Standing on the Shoulders of Giants: Embedded Finance

Picture this. It’s 1990 and the world’s first web browser, WorldWideWeb, has just been built by Tim Berners-Lee. Most of the household tech names as we know them don’t exist yet, and the idea of speaking to someone across the globe… over video… with just a click of a button is still SciFi.

How did tech change so quickly in 30 years?

Basically, each tech innovation built on top of what came before:

• After the launch of the WorldWideWeb in 1990, innovators built commercial browsers, like Netscape (1994);
• As web browsing gained popularity, we saw a growing business case for search engines, like Google (1998);
• As search engines became widespread, it became possible to build on top of that, creating ‘online directories’ connecting individuals through social networks (LinkedIn in 2002, Facebook in 2004);
• Social networks made us more interconnected, increasing the appeal of smartphones (first iPhones released in 2007);
• Smartphones laid the foundation for mobile apps (App Store released in 2008).
  

The same way the internet provided the building blocks for social networking websites, smartphones and mobile apps, we’re now moving towards an era where financial services provide the building blocks for other applications.

In today’s world — where banks are being “opened up” by regulators, where partnerships between banks and startups are flourishing — a new breed of Fintechs are emerging that provide the infrastructure needed for any company to add financial services to its product.

Also known as embedded finance.

Adding financial capabilities to any product

In simple terms, embedded finance is about adding financial capabilities, such as payments, lending, deposits, and insurance, to any product.

For example, imagine you are selling goods on an e-commerce platform — let’s call it “Rainforest” — and you receive payments in return for each good sold on the platform. Typically, Rainforest would pay you in your local bank account. You would then transfer this money to other bank accounts in order to pay your suppliers.

Now suppose that the platform decides to offer you a Rainforest bank account in which to directly receive all payments for goods sold. To do this, Rainforest would normally need to acquire a full banking license. This requires jumping through hoops to meet regulatory requirements, such as anti-money laundering, capital adequacy, deposit protection… the list goes on.

With embedded finance, a third party could provide Rainforest with this banking infrastructure, as a service. All of a sudden, it would become possible for a non-bank business (Rainforest) to provide banking services (bank accounts) to its sellers by using a third party (banking-as-a-service provider).

But why on earth would an e-commerce platform like Rainforest want to provide its sellers with bank accounts in the first place?

Embedded finance increase loyalty, lifetime value and revenues

For starters, these products increase customer loyalty. With a new Rainforest bank account, you, as a seller, are now able to receive payments instantly and conveniently on the platform. With the funds that you receive in your account, you are also able to directly pay your suppliers on Rainforest, without ever having to leave the platform. The Rainforest platform now becomes a lot stickier for you, as a seller, thanks to your shiny new bank account powered by the banking-as-a-service provider.

Embedded finance also increases the lifetime value of each customer. As you start to build a relationship with Rainforest, you feel more comfortable sharing your transaction data on the platform, which provides helpful insights into your creditworthiness. This, in turn, makes it possible for Rainforest to offer you new products — not just a bank account, but also potentially loans — at a better rate. In the end, the Rainforest platform has become more relevant for you when growing your business, and you are a more valuable customer for Rainforest.

In addition, embedded finance presents new revenue opportunities. In the past, Rainforest was restricted to earning revenues from its core product alone — say, the commission on goods purchased on the platform. By embedding bank accounts into the platform, Rainforest can now break this revenue ceiling and earn additional revenues.

Beyond what it earned before, Rainforest will now also earn a float on each bank account and could receive a share of the interest income on the loans. As such, these new products make it possible for Rainforest to diversify its revenue streams and increase recurring revenues.

Finance will become a building block on which any company can be built

The good news is that these benefits are very achievable because third party providers of finance infrastructure are not just fictitious.

Stripe recently ventured into the embedded finance space with its latest Stripe Treasury offering and, just this year at Speedinvest, we invested into both Agro.Club and ShopUp, two startups that embed financial services into their core product.

As more Fintech startups emerge that provide payments, lending, deposits and insurance infrastructure-as-a-service to any business, it will become easier and increasingly commonplace to embed financial services into products. This, in turn, will make them a key building block for any company.

In short, embedded finance will be an easily accessible toolkit that any company can use to grow customer lifetime value, loyalty, and revenues.

In providing this toolkit, a whole new ecosystem will emerge — an ecosystem of financial infrastructure-as-a-service, one in which new Fintech startups provide the building blocks needed to help make finance a seamless part of the customer journey.

An ecosystem in which each new innovation can continue standing on the shoulders of the giants that came before it.

And the potential of this innovation is just beginning to be realized.‍

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