Seven Unique Risks Of Investing In Fintech Startups

Jeff Bartel is chairman and managing director of Hamptons Group, a private investment and strategic advisory firm headquartered in Miami.

Financial technology has expanded both in usage and capabilities in recent years. Today, more and more businesses are investing in this type of technology investment banking to improve the overall customer experience. However, before making any fintech investment, it is crucial to understand what is driving its growth and what risks are involved.

Fintech Versus Banks

One of the significant differences between fintech companies and traditional banks is their business structure. While conventional banks focus on direct customer services, fintech companies leverage advanced technologies like machine learning (ML) and artificial intelligence (AI) to streamline their services. Additionally, banks are highly regulated. They must be licensed and follow a strict set of guidelines. On the other hand, no one regulatory agency oversees fintech services. This lack of oversight gives fintech companies more freedom to set their own rules and regulations. This factor, however, makes fintech companies riskier to invest in than traditional banks.

Future Of Fintech

Fintech innovations are expected to continue to advance and increase well into the near future. For example, blockchain technology, seen in applications such as Bitcoin and Ethereum, continues to gain traction despite being considered a high-risk investment. However, one significant change that may not be too far on the horizon is the development of stronger regulations of fintech. Many in the technology sector expect regulations to change the landscape of the fintech industry and force fintech providers to update their offerings to meet these new rules.

Driving Force Behind Fintech

Consumer demand is the most significant driving force behind fintech products and services growth. Fintech can often provide faster, more efficient services for lower costs than banks. These factors make fintech a popular option for entrepreneurs building startup companies or those having trouble working with traditional investment bankers.

Unique Risks Of Investing In Fintech Startups

On the surface, fintech services and products may seem like the ideal investment opportunity. However, it is essential to understand the unique risks of investing in fintech startups before beginning.

1. Transactional Speeds

One of the main benefits of fintech offerings is the speed of transactional services. Not only do these technology companies need to deliver fast and efficient financial products and services, but the firms using these technologies must also adapt. For fintech to be successful, firms must commit to investing in new technology that can efficiently operate fintech products.

2. Technology Failures

Repeated technology failures can destroy a fintech company’s reputation as well as the company utilizing the fintech solutions. A technology investment banking failure in the financial industry could limit or even deny users access to vital services. With today’s economies running 24/7, continuous access to services is essential.

3. Unfair Outcomes Due To Algorithmic Decision-Making

Fintech products depend heavily on automation and machine learning. Typically, it uses specific algorithms to make business-related decisions. For example, firms can use technology to determine eligibility for certain services. This automation, in turn, can lead to unfair or even discriminatory practices. To ensure this does not happen, firms should conduct frequent audits to assess these algorithms and confirm that the technology will remove bias.

4. Increased Risk Of Product Unsuitability

Fintech technology, especially in startup companies, risks product unsuitability. Fintech must consider the target audience and end user as it is developed. Creating technologies that are not user-friendly or that have too many added features can hinder the user experience. If the technology is too complex, it could slow down the deployment of services, which is a primary advantage of fintech.

5. Cross-Border Transactions

Firms that depend on cross-border transactions should be cautious when implementing fintech technology. It is important to note that because the technology works well in the United States, it does not ensure similar results in other countries. Not all countries have the same systems in place for technology investment banking. Without the proper safeguards for global technology, fintech could increase the risk of security issues and generate difficulties with tracking certain transactions.

6. Regulatory Practices

In many cases, fintech companies are not obligated to meet the same degree of regulatory oversight as investment banks. While this lack of regulatory oversight allows fintech companies to provide faster services, which is an attractive benefit for many investors, it also puts the company at a greater risk for fraud. Additionally, many believe fintech regulation is just on the horizon. If fintech regulation becomes a reality, it could significantly alter the services fintech companies can provide.

7. Fintech Operator Fraud And Misconduct

Technology investment banking services or products, including those in the fintech sector, bring an added risk for misconduct and fraud, such as money laundering. It is crucial to have safeguards in place to protect the company. For example, fintech companies can work together to develop a list of potential threats to stop these threats. Having a plan to identify and stop potential fraud and misconduct threats can allow the firm to prevent these issues before they damage its reputation.

Fintech innovation is likely to continue changing the investment banking industry for years to come. Therefore, investing in a fintech startup now can be an excellent option for many financial service companies. First, however, it is vital to understand the unique risks associated with fintech so your firm can make sound investment decisions.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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