The History of Fintech Development

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Abstract

FinTech or financial technology refers to innovation of technology in the financial services. FinTech has evolved from developments of electronic technology in financial products to online based financial products and services. FinTech now, offers a variety of products in the financial industry which range from mobile payments, crowfunding, asset management, instant money transfer, instant loans, cardless withrawals, financial softwares, and cryptocurrencies. This paper will explore the background and development of FinTech over the years as well as focusing on two major segments of FinTech: Crowdfunding and Cryptocurrency.

Introduction

Definition

“FinTech” is an abbreviation of the term Financial Technology and the term, now, has evolved from when development in technology first introduced to the finance industry to how the technology itself being used to replace and disrupt traditional financial methods and transactions. Nowadays, Fintech is a sector with varieties of elements and broad selections of products to choose from. Some of the elements in FinTech include: mobile payments, crowfunding, asset management, instant money transfer, instant loans, cardless withrawals, financial softwares, and cryptocurrencies. These elements has changed how people and businesses do their transaction and it also forced most businesses, particularly banks and financial institutions to adopt Fintech and incorporate it into their business model. The definition of FinTech generally depends on what elements of FinTech the definition is talking about. A literal definition of FinTech is that it is the use of technology in financial services. Dorfleitner et al. (2017) stated that the term FinTech refers to companies or organisations that integrate financial services with modern and innovative technology, with the aim to provide an automated, efficient, and user friendly products compared to traditional financial products. Patrick Schueffel (2016) in his paper Taming the Beast: A Scientific Definition of Fintech defined FinTech as “…a new financial industry that applies technology to improve financial activities” (p. 32). FinTech could also be defined as those in the industry that are involved in the development of new technologies to disrupt traditional financial markets (CNBC, 2017). Putting all the elements from the definitions, it could said that FinTech is the result of continuous technological innovation in the financial industry that provide products that seek to bring convenience and ease towards the users compared to existing products offered.

Background and Development

To understand FinTech, it is necessary to know the history and development of technology in the financial industry as FinTech that are known today are an accumulation of a century worth of technological advancement and therefore, there is a need to know how the current FinTech came to be (Raza, 2018). There are a few major development and key innovation that shaped FinTech today, particularly, since the creation of the world’s first Diner’s club credit cards in 1950 by Frank McNamara, introduced the world to a series of continued technological innovation and development in the field of financial technology, particularly, in the last 65 years (Desai, 2015).

The invention of ‘ATM’ or Automated Teller Machine in 1967 by Barclays’ Bank in London proved to be the first major development of financial technology where the concept of ATM allows people to get their own money outside of banking hours and bank premises; overall saving time for customers and saving cost for the banks (Chandio, 2011). This lead to the idea that people can do their own transaction at their own will and leisure without the need for procedures with the tellers or queueing for transactions at the cashier and from then, numerous innovation such as self-checkout at stores, online shopping, self-ticket payment for movies and train are developed with this idea in mind (Sweet, 2017).

Four years after Barclays’ unveiled its cash machine, NASDAQ established the world’s first electronic stock exchange platform in 1971 (Raza, 2018). This establishment led to the current financial markets where it involves minimal human operation and lack of physical cash and product in the market. An example would be the Forex market where businesses are recorded in a digital book entries instead of physical cash (Khan, 2018). In 1981, Michael Bloomberg created the Innovative Market Solutions (IMS) where he built a computer system that provides a real-time market data, financial analysis and calculations to Wall Street firms. This proved to be a major development in the financial industry as stock exchange went fully electronic, inviting a high demand for market information and analysis. This remains true until today where Bloomberg still manage to stay relevant in the business as investors, traders and market analyst turned to the software for data, graphs, ratios, comparisons and most importantly regular update on the market prices, predictions, and real-time tracking on a particular commodities (McCracken, 2015).

Starting from the 1990s, financial technology expanded rapidly as companies began to incorporate the Internet and e-commerce in their business model. The first online banking system by Wells Fargo in 1995 marked the point where customers are now able to access their accounts online without the need to go to the bank or the need for bank-provided floppy disks and hard drives (Thompson, 2015). Three years after that, in 1998, PayPal, an online payment processing platform was founded and it created an alternative to other online payment systems. It quickly became the most trusted form of online payment over the years, not only because of its safety and fraud prevention control; it is also due to its use of e-mail as medium for communication for customer service and feedback (Mochari, 2014). This shows that PayPal managed to use most of the internet as a platform for business transaction and also a medium for good customer services.

