Fintech 🧠 Food - The Frontier of Embedded Finance

Hey everyone 👋, welcome to Brainfood, the weekly read to go deeper into Fintech news, events, and analysis. Join the 33,596 others by clicking below, and to the regular readers, thank you. 🙏

Hey Fintech Nerds 👋

👀 When I saw JP Morgan is launching Payroll in partnership with Gusto, it struck me that Bank and Fintech partnerships are all the rage right now. Banks need growth, Fintech companies need growth, and everyone needs great partnership managers. (More below)

👀 PayPal is also making its Stablecoin available to Venmo. I think this could be how Venmo starts to get more into Remittances. Combined with launching its off-ramp, PayPal is slowly, consistently backing its Stablecoin efforts (More thoughts below and full Rant coming on Stablecoins next week).

Speaking of Rants.

📣 Existing embedded finance products will grow, but the new products offered as APIs are the frontier. This post explores the existing products, their growth, and where the new ones fit in. How? Read the Rant.

PS. Thanks to a16z for letting me share thoughts on why the UK is the Goldilocks of Fintech innovation. Check it out if you can’t get enough 🧠🍣

Let’s do this.

Here's this week's Brainfood in summary

📣 Rant: The frontier in embedded finance 

💸 4 Fintech Companies:

1. Keep - Spend Management for Canada

2. Capi Money - International Payments for African Importers

3. Enduring Planet - Working capital for climate entrepreneurs

4. Koltin - Digital Health Insurance for Mexico 

👀 Things to Know:

1. PayPal launches USD Off-Ramp for US-based users + Adds Stablecoin to Venmo

2. JP Morgan to launch Payroll to compete with Square

📚 Good Read:

1. Plaids perfect timing

You’re probably missing half of Brainfood if you use Gmail. Click below to see the full thing!

Weekly Rant 📣

The next frontier in embedded finance

(The embedded finance machine, generated by Stable Diffusion with the prompt “imagine a machine that embeds finance in a matrix future dystopia where the whole economy is water”).

Embedded Finance, like all financial services, is coming up the complexity curve.

The frontier is complex products like fixed income, insurance and the private markets.

Payments and lending are embedded, but their battleground is regulation and unit economics.

If the rumors are true that Goldman has taken a kick from the Fed over its partnership division, you have to wonder if the revenue projections for embedded Finance can ever be delivered.

I think they will.

Two things are happening in the market.

1. Early embedded finance products are finding maturity

2. A new frontier of embedded finance is emerging

This Rant explores both.

Let's dive in 🏊‍♀️🥽

(If you want to see the new frontier products, skip to section 5, but the data nerds will enjoy the first few sections, many pretty charts).

1. The business case for embedded finance

2. Recap: The business case for banks from mature products

3. Recap: The business case for payments processors from mature products

   1. Gen 1 Processors (founded pre-2000)

   2. Gen 2 Processors (founded 2000 to ~2015)

   3. Gen 3 Processors (founded 2015+)

4. Where the growth of existing Embedded Finance revenue lines is happening

   1. Neobanks are cross-selling with more lending and new products

   2. Fintech and SaaS companies also want to cross-sell but have more product work to make it coherent with their offering.

   3. A new breed of startup builds with atoms, not bits, and can "embed" in new ways

5. New products are the frontier for embedded finance

   1. Fixed-income and treasuries are a new default

   2. Private credit is having a moment

   3. Insurance is having a moment, too (finally)

   4. Lending innovation is a constant source of innovation and future wedge products

6. The Embedded finance "risk" story is a sign of maturity.

   1. The mood music isn't good

   2. But clarity follows adoption

7. The future of finance is horizontal and embedded

1. The business case is a no-brainer.

Embedded business-to-business payments will reach $2.6 trillion by 2026, generating $6.7 billion in revenues for platforms and enablers

On the surface, it looks like everyone wins.

• Regulated banks and insurers get more deposits, customers, and "Zero CAC" or marketing spend. 

• Payments companies get higher total processed volume (TPV) 

• Every company gets a new revenue line as they monetize payments, lending, fixed income, Insurance, or deposits.

