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What VCs need to know about digital identity startups

  • The broken identity problem presents a huge opportunity for investors
  • VCs need to define whether they're investing in business or technology, security or access
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What VCs need to know about digital identity startups

The hottest word in financial technology right now is about digital identity.

“Identity is such a core component to being able to deliver financial services,” said Jay Reinemann, a general partner at fintech venture firm Propel Ventures Partners. “It’s the way financial services are priced. It’s a core component of fraud. Even from a governmental perspective, taxation requires identity.”

Here are three big distinctions investors make when analyzing a potential deal in the digital identity space.

Financial inclusion
In the developed world, fixing identity is important for matters of security. In the developing world, it’s a way to bring identity to those that don’t have an economic identity or financial access to those excluded from the formal financial system. Investors’ checklists and how they analyze potential deals will be different in each world.

Also, some jurisdictions don’t have national identity schemes. To some investors it may be easier or more interesting to look at investments in a country that has an identity scheme on the basis that it’ll be easier to create a digital version, but others will prefer to play in the gaps.

PTB Ventures, which invests in early-stage digital identity companies, is backing a company that uses biometric authentication in markets with poor infrastructure for authentication at registration, said managing partner Dave Fields.

“In markets that have really poorly developed infrastructure, creating this basic identity scheme can be really disruptive,” Fields said. However, “if their go to market strategy was based in the U.S. I don’t think people want to be waving their hands in front of cameras every time they need something to eat or are seeking healthcare.”

Reinemann takes a slightly different attitude.

“As long as theres a bad guy they’re always going to find new ways to falsify or to steal an identity to use it for something — whether theres a national identity system in place or not,” he said.

Collaborating with the government 
Despite the many entrepreneurs dedicated to the idea that blockchain technology can solve the fragmented digital identity problem, some VCs say it’s better to invest in a business opportunity build on top of existing technology — blockchain or otherwise — instead of investing in building new technology.

“We invest more in areas where there is a clear business case — trying to find places where to implement solutions,” Reinemann said. “Even in the U.S. … there are very clear requirement of what companies need to gather but a very unclear way of how to do it,” he added, citing banks’ Know Your Customer requirements.

Andi Dervishi, fintech global head of the International Finance Corporation, said it’s interested in companies that mine identity instead of building it.

“As we enter the digital world we leave traces on a day-to-day basis,” he said. “Companies not building identity, but identifying it by reading all these different traces, could be companies we’re interested in because they don’t have this dependence on the government, they look at what’s already there.”

Any early stage business requires some strong collaborating body, Fields said. Fintech startups are partnering with banks — OnDeck Capital and JPMorgan Chase have partnered on small business loans, for example. Digital identity startups are too. When it comes to digital identity, entrepreneurs would be better off thinking of regulators as partners instead of taking an antagonistic approach to them.

Paying for protection
In a perfect world, consumers would get the money from the deals that allow companies to monetizing our data, said Andre Boysen, chief identity officer of SecureKey. Amazon pays about a 2 percent for taking customer credit card information to make a transaction. That pile of fees over the course of a year would average about $50 if Amazon put that burden on the customer. Most customers wouldn’t pay that.

That’s one reason business-to-business companies make for easier investments, for the time being, than business-to-consumer companies: Customers aren’t willing to pay for their protection. There’s a knowledge gap, however. Customers generally understand that their data is being used for reasons beyond identifying them and being sold to third parties to use in some way. Most allow it so they can easily interact with the services they like.

“Actions can be driven by who is more directly bearing the cost of these things,” Fields said. “At a consumer individual level we suspect there are privacy violations but it’s hard to attribute the cost of it. A lot of times the violations are being born of the businesses… but potentially privacy of an individual will be more solved by people who are directly bearing the costs.”

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