What are fintech companies?

But what are fintech companies exactly, and how are they trying to disrupt the role of traditional financial firms? In this article, you'll learn how to define fintech, how it's reaching out into different market areas and which fintech companies are leading the way.

Who uses fintech? 

Fintech companies aim to serve various clients across the financial services industry. Products and services focus on three areas: business-to-business, business-to-consumer and consumer-to-consumer.

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Business to business

Business-to-business fintech areas include:

• Crowdfunding platforms and business lending
• Accounting and money management services

Business to consumer

Business-to-consumer companies that use fintech include:

• Stock trading apps
• Cryptocurrency exchanges
• Robo advisors
• Embedded finance

Consumer to consumer

Consumer-to-consumer companies that offer fintech include those that offer:

• Peer-to-peer lending
• Payment apps
• Blockchain innovations like DeFi and smart contracts

Understanding the fintech industry

While fintech has roots dating back to the 1990s, many of today's products and services were born in reaction to the Great Recession. The traditional banking industry was labeled with a permanent black mark in the eyes of many Americans following the financial calamity. It allowed many entrepreneurs and investors to get involved in the financial system or at least put some heat on the monolithic banking culture. 

What are fintech companies? For many, they are solutions to the problems that plague traditional banking. Today's savers and investors often don't work the typical nine-to-five job with a steady paycheck directly deposited into their checking account. Many Americans today freelance, run small businesses or participate in various side gigs like rideshare driving or meal delivery. 

Many of these career paths aren't malleable to the traditional banking model. Fintech firms seek to reach these clients — workers and investors who prefer modern digitalized financial services without the outdated overhead, fees and limitations.

Evolution of financial technology

Innovation has always been a core goal of financial institutions. Sometimes, that innovation leads to great ideas, like the first mutual funds and ETFs, which allow investors access to diversified portfolios by purchasing a single security. Other times, innovation can go too far, like the complex derivatives used by mortgage bond traders leading up to the 2007 Great Recession.

Today, innovation occurs in an increasingly digital world, which can also have its benefits and drawbacks (more on later). Fintech can provide financial advice and tools to millions of people who were previously priced out or unable to access the proper financial institutions. Investors can also benefit as many of these fintech firms (now fintech ETFs) are publicly traded companies.

Key players in fintech

You'll probably recognize the names of several key fintech companies from the 2021 meme stock craze. 

Companies like Robinhood and SoFi Technologies made it easy for young retail investors to access markets at a time when they were flush with stimulus money and spending most of their day in front of some sort of screen. Fintech companies offer services like credit cards, financial advice, mobile banking and investment apps.

Analyzing performance metrics

Suppose you want to trade stocks in the fintech sector. In that case, you’ll need to understand particular technical trading and sentiment signals since fintech companies are often small and volatile companies with primarily venture capital backing them. Support and resistance are crucial for identifying short-term entry and exit points. Social media sentiment is another essential factor to track since many fintech stocks went parabolic during the meme stock craze.

Fintech ETFs present better tools for long-term investments. Still, instead of technical trading signals, you'll be more concerned with numbers like assets under management, expense ratios and portfolio of holdings. Fintech ETFs also focus on different market segments, such as artificial intelligence and data analysis.

How fintech works

To understand how fintech works, you'll need to understand how financing technology can improve outcomes for both business and individual clients. While the services they offer can vary, all fintechs tend to embrace two critical factors in their products:

• Digitalization: What is a fintech if not a digital application of traditional finance? With so many clients today preferring to manage their finances from their smartphones and computers, fintech companies offer digital solutions for banking, wealth management, payments and more. 
• Automation: Digital financial services reduce friction. But automation takes it a step further by reducing friction, costs and barriers to entry. Remember life before autopay for your cable and electricity bills? Automation has improved financial outcomes by keeping individuals on target with their savings and investing goals. Financial technology has even brought automation to the wealth management industry, which allows investors of all income levels to access affordable services.

Examples of fintech

What is financial technology in action? Here are eight areas of the banking and finance industry ripe for disruption and a list of the firms providing the newest innovations.