• New infrastructure companies capture the opportunity by serving this new market demand, reducing time to market, and aggregating a complex network of suppliers.

Projections are easier to make when we have more mature markets. You can see this with banks and payment processors. 

2. The business case for banks is a lifeline.

I wrote in "The future of embedded Finance"

Banks need new products and new revenue.

Since the collapse of SVB, it has been a tough market for bank stock prices.

In fact, the whole past decade has been ugly.

Despite higher rates driving more core profitability, the marketing isn't turning that into share price growth.

After decades of underperformance in a low-rate environment, bank stocks can't catch a break.

(Credit: Images from Yahoo Finance, S&P and text my own)

The smallest banks (sub $10bn in assets) have navigated the market shift well. Partly because they're nimble, but in some cases, they're embedded finance specialists. The largest banks are so large that their worst-case outcome is a malaise like the one in which Citi Bank finds itself. 

The squeezed middle.

The pain is in the mid-sized banks. 

Too big to be nimble, to small to be massive, these banks get lumped together no matter how well they perform. Many banks outside the top 20 in the US would be top 5 banks in markets like Canada or the UK by asset size. But in the US, they need an investor story to stand out. 

Deposits are heading to fixed income or being risk-managed across multiple banks. Fewer deposits give a bank less firepower to lend. They need to find growth. The market wants to see M&A or something. Without that, the stock returns are ugly.

That's why I found it interesting that Fifth Third acquired the BaaS platform Rize Money. They're squarely in the "mid-sized" category and have a solid payments and transaction banking pedigree.

If Goldman was too big, Wells and Citi too in their own way, and the smaller banks, is the next phase of embedded finance mid-sized banks owning more of the value chain? (We'll come back to that later).

Embedded finance is a massive new revenue opportunity.

And mid-sized banks need it the most.

3. The business case for payment processors? 

Marqeta's biggest customer was not a bank until recently (Block), and Galileo's biggest customer is not a bank (Chime). So, the short answer is yes. The longer answer is more complicated for two reasons.

1. Embedded Finance is much more than embedded debit card payments.

2. Not all processors are created equal.

Card issuer processors come in three "generations." 

a) Gen 1 issuer processors are typically founded before the year 2000. Examples are your household names FIS, Fiserv, Global Payments (TSYS), etc. These companies are the products of decades of M&A ~100+ products, from core banking to payments to digital banking. They sell to the smallest and largest banks across segments and Geographies. 

For these companies, getting into embedded finance is the hard part. They have all the small banks as clients who might want to enter this space, but should they buy, build, or partner? FIS has moved with what appears to be an opportunistic acquisition of BaaS platform Bond. But what's the Go To Market and business case? Let's see if their competitors move.

It can work for this segment; they have all the distribution and none of the execution. Execution will be everything.

b) Gen 2 was founded from 2000 to ~2015. Examples are companies like Marqeta, Galileo, i2c, Thredd, etc. Either private equity backed, public, or randomly acquired by SoFi because why not. Most of their revenue comes from a single region (e.g., The Americas or Europe), and their product set is rooted in their core card issuer processing. They haven't gotten into M&A yet but might.

These companies are net beneficiaries of the early Fintech boom. Today, they are torn between chasing bigger enterprise clients or ensuring they're well-positioned for embedded finance. Enterprises want ever-better pricing and stability. Embedded finance clients want faster time to market and more flexibility.

c) Gen 3 from 2015 onwards includes Lithic, Highnote, and Episode 6. Typically venture-backed, their revenue and product market fit is a work in progress. Their product set is typically core processing but with an insane level of customization that comes from being ultra-modern tech stacks.

While it's hard to name a massive company built on the newer processors, their clients are either a) Often as young as they are or b) not your typical growth company. I know one of these companies supports a project for a global bank, and another has a massive fleet card client. As you get closer to the metal, the product innovation that can be unlocked is astonishing. But that's not an easy mode product to build.