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The next highlight in the development of FinTech happened in 2009, when Bitcoin, a cryptocurrency was created. It revolves around the concept of digital asset as a medium of exchange or simply put, digital cash (Britto & Castillo, 2013). Although there are digital cash introduced before Bitcoin, none of them are as stable and fast growing as Bitcoin. Based on Bitcoin’s open source code, it contributed to the development of other cryptocurrencies which leads to organizations such as Electronic Frontier Foundation (EFF) started accepting Bitcoins as funding for donations and payments (Reitman, 2011). The latest major development in FinTech is the introduction of digital wallet such as Apple Pay in 2014, allows users to make payments in stores, on the web, or in apps and also allows them to send and receive money straight from Messages (Apple Pay, n.d). This introduction not only sets the trend of paying straight from mobile phones and apps, it allows other companies to deliver their own version of digital wallet, signifying the potential of digital wallet replacing physical card as a form of payments in the near future.

Literature Review

FinTech is a broad sector with a varieties of segment in it. FinTechs’ segments include: mobile payments, crowfunding, asset management, instant money transfer, instant loans, cardless withrawals, financial softwares, and cryptocurrencies. This paper will only focus on two which are; crowdfunding; and cryptocurrencies. Crowdfunding is an alternative way of getting money from large number of people or “crowd” on the internet with the purpose of funding or financing a project or venture (Schwienbacher and Larralde, 2010). Crowdfunding gain popularity after the 2008 Financial Crisis, where there are a lower number of investor such as Business Angel active in the investment of small projects and ventures makes crowdfunding a popular source of alternative form of financing and also investment opportunity (Tomczak and Brem, 2013). There are four main types of crowdfunding which are: Reward-based crowdfunding, Equity-based crowdfunding, Debt-based crowdfunding, and Donation-based crowdfunding. Reward-based crowdfunding are the most common and also provide a direct transaction or agreement between the investor and the investee.

The investors will receive a form of reward, usually not in the monetary form and may also came in the form of prestige or benefit such as contribution credit or free access to new products (Dorfleitner et al., 2017). The second type of crowdfunding, Equity-based crowdfunding is a type of crowdfunding that allows businesses to seek funding from selling shares of their company. The investors invest in the companies in exchange for owning shares and become a shareholder. Some of the benefits with this type of crowdfunding include a larger opportunity to gain more capital whilst also maintaining the Investors as one group (Miller, 2018). The third type of crowdfunding, Debt-based crowdfunding also known as peer to peer lending crowdfunding where companies can get loans more easily from the ‘crowd’, with the return are paid back with a fixed rate of interest (Bradford 2012; Dorfleitner et al. 2017). Miller (2018) argued that while debt-based crowdfunding enjoyed a lower interest rate compared to getting loans from the banks or financial institution, it still does not avoid the fact that a debt is still debt and a liability which is needed to be paid. Donation-type crowdfunding usually occurs to non-profit organization and charities where campaign involves raising money online from interested donors, particularly those that sympathizes or in line with the organization’s ideology and goals.

While crowdfunding is an excellent alternative to traditional sources of finance, it also comes with an obvious issues which always pointed to two main problem; what affect investor’s willingness to invest; whether or not a company able to meet investors’ expectations. Things that affect investors’ willingness to invest may involve factors such as intellectual, social, risks. A study conducted by Ahlers et al. (2015) in Signalling in Equity Crowdfunding presents an empirical tests regarding indication shown by entrepreneurs’ in getting investors into equity-based crowdfunding. The test analyzed the impacts of venture quality and uncertainty on fundraising success. The test result showed that retaining equity and providing more information regarding the potential threats and risk gave a positive indication towards successful fundraising whilst aspects such as social and intellectual capital shows little to negative impacts towards positive fundraising.

