and today payments businesses are once again trading at a discount to pure software. Further complicating matters is the fact that virtually every financial services business is tech enabled, making the bar for being a true tech company that much higher. Meanwhile, payments companies can easily fall out of favor if, say, their growth starts to slow down. It’s been a real rollercoaster ride and challenge trying to figure out how to value these companies correctly.

You mentioned account-to-account real-time payments. Can you tell us more about that and how it could lead to new business models in the industry?

Traditionally the majority of digital payments have gone through credit cards like Visa and Mastercard or through bank-issued debit cards. Account-to-account real-time payments are an increasingly popular alternative in countries where the technology has been adopted such as the UK, Australia, and Singapore. Fundamentally, these are payments that can be made digitally via a mobile app, with funds instantly deposited into the recipient’s bank account without the lag time associated with traditional forms of payment. And, in addition to being instantaneous, account-to-account payments are cheaper since they cut out the middleman and can be connected to other apps and digital payment systems. 

Once account-to-account real-time payments gain full adoption, they will significantly improve the velocity of money, which is obviously good for the economy. In most instances they should also lower the costs of transactions and lead to richer data and data-enabled services. Over time, this will drive quite a meaningful shift in how commerce is done, opening up new use cases such as more complicated and higher value payment transactions. For example, it could become the de facto way to pay off a car loan or move large amounts of money overseas, which would create a lot of new opportunities.

Interesting. Switching gears, what can you tell us about the role of fintech in alternative assets?

Private capital investment in alternative assets grew from $4.6 trillion in the early 2010s to close to $13.5
trillion in 2021. More importantly, financial advisors that previously steered clear of alternatives are now recommending that their clients allocate as much as 25% of their portfolios to them. As a result, we’re seeing endowments, sovereign wealth funds, and other big allocators of capital moving to alternative assets in an effort both to diversify their portfolios and earn higher returns.

As the inflows to alternatives have grown, three key challenges have emerged, the first of which is accessibility. Historically, you had to be an accredited and often wealthy investor to access alternatives, meaning it was difficult for anyone other than high-net-worth individuals and institutions to get exposure to the asset class. And while part of the reason for this is because alternatives are viewed as highly sophisticated investments, the middle and back offices of the shops offering them haven’t typically been all that sophisticated. As a result, they often face challenges with scaling, including putting all of the money flowing into them to use and onboarding new customers effectively. 

The final challenge is unlocking the alternatives market so that investing in them is more like investing in a public market security. Ultimately, that will require the digitalization and standardization of the data that wraps around this asset class. 

As a VC, I’m looking for tech-enabled companies that drive better, faster, and cheaper solutions that will help make alternatives more accessible, scalable, and digitized. Within that context multiple business models are possible. These include independent fintechs making alternative investments that they can package up and sell to retail investors, using AI for risk management and to help automate customer onboarding, or providing software solutions to alternative investment houses so that they can become more scalable and efficient.

And what’s happening in terms of M&A activity?

Fintech and techfin in the alternative assets space is very much an emerging category, so while there is consistent appetite for smaller companies at the $10 million to $100 million range, we’ve not yet seen the multi-billion-dollar exits we VCs hope to achieve, though there is plenty to suggest that they will come. 

There have been a number of multi-billion IPOs of private equity funds (most recently CVC) and acquisitions of alternative credit firms (e.g., Angelo Gordon), and past experience in other parts of the markets has shown that once the allocators of capital reach scale and become publicly traded, the service and technology layers around those ecosystems will also see significant equity value creation (we’ve already seen hints of this with the recent $5 billion valuation for Alter Domus.)

Last question: What’s your outlook for fintech going forward and where do you see things headed?

As industries and economies mature, they become increasingly financialized. From a fintech perspective, that’s what it’s all about. In most parts of the world, and particularly the developed world, there is a growth and productivity challenge. If we want our economies to continue to grow, we need more GDP per capita, meaning a greater velocity of money flowing around for the same number of people doing the same number of jobs. Fintech plays a key role in that as well as in financial inclusion by making financial services more scalable, including to those further down the economic pyramid. 

To me, all of this means that the opportunities in fintech are virtually boundless, which leaves me feeling pretty bullish on where things are headed.

Thanks Alston, we really appreciate your sharing your insights with us!