4. Growth of existing Embedded Finance revenue lines. 

There are many types of companies embedding Finance. Non-bank financial brands (e.g., Neobanks or Payroll companies), Non-bank digital brands (e.g., SaaS platforms like Shopify), and Non-bank atom brands (e.g., car companies, airlines, hotel chains, and everything else that's not online).

a) Neobanks are cross-selling with more lending. The larger Fintech companies raised in ~21/22 have a large valuation to grow into and a focus on costs. They're probably already doing debit cards, maybe even credit or charge cards, but cross-selling is the big embedded finance opportunity. The one consumer "Neobank" really crushing is SoFi, and they went big on cross-selling early. The B2B companies have gone deeper into treasuries, SaaS, and revenue-based finance.

These companies need to cross-sell and are on the front line of making it more compliant. If there's a space to look for who's doing the hard yards on "embedded everything and managing risk." This is it.

b) Fintech and SaaS companies also want to cross-sell but some are entering the frenemy zone. Stripe capital has been around for a few years, and it's normal to see working capital loans distributed through marketplaces or SaaS companies. SaaS multiples aren't what they used to be, and there's a push for growth from product extension. 

Embedded features are the default but can have unintended consequences. Here's an example of Quickbooks, the long-time partner of Bill.com, now building a competitor. Oh, and they cut off Bill.com's API access, too. Unit CEO Itai predicts this will happen much more when everything is easier to embed.

Everyone is a frenemy at scale.

The Frenemyfication of Fintech feels like a Rant title. 

c) A new breed of startup builds with atoms, not bits, and can "embed" in new ways. Traditionally, sleepy sectors like car manufacturing or defense now see Tesla and Andril as major market actors. This is coming to every sector as software engineering philosophies become the default way to build any company. 

This starts with fleet cards but could head in some super interesting directions. Why wouldn't the Tesla Semi be available on a lease from Tesla Finance one day? Why wouldn't pre-fab house builders change the economics of owning or renting?

5. New products are the frontier for embedded finance.

a) Fixed-income and treasuries are a new default. Have you noticed how every Fintech or Neobank suddenly has money market funds and T-Bills available? Infrastructure companies like Atomic Invest abstracted much of the complexity and made an entire company and product category exist. Every B2B Neobank, financer, or operations platform is now embedding T-Bills. 

This makes complete sense for a Fintech company; their clients want to extend their runway and get a higher yield. 

The banks aren't offering it. 

It would be daft for a bank to offer a product that competes with their deposit offering. Banks want deposits; this fuel (funding) enables them to lend.

Fintech companies can offer this product.

b) Private credit is having a moment. Professional investors and family offices use private credit to create a balanced portfolio. It helps diversify and offers consistent returns and low volatility. Sounds great, but you can't have it. If only you could, and it was embedded into everything you use daily?

Companies like Percent give direct access to private credit for investors, Moment allows any company to embed private credit through its APIs, Tradeable helps syndicate the loans, and PactFi is a platform that helps arrange credit issuance. (h/t Nik Milanovic for a couple of these; you should be an LP in his fund* already).

Private markets broadly warrant a whole Rant. There are approximately 22k publicly listed companies, vs. 98,000 private. Publicly listed debt (credit) is around $106trn vs. $250trn private. Publicly listed real estate is around $10trn vs. $317trn private. (Source). (I have a whole list of companies in this sector, too, but you've got to wait for that Rant).

(Image from the Ownera homepage)

You're systematically paying too little attention to private markets and the infrastructure stack that supports it.

c) Insurance is having a moment. Growth rounds are dead everywhere except for Insuretech. Rarely does a week pass without an Insuretech infrastructure company hitting a growth round and winning significant clients (Neobanks and classic banks). Insuretech was always, "will it ever happen." And now, when everyone looked away from finance broadly, Insurance is having its moment. 

These companies have strong unit economics. By its nature, profit in Insurance is about risk management. A company that is good at managing risk might not grow as fast as WeWork or a meal delivery service. My hypothesis is that these companies got overlooked during the ZIRP growth-chasing market of 2021 but quietly, steadily built great businesses with solid unit economics.

Bain's 2022 report notes that a decent chunk of market cap opportunity for "embedded finance" comes from insurance. Given it's decade of "will it ever happen," there's a good chance you're systematically paying too little attention to Insurance.

d) Lending innovation is a constant source of innovation and future wedge products. SoFi made its name in student lending, Starling Bank became profitable business lending during the pandemic, and "BNPL for business" is just getting started. 

The ability to offer finance to anyone buying from you drives more sales. 

Splitting any large payment into installments gives users a sense of control and (done well) can help manage cash flow.

I really liked what Episode 6 is doing with "Business Now Pay Later" to split a business payment into installments. They've put the onus on the finance team to paying from the banking dashboard to split the payment into installments. The reality for most businesses is that's where they have to go to push a button no matter what other software they use. 

Which made me wonder. Where else do we push buttons that lending could show up?

Payment is the core primitive of finance; it is in service of a better cash balance for the user. Cash flow smoothing, better managing weird structural debts, funding your rental deposit, and just dealing with the stupid quirks of finance have just scratched the surface. 

Lending innovation always sounds like a recipe for risk. Each new lending product will run a compliance and regulation gauntlet, but that's a badge of honor. It's a sign of success. We still need to get it right. That's why there are always zero downsides to starting at risk and working backward.

6. Embedded finance risk story is about maturity.

a) The mood music isn't good. If the big banks are going to arrive, the news that Goldman is in hot water with the Fed won't help. 

Per Jason Mikula

If we have a Cambrian explosion of products distributed in various places from multiple providers. 

Imagine a digital business selling to businesses with embedded Insurance, fixed-income, and working capital products. Let's call this company Hopishy. Hopishy customers can get a higher return on cash with T-bills, manage their supply chain with working capital, and insure against cyber risk or fraud all in one place. Great!

Who's responsible for what, with what product? 

Oof.

b) Clarity follows adoption. Embedded finance will sort out its risk management to hit scale. Success stories don't make headlines as easily as negativity when the narrative is "Fintech bad." But the counter-narrative is how banks adopt Fintech infrastructure to automate and manage risk.

We wouldn't be debating embedded finance regulation if nobody used it. We need to acknowledge that it is solving problems for consumers and businesses. 

As companies hit scale, they either figure out regulation and risk management or face consequences. The consequences can range from a regulatory fine to being unprofitable to existential. For example, an executive can be arrested for substantial BSA/AML failings as they head through an airport. 

7. The future of finance is horizontal and embedded. 

Financial services is a horizontal that thinks it's a vertical.

Finance is fuel for the journey, not the destination.

Payments are embeddable. Lending is embedded.

Every company has a legal, HR, and finance department. They likely don't have a water or energy department. 

Lawyers, HR firms, and energy and water companies don’t have branches.

Finance is on an inevitable and unwinding path to becoming a utility, and that's a good thing. 

It just needs to admit it to itself.

To the objection "but some bits will always be too complicated for an API." I get it; some bits are complicated. But betting against automation is like betting against gravity. It's a law of nature. 

Have you ever heard the quote, "Sorry I wrote you a long letter, I didn't have time to write you a short one?" 

I feel the same about product. 

Embedding the enormous complexity of capital markets into a clean API is a work of magic.

A great product is often about what you take away more than what you add. People couldn't believe the iPhone "didn't even have" copy and paste at launch. 

The future rarely looks like the past. The future customer wants different things. That's why a sleepy bit of financial services like fixed income can become the next big thing in Fintech.

Finance is being disrupted steadily upward through the complexity curve.

You can't fight an inevitability.

Your strategy question is to figure out how you position yourself accordingly.

• As a bank, do you build more things at the last mile (like how JPMC is building a travel agent)? Or enable this new world? Or both?

• How do you enable your incumbent banks as a payment processor, and how should you think about M&A? 

• If you're in private markets, is now your time to get into Fintech?

I once heard that for an incumbent, the optimal strategy is often to do nothing. Wait for the market to figure it out and adopt it when it is big enough to matter.

They'll do that with embedded finance, too.

But by then, they've missed all of the growth opportunities on a slow, inevitable slide path to eroding market share and mind share. 