Robo advisors

One area where traditional money management is disrupted is financial advisor services. For many Americans, a customized financial plan or investment advice from an advisor is too costly. Affordable advisors often lack fiduciary status, which can lead to conflicts of interest. 

But robo advisors like Betterment and Wealthfront use algorithms to design portfolios and financial plans based on client's needs. Even legacy firms like Vanguard Inc. and Charles Schwab Corp. NYSE: SCHW now offer robo-advisory services for a fraction of their typical asset management costs.

Stock trading apps 

Smartphone apps have made stock trading more accessible to retail investors than ever. Positions can be opened and closed at a moment's notice from any location provided you can get a signal and commissions have disappeared at nearly every major brokerage firm. 

Robinhood Markets Inc. NASDAQ: HOOD was one of the first fintech stock trading apps geared toward young retail investors and currently offers commission-free trading on stocks, options and cryptocurrencies. Robinhood competitors like Webull, Bloom and Public have also built the Apple App and Google Play Stores.

Of course, Robinhood has also found itself under the eye of regulators for potentially misleading customers and failing to disclose all transaction costs. Robinhood also received criticism for its decision to limit trading during the meme stock craze of 2021 and faced a class action lawsuit from former clients. The suit was dismissed, but Robinhood's legal woes persist, and HOOD shares have languished since its IPO.

Peer-to-peer lending 

With increasing lending standards, getting access to capital can be complicated, especially if you don't have stellar credit. Brick-and-mortar lenders like banks and credit unions are still most Americans' primary source of loans. Peer-to-peer fintech money lending platforms like LendingClub Corp. NYSE: LC offer an alternative to the traditional model.

LendingClub offers many traditional financial services today, but its original service was an online lending marketplace. Through this marketplace, borrowers could receive loans for as little as $1,000 (or as much as $50,000). These loans were marketed to investors, who could search the platform for loans that fit their risk profile and supply capital. Investors would then earn a return on their capital through the interest payments borrowers make. Other peer-to-peer lenders in this space include LendingTree, LightStream and Avant. Additionally, commercial lending fintechs like Biz2Credit offer solutions for businesses and institutions.

Payment apps

We've already discussed how payment apps like PayPal and Venmo have improved how money is moved from person to person. But sending your commissioner your fantasy football league fees isn't the only way payment apps make life easier. Both individuals and businesses can now use payment apps to send money, receive payment from clients or send funds overseas. 

Former Twitter CEO Jack Dorsey's Block Inc. NASDAQ: SQ has the popular Cash App platform for personal payments. Stripe Inc. offers invoicing and bill pay options for business payments, making it an ideal service for freelancers or self-employed individuals.

Cryptocurrency

Cryptocurrency exchanges like Coinbase Global Inc. NASDAQ: COIN certainly fit the fintech mold, but cryptocurrency itself can also be considered an innovation of technology in finance. Bitcoin was the first digit asset to solve the double-spending problem by creating the blockchain ledger system. Blockchain enables users to validate transactions without needing a third-party intermediary (i.e., a bank or traditional institution) to confirm. Blockchain isn't the only fintech innovation in the cryptocurrency space. DeFi, NFTs and smart contracts are all examples of financial technology.

Budgeting and money management 

Budgeting and personal finance apps can automate savings, investing and bill paying while providing insights into spending. Investors may not consider Intuit Inc. NASDAQ: INTU a fintech in the traditional sense (especially since it's now 40 years old). Still, QuickBooks has been a game-changer for many small businesses seeking simple accounting services. Additionally, Intuit offers TurboTax for easy online tax prep.

Embedded finance

One of the newest fintech innovations is embedded finance. With embedded finance, customers can purchase an item or service, get financing and provide payment all within a single app. For example, Uber Technologies Inc. NYSE: UBER now offers financial services like UberPay, UberCash and the Uber debit card that allows customers to deposit funds, pay for rides or food delivery and earn rewards, all within the Uber app.

E-commerce

Fintech is a natural extension of the e-commerce industry, where mega-cap companies like Amazon.com Inc. NASDAQ: AMZN seek to become a one-stop shop for retail shopping and financial services like mobile banking and insurance. And when companies like Amazon expand into a certain space, the market tends to take note.

