The Economy of Everything. The short story on Embedded Finance.
There is a high chance that today you have already experienced embedded finance — and most likely more than once. Taken an Uber? Bought a…
There is a high chance that today you have already experienced embedded finance — and most likely more than once. Taken an Uber? Bought a coffee with Apple Pay? Got that jacket online with Klarna?
Slowly and gradually the financial industry that once belonged to an independent category has been becoming a part of our everyday lives. With an increasing number of companies embedding finance as part of their value creation, the industry is on a trajectory to reach a massive US$ 7 trillion value by the end of this decade.
In this article, I want to lay out the key levers that drive the adoption of embedded finance and look into the future, where I believe, the industry will become the backbone of the new digital economy.
The customer-first approach.
Only 30 years ago, banking was something we mostly did at a specific physical place and at limited times. However, with the evolution of credit cards, ATMs, and mobile banking (thanks to the mass adoption of a smartphone), in the past decade, banks have expanded their digital footprint equipping their services with APIs, AI, and cloud computing to serve their customers better.
Embedded finance takes that customer experience one step further — it fully revolves around a customer’s need.
By integrating a financial service (payments, insurance, lending) into a non-financial one (e.g. a taxi ride), embedded finance seamlessly delivers customers access to traditional financial services, through another provider.
In today’s world where customers expect instant service delivery (hello Netflix and Amazon Prime!) and where their wallets have been replaced by mobile phones, it is not surprising that embedded finance has been becoming a new norm from a customer standpoint, making personal finance, once full of friction, truly frictionless.
Businesses win too.
However, a retail customer is not the only beneficiary of the embedded finance system. Non-banking merchants are branching out into financial services, not only to provide a competitive user experience but also to tap into often entirely new revenue streams. a16z predicts that, by embedding banking into their existing offerings, and through getting a share of interchange fees and capturing revenue from share agreements, software companies can grow revenue per user by up to 5x, compared to a standalone subscription.
For businesses, embedded finance can also create new data monetisation opportunities. Shopify, one of the earliest adopters of embedded finance, that uses AI to analyse customer data and deliver competitive rates on its merchant loans, has been generating almost 50% of its sales (!) from financial services.
Banking-as-a-Service and other enablers.
In the embedded finance supply chain, it is specialised fintech companies, Banking-as-a-Service providers (“BaaS”), that offer the regulatory and technological infrastructure that allows merchants to launch their own-labeled banking products. In general, BaaS providers either build on top of licensed partner banks (Soldo) or obtain their own license (SolarisBank).
In any case, via simple APIs and with traditional banking services treated simply as a utility, BaaS providers handle the development, integration, and even compliance aspects for a merchant, delivering a plug-and-play finance layer that merchants can directly add to their product offerings. Developers simply drop the code of any banking activity directly into their application workflow and orchestrate modular banking operations in the background.
As a result, a merchant can use BaaS infrastructure for everything fintech: accounts (Bankable), cards (Cardless), payments (Marqueta), loans (Synapse), KYC (Alloy) and focus on nurturing customer relationships, profitability, and the creation of new offerings without all the time and cost of traditional customer acquisition. This in itself has unlocked a new wave of business model innovation, transforming the way companies view their products.
For instance, Credit Karma which used to give free access to credit scores of people for pitching products to their customers has now integrated its own savings account. Google Maps recently announced that it is planning to roll out a new Google Maps service allowing everyone to find and pay for parking spaces directly through the app. Similarly, a Chinese app Yizhibo now allows customers to make a one-click purchase from company live streams via Ant Financial.
From less known examples, Saveo, a startup B2B marketplace for pharmacies, embedded banking last year to offer credit to its retailers, in turn, improving Saveo’s business cash flows. Also, Workflexi, the gig economy startup platform that helps hirers & workers to connect and get a ‘gig’ done now settles all the financial transactions including payroll within the platform.
Redistributing power.
As a result of described technological and societal shifts, embedded finance has been shaping the new role of tech companies, redistributing the power in the financial services sector as a whole. Retail banking is not dead (yet), but customer relationships, once belonging mainly to retail banks, are progressively being handed over to the application and technology providers, changing how finance is perceived and consumed. As Bill Gates noted in 1994: “Banking is necessary, but banks are not”.
Embedded finance has given rise to some of the most successful fintech companies of all time. Stripe, a payment provider, reached a US$ 100bn valuation, only 12 years after its founding. Wechat, a super app of China, reached over US$ 70bn valuation last year — that is more than top three major banks in China combined. Just nine years on, Plaid one of the hottest UK fintechs in the UK is worth US$ 13.4 billion.
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Everything finance.
Based on everything said, it is not difficult to imagine that in the new digital era, every company, even the one that has nothing to do with financial services, will be somehow connected to embedded finance. Thanks to the radically evolving BaaS providers, an increasing number of small businesses across a variety of verticals, from specialised SaaS to marketplaces and telcos will take advantage of it, and this will mean more choices, better products, and lower prices for consumers. I have tried to capture the spirit of this evolution in this article.
I am even more excited though about what lies on the further horizon —
I believe we are only seeing the tip of the iceberg when it comes to the role embedded finance will play in our lives in the future. I believe that the development of applications of embedded finance on the blockchain will open up yet another layer of this potential.
The externalisation of risk, funding, and infrastructure in the financial system will eventually eliminate traditional intermediaries such as banks, and allow blockchain native applications of embedded finance to abstract the way we perceive and understand the value. This will further shift financial power, not only to companies but more excitingly, to creators, and individuals — but that’s the material for a separate article (coming up next).
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Agata