Fitness trackers are on the outs, but wearables are not

May 8, 2014, 9:38 PM UTC

FORTUNE — The news broke on a recent Friday night: Nike Fires Majority of FuelBand Team, Will Stop Making Wearable Hardware. It was a shock to just about anyone who had bought, worked on, wrote about or invested in the white-hot category called “wearables.”

Hailed as the next big platform in computing, wearable “smart” devices like fitness tracking bracelets, clip-on heart monitors, Google Glass, smart watches and even smart wigs (yes, smart wigs) suddenly looked a lot less interesting.

If Nike (NKE), which had sold an estimated $33 million worth of FuelBand bracelets in 2013, employing 200 people and even running an accelerator program around the device, was no longer interested, did this spell disaster for the category? What does Nike know that the rest of us didn’t?

Since the news, the top wearable makers have openly touted the future of their business. This week at the TechCrunch Disrupt conference in New York, Hosain Rahman, CEO of Jawbone, said his company will expand the amount of data it tracks and services around it. Jawbone’s UP band accounts for 19% of the fitness tracking device market. Meanwhile Fitbit, which dominates the category with 68% market share, made a short statement to CNET that it’s been doing this for seven years, guys. Fitbit, with products like the Flex, One, and Zip, remains confident, “despite some of the recent sensationalized headlines.”

MORE: Why I failed as a quant junkie

Even Nike has clarified the initial report, saying it is not giving up on all of fitness tracking, only the hardware part. Nike will stop producing FuelBands itself, but it will continue to build software and fitness tracking apps for phones, smart watches, and whatever other form factor smart devices take.

Nonetheless, it’s clear the fitness tracking and wearables need to evolve beyond their initial offerings. Many of the fitness trackers in their current form are large, unattractive, uncomfortable bracelets. But an even bigger issue is what these devices do. As my colleague JP Mangalindan wrote earlier this week, his quest to become a quant junkie failed when the available options required him to use disparate systems that didn’t talk to each other:

One day, I just stopped using everything. I had invested hundreds of dollars into hardware and software and cobbled them together so I could to get a holistic picture of my day. But the process felt too complicated for its own good — a wristband for sleeping, another for the daytime. An app for eating, and then another running. Why couldn’t there be one piece of hardware and software to rule them all?

Beyond that, merely knowing how many steps you’ve taken each day isn’t all that compelling to a large, mainstream audience. It’s why one-third of consumers have abandoned their devices, according to a report by Endeavor Partners. Industry insiders say the number of inactive fitness tracking devices is likely much higher than that.

For wearables and fitness trackers to become a permanent part of our lives, the devices must become “need to have,” not “nice to have.” The only way to do that is to offer better functionality. I spoke with Sonny Vu, CEO of Misfit, about the future of the category. His company was called Misfit Wearables until recently, when it dropped the word “wearables” from its name.

MORE: In corporate wellness programs, wearables take a step forward

Vu said he expects fitness trackers to be a tiny part of the overall wearables industry. They’ll be like iPods and GPS trackers – useful to some, but no longer top sellers, and mostly replaced by smartphone apps. Fitness trackers will likely be killed by the smart watch, Vu says.

His company produced a fitness tracking wearable device for practice, even as he knows the category will quickly peak and decline. “We did it because we’re being opportunistic,” he says. “This is where things are going now, and we’re exercising our muscles as an organization to build and ship a product.”

The next step in the evolution of wearable devices will require a more compelling use case. It will need to pass the “turn around test,” he says. That means, would you turn around for it if you were halfway to work and realized you’d forgotten it? Most people would turn around for their phone, keys or wallet. But they wouldn’t turn around for their activity monitors.

“Fitness tracking is just not a compelling use case,” Vu says. “We makers haven’t been able to make it sufficiently compelling. It doesn’t pass the turn around test. It doesn’t even come close.”

Vu is already scheming up ideas to make wearable devices more compelling.

One way to pass the turn around test is with “persistent identity.” Better than fingerprint recognition, wearable devices would use a person’s heart waves to identify them. This proposition becomes compelling, “if it identifies you, opens your car, turns on your lights and you can use it to pay, all with your physiological signature,” he says, “and once your take it off of your body, it is no longer a secure device.”

Vu said this would be similar to Disney’s MagicBands, the bracelets that allow families visiting a Disney (DIS) theme park to check in, unlock their hotel rooms, enter parks, pay for goods and connect to their photos online, all by scanning a bracelet. MagicBands essentially replace keys and wallets within Disney’s properties. “That is something I could get behind if they could make it a little nicer and it worked outside of the Magic Kingdom and in the rest of the world,” Vu says.

MORE: Meet the designer behind the Fitbit

That’s one direction the hot category of wearable devices is likely to go. But for now, Vu is sticking with fitness trackers. Launched in the fourth quarter of 2013, Misfit sold 200,000 devices, a number that’s increasing each quarter. He expects that, like the market for iPods and GPS trackers, fitness trackers like his will decline, and some hardware makers will follow Nike’s footsteps, focusing on smart watch software over hardware.

The era of fitness tracking devices might be waning. But for wearables, it’s still early days.