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Turbulent waters up ahead for fintech?

Rising interest rates and the looming threat of recessions on a global level are testing every industry, but the fintech industry is especially vulnerable. Many fintech companies have seen their market caps plummet by more than 75% since last summer. Companies that are not yet public have seen their values drop as well by potential investors and pre-IPO consultants. Companies worth billions, such as Klarna and Wealthsimple, have had to lay off many workers. Overall, the industry has seen 5,500 employees lose jobs in the last two months alone, which is shocking considering there were zero layoffs last year.

The turbulent waters the industry is now navigating are especially worrisome for those that experienced such smooth sailing over the last decade. 2021 was particularly fantastic, as digital finance experienced a massive boom, and investors were rushing to get in while the getting was good. In 2021 alone, fintech startups raised 132 billion USD, which was more than double that of the previous year. Moreover, 150 firms obtained valuations of 1 billion USD or more. But times have changed. More traditional investment firms like pension funds are becoming quite wary of fintech startups. Some venture capitalists are even pulling out of deals after they have signed them.

Cleansing Fires

Every recession inevitably becomes about the survival of the fittest. Some industry insiders welcome the competition, since there have been a lot of people rushing in and crowding the fintech space. The wheat will be separated from the chaff, leaving more for those that survive. Moreover, even though the bubble may be deflating, industry proponents do not fear a true pop, just a correction in valuation because the fundamentals of the industry are still good. As evidence of this fact, one simply just has to see that current valuations resemble those of early 2020.

That said, wary investors could mean that lasting damage will be done. Companies are being forced to borrow more money, since investor funds are much harder to come by. But borrowing more money while interest rates throughout the world are rising so fast is not a sustainable path. Because of these risks, venture capital firms, which exhibit extensive control over their rising stars, are forcing them to hoard much more cash so that they can better withstand any future shocks that the market may throw at them.

And the market may continue to throw haymakers. Many fintech business models rely on people securing loans and credit cards, as well as bank funding. Rising interest rates impede these transactions. Moreover, increased inflation, and therefore declining real incomes, could lead to more default rates, which are disastrous for all involved. And finally, much of the fintech industry has been about staying one step ahead of regulators. These startups were able to base their models on loopholes that allowed them to operate in ways that traditional banks could not. But as banks lobby and governments move, those loopholes are being closed, and quickly. Whether caused by market waves or government headwinds, the fintech industry will not face smooth sailing up ahead.