Fintech Innovation and the Capital Gap

5 min readNov 8, 2023

Quick Summary:

  • Banks have historically dominated core functions in commercial finance, acting as the lowest-cost source of capital.
  • Despite fintech’s growth, traditional banks retain their supremacy due to their cost of capital advantage.
  • The next generation of Fintech envisions a transformation integrating banking services efficiently via software access points, aiming to lower costs and optimize underwriting.
  • The biggest impediment to his promise is a “Capital Gap” of institutional funding that properly understands the much better risk/reward of these lending models
  • This institutional Capital Gap represents both a large arbitrage opportunity and a crucial building block for fintech evolution, and we’re urging institutional capital providers to join us as we showcase some of the most promising opportunities coming out of the ecosystem at our Alternative Capital Demo Day (Request an RSVP Here)

Too Big To Fail? Don’t “Bank” On It

At its essence, a bank fulfills crucial roles in commercial finance — gathering deposits as the lowest cost source of capital, originating loans, underwriting, and servicing these loans to recover returns that surpass its deposit rates. For centuries, banks have stood untouched in their ability to execute these core functions, reigning supreme in the financial landscape, particularly in Commercial (B2B) financial services. They are constants in a modern society subject to incessant change. Their significance is so profound that they’ve earned the label “too big to fail.”

As much as a decade of fintech innovation has sought to unseat banks from their throne, the capital advantage has made competing lenders, particularly in B2B, never achieve the requisite scale to compete. In fact, much of the fintech ecosystem that was created over the last decade has been as a wrapper over the traditional banking infrastructure because of the long-term Capital Advantage.

We hold a strong conviction that the time has come for this age-old dominance of the business banking bundle is about to undergo a profound transformation. Over the next decade, we envision a radical shift where core banking software is seamlessly integrated into the software powering wide swaths of economic activity.

This belief stems from the explosive growth and investment in fintech infrastructure — a revolution that’s at the nexus of financial services primitives and the software applications driving the world’s largest industries. Here, we perceive an extraordinary opportunity for startups to access trillions in share gains and enterprise value creation.

The Next Generation of Fintech & the Imperative Shift to Capital

As we look towards the next stage of fintech’s evolution, the core of this transformation may seem less revolutionary but promises to be significantly more lucrative. The next decade of fintech innovation is not about creating new financial services infrastructure for underserved parts of the economy, but rather about the distribution of commoditized and well-understood financial products through software access points.

These avenues offer superior underwriting, reduce adverse selection, and drastically cut origination and servicing costs. This transformation fuels the Negative CAC revolution, promising a shift of substantial enterprise value into the domain of vertical software.

Yet, to make this a reality and not just fodder for pitch decks, a crucial challenge emerges. The next generation of innovators will need the debt capital for start-ups to fuel their financial products. Because of a meaningful capital gap, these emergent financial services companies are borrowing at near-equity rates to lend into low-risk, commodity financial products like working capital lines.

The result is rates that have 1000 bp spreads (or today a ~3x higher cost) to the competitive products of traditional banking. Regardless of how much better the distribution, underwriting, or product experience is, it’s hard to imagine any startup getting to escape velocity selling a commodity at what is fundamentally a much higher price.

The same theory on market efficiency would then suggest that, if these start-ups were truly originating better risks at a significantly lower cost, then the premium of 1000bps on these debt facilities would be competed away by the trillions of capital looking for incremental yield. This shift hasn’t happened yet, and I believe this to be a massive arbitrage opportunity hiding in plain sight.

Perhaps this all is due to the relatively insignificant size of the tech-enabled commercial credit market today (alternative capital products like this are probably at <$10B scale), and in some ways, a reinforcing cycle of sub-scale capital deployers not being able to access the largest pools of capital could be a vicious cycle. That said, it’s our bet that an emerging class of technology-enabled capital products will generate enough consistent alpha to bridge this gap and bring institutional capital off the sideline.

The Capital Gap and an Open Call for Partners

The Capital Gap for innovation is felt across various segments of the fintech ecosystem, but nowhere is it more critical than in lending. While there are plenty of capital providers with similarly low cost of capital (pensions, insurance companies, banks themselves, etc.) who play in the venture capital ecosystem on the equity side, haven’t (yet) been able to see the arbitrage in addressing the potential from the Opco that they indirectly back to drive a meaningful lift on private debt.

While not a perfect comp, the explosion of Private Credit speaks to the emergent value between bank-level loans and equity returns that can be accessed on an institutional scale. Private Credit has grown 10x in the last decade but still, in its traditional approach to underwriting, it has been only able to deploy capital at average originations that are still 10x higher than banks. For Private Credit and general yield seekers to be able to capture the opportunity in the small-to-midsize loan market that banks have historically dominated, they will need a software-driven delivery model that can accomplish the underwriting and distribution at scale.

Across the ecosystem, new investment models from public markets to real estate are being fundamentally reshaped by these same trends. We think whether a debt facility, a forward flow, or a propco, the arbitrage embedded in these new models is both real and underappreciated by large capital allocators.

We extend an open call to all capital partners, including pensions, insurance companies, and even banks themselves, to recognize this arbitrage and contribute to the vision of a seamless, tech-forward financial services infrastructure. Let’s collectively play a role in materializing this vision and fuel the transformation toward a more streamlined and tech-driven financial future. To that end, we hope to see you at our inaugural Alternative Capital Demo Day (details below) to see a good example of these opportunities across the structured capital landscape.

Demo Day Details

We’re excited to share details of a special and private FirstMark event: the Alternative Capital Demo Day, set for the evening of December 5th.

This evening is an opportunity for select members of our network to hear from emerging companies whose businesses leverage credit / structured capital to scale their businesses.

The evening will feature lightning presentations from six fascinating companies (both inside and outside of our portfolio), spanning next-generation structured credit, real estate, and alternative investments. The content is meant to give you an inside look at non-obvious opportunities to drive outsized returns in the fintech ecosystem. In parallel, it will also provide an intimate forum for networking with entrepreneurs, hedge funds, credit funds, institutional LPs, family offices, and VCs.

Are you able to join us? Request an RSVP Here

When: December 5th 6–8PM
Where: FirstMark Capital 100 5th Avenue, 3rd Floor, New York NY 10011