This shows that investors of equity-based crowdfunding generally more concerned towards risk shown and equity offered compared to social values which investors of donation-based crowdfunding valued more. Issues of companies not meeting investors’ expectation also became a problem for investors. Mollick (2014) in The dynamics of crowdfunding: An exploratory study explores the success and failures of crowdfunded ventures. He founded that the ventures product quality depended on the degree of success of the fundraising. In his report, Mollick (2014) conclude that while a large number of ventures completed their obligation and responsibilities towards the investors, more than 75% of them delivers the product late of schedule due to the limited fund raised. This gives an indication that, while most venture founder fail to meet 100% of the investor’s expectation, most of the issues came from the lack of success in fundraising which lead to lower quality product presented.

Another segment of FinTech is cryptocurrency. It is an electronic and decentralized medium of exchange that served as an alternatives to money issued by the government and states (Jiang & Liang, 2017). Cryptocurrency uses a distributed ledger structure where mining forms the core operation of the system. Mining resulted in every transaction to be recorded in the ledger known as “Blockchain” where every transaction being processed (Mukhopadhyay et al., 2016). Mukhopadhyay et al (2016) argued that since mining brings money in the form of units, the lack of central authority governing the issuance of the currency means that all transaction process are being validated by the miners themselves; highlighting the miners dependence on mining algorithms. One of the most important and dominant cryptocurrency in the market right now is Bitcoin. When Bitcoin was introduced, it changes how cryptocurrency used to work. People began to understand its potential and are investing in it with organizations started to accept Bitcoin as payments and fund (Reitman, 2011). The success of Bitcoin are also followed by hundreds of new cryptocurrencies emerging and that leads to a high competition not only between cryptocurrency and traditional legal tender exchange but also between other cryptocurrencies (Iwamura et al., 2014). Although Bitcoin established much potential over the years, it does not escape from the problem all cryptocurrencies faced, which is a highly unstable market as cryptocurrency in itself is not a commodities and are subjected to rigid money supply in contrast of demand swings (Harwick, 2016).

Discussion

Advantages of FinTech in the financial services pointed to one thing: convenience to the users. With crowdfunding, for example, not only it provided new ventures an opportunity to raise fund, it also allows them to proceed with their project without the strict financing requirements of banks and financial institutions. Investors are also rewarded based on the type of crowdfunding they chose. The reward-based crowdfunding, for example, are more relaxed in terms of requirement and accessibility as it only requires investor being rewarded of non-monetary considerations (Dorfleitner et al., 2017). The equity-based crowdfunding not only opens up the chance of an individual to be a shareholder, it is also comes at lower cost to the venture itself and some investors may end up owning majority of company if their contribution is enough. Cryptocurrency, on the other hand, introduced a new type monetary system that are generated based on the mining algorithms. It is also an opportunity for investors and miners as while people generally neglected cryptocurrency; banks, financial institutions, and analysts keep close track on them. FinTech, however, are not without fault. For venture founder, while raising capital is important for their project, they might lose the ownership itself and not only that, depending on the type of crowdfunding they chose, venture owner may face little to no cost to having liability to be paid. The debt-based crowdfunding generally attracts a lot of lenders as it offers a return with fixed rate of interest. This comes at the expense of debt payments and a liability to the firm. Generally, for investor, different crowdfunding entitled to different amount of risk bourn. Cryptocurrency, are implicated with the unstable market environment and with no physical commodities backing it, prices fluctuates at an alarming rate with uncertain demand (Harwick, 2016).

Conclusion and Recommendation

FinTech penetration in the financial services runs deep, although it may seem that FinTech offers innovative product that threatens to disrupt and replace traditional financial products and services, it may not be true to all the products offered. An example is how crowdfunding, despite being a popular choices for many small, venture business seeking for finance only appeal to majority small business whereas large projects and already established companies still decided to use traditional finance seeking method. Although the trend of online based product may dominated the future of banking systems and financial services offered, it shows the fact that the possibility of cryptocurrency replacing traditional currency are extremely unlikely, at least for now with all the issues and problems associated with it.

Recommendation for crowdfunding should be addressed to how crowdfunding online platform be made more open and widely accessible so that it is easier to reach more “crowd” and get more funding. Recommendation for cryptocurrency should focus on the path of technological advancement in terms of stronger Blockchain algorithm or international institutions regulating and encouraging cryptocurrency usage.

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