But blue-chip giants like Amazon aren't the only ones using financial technology to disrupt e-commerce. The emergence of "buy now, pay later" firms like Affirm and Klarna allow customers to purchase high-ticket items and pay them off in installments without taking out a loan or other traditional financing source. 

But blue-chip giants like Amazon aren't the only ones using financial technology to disrupt e-commerce. The emergence of "buy now, pay later" firms like Affirm and Klarna allow customers to purchase high-ticket items and pay them off in installments without taking out a loan or other traditional financing source. 

Fintech limitations

Fintech limitations include the following:

• Security: Big data breaches, ransomware and other malicious computer attacks are always at the forefront of fintech concerns. While traditional banking institutions may not have the best reputations, most clients trust their bank with their funds and personal data. Fintech clients must be more conscious of cyberattacks, or in the cases of crypto exchanges like FTX, outright deception and fraud.
• Customer support: For many savers and investors, having a relationship with a broker or advisor is a major perk. Face-to-face conversations and personal relationships with our accountants, advisors and money managers can provide peace of mind that you can't find through an automated chatbot or message board. Additionally, many fintech products lack a customer service department, which could cause less tech-savvy customers to stay away.
• Transparency: Fintech is still a relatively new industry, and these services have plenty of regulatory gray areas. Cryptocurrency exchanges have frequently butted heads with the Securities and Exchange Commission (SEC) over the definition of a security, and the U.S. Government Accountability Office (GAO) has raised questions over lending and fee transparency issues.

Building a fintech ETF portfolio

If you want to build a fintech ETF portfolio, you'll need to consider your own goals and risk tolerance before looking at any specific funds or figures. How long is your time horizon? How much volatility can you comfortably handle? Fintech is a relatively new industry, and many of today’s promising ideas will eventually be discarded in time's dustpan. Figure out what you want from a fintech investment beyond just "number go up."

Fintech risks and challenges

Two of the fintech sector's biggest challenges come from related sources: trust and regulation. 

Traditional financial institutions like JPMorgan Chase and Goldman Sachs have spent (literally) more than 100 years developing trust from their clients and relationships with legislators and regulators. 

While larger banks certainly aren't immune from fraud (right, Wells Fargo?), clients and governments view financial innovation through a skeptical lens. Having a new cryptocurrency rug pull or big data breach every few months probably doesn't help matters here, either.

Future trends in fintech ETFs

The pace of technological innovation is challenging to slow down, and the fintech industry is likely here to stay. 

For 2024, the most significant trend will likely be the launch of various cryptocurrency spot ETFs, such as the Bitcoin ETFs launched in January and the anticipated Ethereum ETFs later in the year. While these ETFs didn't shoot to the moon out of the gate, they did amass an impressive amount of investor capital within the first few weeks. With fees far lower than traditional cryptocurrency exchanges, how companies like Coinbase and Gemini respond to these new vehicles remains to be seen.

Regulatory outlook

Here are a few areas of legislation where fintech firms may run into compliance headaches:

• Privacy 
• Capital requirements
• Securities law (i.e., is crypto a security?)
• Transparency on fees

Fintech aims to reduce friction but also creates new risks and challenges 

A digital financial world is one where many traditional areas of friction have been eliminated. Thanks to financial technology, individuals and businesses can move money, obtain financing, trade securities or borrow and lend, all without ever setting foot inside a bank or credit union. Additionally, budgeting, personal finance and wealth management have become more accessible and effective thanks to automation and sophisticated computers.

But fintech still has some tradeoffs with traditional finance that may make some potential clients uneasy. Security will always be an issue thanks to malware and cyberattacks. 

Gone are the days of face-to-face interactions, which may see fintech firms struggle to build personal relationships with their customers. Without a personal relationship, client loyalty can waver, and the company with the best rates or yields will likely win the business. 

As we saw with Robinhood, many clients will leave and never return once you lose that loyalty and trust. Fintech promises great innovations, but these companies face different challenges than traditional financial firms.

FAQs

Interested in learning more about the fintech industry? Here are 3 frequently asked questions about this growing space: