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Chapter 1
IN THIS CHAPTER
Defining FinTech
Distinguishing FinTech's dimensions
Understanding financial technology changes
Looking at the size of FinTech around the world
Checking out important FinTech vocabulary
FinTech has undoubtedly become one of the hottest topics in business. Web searches for the term fintech in Google have grown exponentially in the last several years, so it's obvious that people are curious about it. But what is it, and why is it relevant to today's financial industry? This chapter looks at those very basic questions, helping prepare you for the more detailed information you discover later in this book.
Having FinTech knowledge gives you a competitive advantage in your personal career, because FinTech experts are in high demand globally. Reading this book will also empower you to help your institution innovate and develop its services faster than your competitors. Globally, the FinTech market is booming, and we see investors investing across all stages of FinTech companies' life cycles.
In 1996, Michael Goodkin, Mitchell Feigenbaum, Nigel Goldenfeld, and Alexander Sokol teamed up to form Numerix, a software company created to supply the finance industry with quantitative research and tools.
Each founder had already had great success in his own right. Michael Goodkin was a quantitative analyst and author of the book The Wrong Answer Faster. Mitchell Feigenbaum was a MacArthur Grant recipient and one of the pioneers of chaos theory. Nigel Goldenfeld was a statistical physicist and director of NASA Astrobiology Institute for Universal Biology. Alexander Sokol was a writer and professor at the University of Illinois.
Numerix was initially a think tank for mathematicians, computer scientists, and theoretical physicists in search of uses for a series of financial industry-specific projects. The first Numerix product was a software tool kit leveraged to speed up Monte Carlo simulations, tree and difference finite methods, and value-at-risk calculations. It sped up the computation time by factors of four, while not negatively impacting the accuracy of the results. Merrill Lynch and Price Waterhouse were the first companies to deploy this product in 1998.
The use of the Numerix Monte Carlo method provided more accurate pricing faster. This enabled banks to mitigate their intra-day risk more effectively.
Between 1998 and 2003, Numerix focused on creating many projects, some paid for by clients but most based on a desire to solve perceived financial industry-related problems. By 2003, the company had amassed 20 different kinds of potential products in search of clients. However, the company was distracted and unfocused and had spent more than $25 million to create a business that was barely generating $4 million in annual billings. During the summer of 2003, a multibillion-dollar financial service company attempted to buy Numerix for $5 million, only to have its offer rejected by the primary shareholder. The company at that time was a broken start-up building '"cool" technology for the sake of it rather than solving real market problems. At this stage, it was going out of business unless it could get backing from committed investors to pivot into a new product or approach. Sometimes parallel changes in the market environment enable your pivot timing.
There are many definitions of FinTech, but for the purposes of this book, this one is the most relevant: FinTech companies are businesses that leverage new technology to create better financial services for both consumers and businesses. Of course, that begs another question: What is financial technology? We define it as all parts of technology that help provide financial services and products to customers. Those customers can be individuals, companies, or governments.
FinTech is also frequently used as an umbrella term for various subcategories, such as WealthTech and RegTech. You find out more about these subcategories in Chapter 2.
The desire for greater profits drove the financial industry to create new instruments that were of significantly higher risk. Credit default swaps (CDS) and mortgage backed securities (MBS) became the instruments of choice for many hedge and investment funds that were promising high rates of return to their investors. However, these instruments were complex and not easy to price. MBS and CDS often had many different components bundled within them, making it hard to determine the true value of what was being sold or bought. This was a real market problem that Numerix could solve.
Coauthor and Numerix CEO, Steve O'Hanlon joined Numerix in January 2002 to lead global sales, marketing, and support. In 2004, Greg Whitten, chairman of the board and CEO, appointed Steve to run the day-to-day operations as president and COO. Steve's primary goals were to refocus the company and eliminate all the distractions. Steve set forth five tenets of operations to bring clarity of purpose and focus to the 50 employees:
FinTech may sound simple from the definition you read in the preceding section, but there are multiple dimensions. You need to think about each of these factors:
FINTECH Circle has coined the term Fintech Cube to describe the intersections of these factors. Figure 1-1 illustrates this cube, in which there are three axes: the financial sector on the x-axis, the business model on the y-axis, and technology on the z-axis.
Source: FINTECH Circle, 2020
FIGURE 1-1: The Fintech Cube combines financial sector, business model, and technology factors.
Each of these dimensions can be further categorized. For example, Figure 1-2 expands on the concept by adding key areas of financial services that can benefit from FinTech. All financial sectors are shown on one side of the cube, including retail banking, trading, and insurance (among others).
Figure 1-3 summarizes the most important business models from business-to-consumer (B2C), business-to-business (B2B), business-to-business-to-consumer (B2B2C), to business-to-government/regulator (B2G), to platform-based business models, crowdfunding, and peer-to-peer (P2P) lending.
Source: The Fintech Cube, FINTECH Circle, 2020
FIGURE 1-2: Key areas of financial services that benefit from FinTech.
FIGURE 1-3: A dimension of main business models.
Figure 1-4 shows the third dimension - the technology being used, which can range from cloud computing, big data, artificial intelligence (AI)/machine learning (ML), blockchain (distributed ledger technologies), the Internet of Things (IoT), and quantum computing, to augmented and virtual reality. Part 2 covers these technologies in more detail.
FinTech start-ups, for example, can now be more easily categorized and compared. For example, you may have a retail banking (financial sector x-axis) solution focused on the business model of B2C and using various technologies, such as cloud, big data analytics, and AI. Such a company would be called a challenger bank, sometimes also referred to as digital bank or neo-bank.
Numerix established clear internal and external branding as a software company focused on the derivative and over-the-counter (OTC) markets, servicing the needs of the four core trading desks: fixed income, equity, foreign exchange, and credit. Its internal communication was constant and consistent about being a financial analytic software company. Externally, it participated in 15 different industry-specific trade shows in different parts of the world to make itself known, while developing industry contacts and leads resulted in product sales.
The financial software industry was fraught with legacy sales models. One of the most common was the perpetual license model (PLM), which involves an initial license fee (ILF) upfront and then an annual maintenance fee (AMF) of about 20 percent of the ILF for each subsequent year to receive supports and updates. The ILF payment ensures perpetual rights to use the software even if the client stops paying annual maintenance.
The other popular software license type in 2004 was the term license model...
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