That's your opportunity now.

Get to it, Anon.

ST.

4 Fintech Companies 💸

1. Keep - Spend Management for Canada

Keep offers a corporate credit card for Canadian businesses with higher limits, rewards, and "no impact on personal credit score." The value proposition is similar to early Brex, targeting founders who often use their personal line of credit to fund the business. 

🤔 As Baas goes North, so do the propositions, not the unit economics. This spend management category is super competitive in the USA but hasn't caught fire as much in Canada despite a burgeoning startup market. It's now homegrown spend management vs. US market entry. Yet the infrastructure landscape to deliver this is very different. Canada is unique in having very few sponsor banks. You'll notice this (and most others) use Prime Trust. This is a massive opportunity for one of the regional banks. 

2. Capi Money - International Payments for African Importers

Capi allows African businesses to pay in Euro, USD, or GBP "on time, every time." They promise the best exchange rates, fast transactions, and, above all, reliability. Businesses in Africa often have to wait weeks for invoices to be processed, and branches manage most payments.

🤔 Fintech for business has a long way to go in Africa. As the continent sees demographic shifts and slowly becomes an economic powerhouse, it needs the same infrastructure the rest of the world enjoys. Most businesses' bank experience is stuck in the 1950s at best. 

3. Enduring Planet - Working capital for climate entrepreneurs 

Users sync their bank, accounting, and payment systems with Enduring Planet to access "non-dilutive funding" without a personal guarantee. EP offers revenue-based financing and an advance for government-funded climate grants. 

🤔 The climate startup sector is super hot (excuse the pun). But because you're often investing in Atoms, not Bits, physical things, not SaaS, the risk of these businesses is usually higher, and the data required to lend is specialist. This is the kind of data set most banks wouldn't understand, but a specialist lender would. Just as non-dilutive funding and BNPL for business are now successful in SaaS companies, the same specialism for climate.

🤔 PS. Isn't it funny how "debt" is now "non-dilutive funding?" 

4. Koltin - Digital Health Insurance for Mexico

Koltin is a private healthcare service available via the phone and WhatsApp to focus on preventative care, and plans start at $3 per month. Underwriting takes an average of a day. Koltin has seen 40% MoM growth since launch and 90% retention.

🤔 This market with public healthcare lacks a private alternative in a market that will shift demographics over the coming decades. While still a relatively young population, Mexico and LATAM are aging fast. Across the continent, many adults cannot afford care and rely on their younger, working relatives to pay unexpected bills. 

Things to know 👀

1. PayPal Adds Stablecoin to Venmo + launches USD Off-Ramp for US-based users.

📰 The news: PayPal also added their Stablecoin PYUSD to Venmo for a select group of users. PayPal says this will extend to all users in the coming weeks. Additionally, PayPal's new off-ramp allows users to convert directly from Crypto to Fiat from wallets like Metamask and Ledger into their accounts. This builds on launching their Stablecoin PYUSD and an On-Ramp product last month.

🤔 The Stablecoin could be how Venmo gets into remittances. Venmo is the logical home of the Stablecoin offering. Most consumer remittance flows are people sending money home to family. One of the most cost-efficient ways to do that is via a Stablecoin (assuming the family member can receive Stablecoins). There is a “last mile” problem here for entrepreneurs in the global south to start to solve.

🤔 I see this as part of the trend as Stablecoins creep towards legitimacy. PayPal is staking a good chunk of its reputation, staying the course with Stablecoins. Stablecoins are quietly becoming the legitimate edge of the crypto industry and another payments rail.

🤔 This news also follows Visa launching instant payouts to Nuevi and WorldPay as a settlement mechanism for payment acquirers. Not all acquirer processors are banks (in fact, most aren't). Getting paid faster is something they want. A point many missed when the news hit.

🤔 From a compliance standpoint, the off-ramp is smart. PayPal know the source of the funds (the wallets and the entire history of that wallet) and the destination (the PayPal account). Limiting risk surface area is a very "big company" thing to do.

