As investment in FinTech continues to rise, investors are becoming more selective in doling out money to startups, including those focused on bitcoin and blockchain.
"There’s an increasing realization that [FinTech] is a specialized sector," said Jalak Jobanputra, founding partner of Future Perfect Ventures. "It's the realization that a lot of this does take extra time and the regulatory landscape is uncertain, and you need to invest in companies and entrepreneurs that understand that and have expertise and patience."
The hesitancy is with both pure play venture capitalists and corporate investors.
Last year, blockchain and bitcoin startups received record-high funding at $474m, and it was the first time those categories of companies secured mid-stage Series C rounds.
Matthew Wong, research and data analysis at CB Insights, the consulting firm that co-sponsored the report, says big deals in blockchain will continue in 2016, although the space is maturing.
Instead of funding in mining and wallet startups, investors will look to broader applications for things like fraud and compliance, he said.
No more naivety
But 2015's increased mega-rounds of $50m or more, coupled with the low number of deals in Q4 2015, signals the investor class is becoming more discerning, willing to put large amounts of money in proven business models and less willing to make deals on theoretical use cases.
While large deals headlined 2015, these tapered off in the last two quarters of the year. There were 154 deals in Q4, the lowest quarterly total since Q1 2013.
Mega-rounds increased dramatically, though, with 60 in 2015 up from only 15 from 2011 to 2013.
A more perceptive investor community could, in turn, indicate a future shake out in the over-crowded FinTech market.
"FinTech as a space has become hot and crowded and because of this, early stage companies are seeing less exuberance than before to invest in them," Wong said. "One reason there's less exuberance is because we haven’t seen as many big outcomes in the space to date as were expected, compared to the amount of startups funded in the space."
A whole section of the CB Insights report is dedicated to blockchain hype, with the authors claiming investors looking for short-term successes are likely to be disappointed.
FinTech is a long-term play that’s all about scale, they say.
In FinTech "the exits aren’t there that return substantial money to investors," said Vinny Lingham, an angel investor and CEO of Civic Technologies, an identity protection startup.
"There are a lot of companies that raise multiple rounds, increasing their valuations but acquirers won't buy them for that [value]."
Lingham’s new company, Civic is touting next-generation identity management tools, having raised $2.7m in venture capital in January. Civic is reportedly looking for ways to leverage the blockchain, as Lingham serves as a board member of the Bitcoin Foundation.
Still, early-stage investors, like Jobanputra, are sensitive to entry valuations and what it's going to take for those companies to grow into that valuation. Large valuations limit exit opportunities with the option of a multi-billion dollar acquisition or IPO, she said.
There have been some fintech IPOs and acquisitions, but 2015 was the worst year for tech IPOs with just 28, the largest being global payments incumbent, First Data.
"Too many people invested a million here and a million there only to see something go down the drain," said Peter Olynick, the card and payments practice lead at Carlisle and Gallagher Consulting Group, adding:
"They’re happy to make some bad bets but they want to believe there are some good bets in the mix as well."
Change for the better?
In short, investors are evaluating FinTech startups with more scrutiny nowadays.
And investors are more hesitant about taking a chance on investing in FinTech startups, which initially launch with rally cries of 'Disruption!' but pull back as they begin working closely with legacy financial institutions.
This is especially true for bitcoin and blockchain-related startups.
The companies have had a particularly tough time dealing with the regulatory environment, but the most successful startups in the space have built aggressive compliance programs and partnered with legacy institutions.
"Anywhere you have larger incumbents it’s always challenging for a startup to compete," Jobanputra said. "Larger companies are often well capitalized and not going to easily give up market share."
The low-hanging fruit for blockchain startups are industries that are predominantly paper-based and time intensive, Jobanputra said. For instance, mortgage origination or insurance could be a good play, and the latter is becoming the new industry buzzword.
The other trick, Lingham said, is to create a business model that doesn't just shift a segment of consumers from one service to another, but that taps into new consumer bases that can increase the size of the pie.
Lingham sold his mobile gift card startup, Gyft which accepted bitcoin, to First Data in 2014.
While blockchain is still a hot topic, more investment dollars went into lending startups last year. And that might shift again this year to insurance companies, Wong said.
The drops are in tune with the broader dip in VC capital activity overall, Wong said. "FinTech is not immune to that."
Wong predicts a continued consolidation of FinTech startups, with fewer exits over the next couple years. But FinTech still holds a prominent spot in terms of investment, with the 19 different private companies with $1bn or more valuations in the market accounting for 12% of the 155 total companies with those valuations total in all markets.
Not only is the money itself being repositioned, but where investment comes from is also shifting. Corporates have started pouring money into FinTech startups as well, according to the report.
Corporate momentum is especially prevalent in Asia. Alibaba, Tencent and Rakuten, among others are building their own financial services and also funding startups. According to the report, 40% of all financing deals to Asian FinTech startups were participated in by corporates.
But startups will continue to be outsourced R&D for corporates.
Carlisle and Gallagher’s Olynick said:
"We’re not talking to anybody that isn’t trying to do one or two prototypes around blockchain. Corporates are totally open to the idea that there is a use case out there for blockchain."
And while corporate momentum won’t dry up investment from pure play VCs, that investment in the FinTech space could contract as banks invest in incubator and accelerator programs and join consortiums to build technology in-house.
"But there will always be a role for people willing to take on more risk than the corporate governance structures are going to allow," Olynick said.
Bailey Reutzel is a veteran finance reporter. Her latest project Moneytripping is a Gonzo-style journalism project.
Follow her on Twitter here.
Investment health image via Shutterstock