Alternative finance, or ‘AltFi’, has become a widely used term. Yet, some misconceptions persist, especially since it is often wrongly used interchangeably with others. This article delves into what is meant by this term, assesses its current state of play, and explores why you need to know this.
Alternative finance is an umbrella term, as it refers to a range of products, processes or financial instruments that have developed outside the more traditional banking system. These instruments have grown in transaction volumes and popularity, mainly since the financial crisis of 2008, and have developed into effective avenues for businesses and organisations to raise capital. The focus is mainly on different means of financing a venture or business without the traditional retail banks or capital markets, hence the ‘alternative’ tag.
These products include some of the older and more established types, such as Business Angels, Venture Capital and Microfinance, as well as more recently setup methods such as crowdfunding, P2P lending and invoice trading. The latter, more modern methods are often the go-to definition many commenters use for alternative finance. Conversely though, I would include Business Angels and Venture Capital as part of this umbrella term simply because they exist outside the banking structure. Delving deeper into these instruments will be the subject of other articles, but suffice to say that we are dealing with types of both equity and lending finance.
At this stage, it is important to clarify that the term Alternative Finance is not to be confused or used interchangeably with the new upcoming term Decentralised Finance or DeFi. The latter is a revolutionary financial system which pledges to be more transparent and resilient and can be used to manage and run alternative finance instruments, amongst other things. So, DeFi is more like the infrastructure, tools and applications that can be used by Alternative Finance methods. However, AltFi also works with the traditional financial system.
To give an example, one can raise finances through alternative finance means such as equity crowdfunding using Fiat money (Government issued currency) or Cryptocurrencies which are an application of DeFi.
According to the Cambridge University Centre for Alternative Finance, in a 2020 Market Benchmark Report on the state of play in 2018, the global alternative finance market volume was $89 billion, excluding China. This means a staggering year-on year growth of 48 per cent from $60 billion in 2017. I am excluding China as, alone, it would add a further $215 billion in transaction volume which would inflate the total. Moreover, since the Chinese government implemented far stricter regulations on alternative finance platforms causing them to shut down, it is estimated that the Chinese volumes decreased since 2018.
The Market Benchmark Report also shows that, excluding China, global business funding for start-ups and SMEs through alternative channels increased from the $21 billion in 2017 to $31 billion in 2018. Furthermore, most markets show that institutional investors provide almost 50 per cent of this funding volume. It is noteworthy that this is also restricted to volumes reported by online platforms and thus excludes the more traditional alternative finance methods. On the back of these statistics alone, one could argue that alternative finance is not ‘alternative’ any longer, but rather quite mainstream.
Moreover, big retail banks worldwide are now also offering their own alternative finance platforms for clients who they would typically have refused through the traditional banking structures. The latter have become increasingly difficult to tap into, especially for start-ups and innovative SMEs with no track record and little collateral. From the investors’ side, the public now has increased access to platforms via improved fintech practices and easier user interfaces. Because of this, the alternative finance industry is predicting further growth. Additionally, the new EU Regulations for European Crowdfunding Service Providers will also improve cross border transactions.
Having said that, there is still a lack of awareness and proper understanding of the alternative finance space which is often seen as riskier and is disregarded altogether. Report after report keeps showing that most businesses will instinctively still go to the bank as their first route for finances and would often just stop there. This is a major problem for the economy and innovation, as some of the most innovative solutions to today’s problems struggle to take off simply due to this.
One of the advantages of alternative finance is that it makes financing and investment more democratic, transparent, and efficient both for entrepreneurs and investors. In fact, the definition or profile of the traditional investor is also evolving because the increase in online platforms has made investing more accessible; creating more investment opportunities. The barriers to become an investor, in terms of funds required, stockbroker, technology and the contacts or network have diminished considerably. This also means that entrepreneurs have more funding options available, which is extremely impactful in situations where ventures would still be considered ‘unbankable’.
The larger crowds on these platforms can also reduce the risk of investing, as a larger pool of people can invest smaller individual amounts. One could easily start with a little bit of money to explore and tap into the options of early stage investing in innovative and impactful ideas while spreading funds across a portfolio of initiatives and ventures to reduce risk even further.
Whether alternative finance is still an alternative and why it was given this tag is, therefore, not the issue. What’s in a name? The important point is to appreciate the fact that for some businesses and ideas, this is not an alternative option, but indeed, the only option, and figures show that it is becoming increasingly popular and needed.
Traditional banking and alternative finance can and should complement each other to offer opportunities for good and sustainable ideas to thrive. We need to develop an ecosystem where access to finance is facilitated and alternative methods are promoted, while at the same time, protecting all parties with proper information, education and awareness. This, however, should be done without choking the system with overbearing protection.
From the investors side, by improving the alternative finance ecosystem the public gets the opportunity of another avenue to invest in innovative ideas with a diverse portfolio which could lead to future gains, especially so as we have a high level of savings which are practically not earning anything and not contributing to anything.
We will further explore alternative finance and its instruments in future posts but, in the meantime, have you used any form of alternative finance and do you see yourself using it in the future? Get in touch.
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