🤔 The pattern continues stable coins of the one area that don't seem to be getting regulatory pushback. Is it time to take it seriously? What are you and your business doing about it?

🤔 Off-ramps make Crypto more seamless. It was always easy to get into Crypto, but getting out was harder. Now, it's a two-way street and is steadily becoming more seamless.

🤔 We are in the depths of a bear market for Crypto. People don't want to hear or talk about it because it's not GenAI. One might argue that this is just a big company delivering things they started 2 years ago. Another might be that this shows a demonstration of long-term commitment and conviction. If they're staying the course, what do they see that you don't see anon?

2. JP Morgan to launch Payroll to compete with Square

📰 The news: JPMC will offer digital payroll processing to appeal to small businesses in partnership with Gusto, the Fintech company. Customers of Chase payment solutions can run Payroll through the same login they use for their banking. The service is set to go live in 2024 and will be available to JPMC's 5 million small business customers, of which 200,000 use Chase payment solutions. Gusto has 300,000 customers and was last valued at $9.6bn.

🤔 Banks have so much more opportunity to partner for growth. This is a new case study example of a bank with amazing distribution partnering with a Fintech company that can deliver enterprise-ready services. Banks systematically do not partner enough, and it's a massive opportunity.

🤔 This is a huge win for Gusto. Rippling and possibly Intuit could have been in the hunt for this partnership. Even if 10% of the Chase payment solutions customers adopt the service, that's needle-moving growth for Gusto.

🤔 Banks can't be told what the future is; they have to see a competitor do it first. Would Chase have rolled this out of Square, and PayPal hadn't already? I highly doubt it.

🤔 Other banks can take lessons. Enterprise-ready Fintech companies can help you cross-sell to your existing client base, reduce costs, or get more operationally secure. Build the partnership muscle. 

Good Reads 📚

1. Plaid's perfect timing

Plaid caught the wave of Fintech unbundling by solving account verification. Instead of waiting 3 to 5 days for a payment to clear to prove you owned an account, you could simply "login via Plaid" and achieve the same objective. At the same time, Chime, Varo, and the early Fintech companies began unbundling every bank product you can imagine in the mobile and cloud revolution of the 2010s. 

They almost got acquired for $5.3bn by Visa, which massively validated Fintech as a sector, then when it got overturned, the consensus was they got a good deal. They'd go on to raise at a $13.4bn valuation a year later. This is a Russian dolls of Fintech moment. Alex Johnson is reacting to a Generalist article about Plaid, and I'm reacting to that. Lol.

🤔 In many ways, Plaid is the flag bearer for Fintech itself. "Plaid for X" is a category of company. Along with Stripe, they are a benchmark for developer-focused products and design. Their move into payments is meaningful. As a European, I observe Plaid has also defacto made "open finance" a thing in the US without regulation. Credit where it is due.

🤔 Like Fintech, it's leaving its teens and having to get a job (profit). They're more grown up, investing in relationships with banks and leading the charge for much of the Fintech sector on policy. Perhaps the most exciting signal for me was their partnership with the "payroll APIs" like Atomic and Pinwheel. They're not trying to build all the things but focus on what they're great at. 

🤔 Their Achilles heel is conversion. The classic meme from Anchorman, "60% of the time, it works every time," applies here. To be fair, this isn't Plaid's fault; we all know some banks break that connectivity, and for its part, Plaid has an open hand for partnership. But the banks' incentive will require a lot more carrot and a regulatory stick. I mentioned the Akoya and Fiserv partnership in the open last week because it signals banks and incumbents are fighting back.

That's all, folks. 👋

Remember, if you're enjoying this content, please do tell all your fintech friends to check it out and hit the subscribe button :)

Disclosures: (1) All content and views expressed here are the authors' personal opinions and do not reflect the views of any of their employers or employees. (2) All companies or assets mentioned by the author in which the author has a personal and/or financial interest are denoted with a * (3) Any companies mentioned in Rants are top of mind and used for illustrative purposes only. (4) I'm not an expert at everything you read here. Some of it is me thinking out loud and learning as I go; please don't take it as gospel—strong opinions, weakly held.