Embedded finance: Unlocking the new frontier of digital banking
Jonathan Chang & Oliver Henry
February 27, 2023
Oliver & Jonathan's Perspectives
Hi! Welcome to issue #3 of Daydreams by Daydream Ventures. Daydreams is our brainchild and canvas, letting us write about life, startups, venture and allows us to craft theses on weekly observations. We are officially starting March soon and it's almost the end of Q1. Just got back from a few trips and in March, planning to be in Seattle, Austin for SXSW, and Vancouver so if you are around any of these cities, would love to meet up! For everyone that used to get my Jonathan's Deal Flow Corner emails, this is going to be the new replacement to those, featuring commentary, highlights to rising stars in the space, but as always, dealflow. As always, if you want an intro to any of the companies in the deal flow corner, let me know and I'll be happy to connect! Happy readings. - Jonathan Chang
Hi it's Oliver, co-GP of DayDream Ventures! We are excited to bring issue #3 for you here - filled with great content on embedded finance, startups we are excited about, and interesting roles we've seen across our networks. We are launching a new partnership and releasing our next syndicate deal soon, so be on the look out for exciting updates soon!
Miami was awesome these past few weeks, now back in NYC. Officially ready for spring and rooftop season. - Oliver Henry
Embedded finance: Unlocking the new frontier of digital banking
Realize that everything connects to everything else - Leonardo da Vinci
We at DayDream Ventures view the future of tech as more connected and integrated, and finance will be at the core of all decision making and customer experiences. For that reason, we are bullish on emerging trends and startups within embedded finance. Embedded finance is not a new idea, but what is new is the growing number of applications and opportunities emerging within the space. A space that has previously been dominated by consumer payment options with little differentiation is seeing new methods for disruption across every industry and across the value chain. We are excited about what the future holds in the space in industries where core value propositions and finance are still separated.
What is embedded finance?
Embedded finance is the integration of financial services into non-financial product and service experiences to enable more cohesive customer purchasing experiences. Embedded finance is at work when an e-commerce merchant provides product insurance, a coffee shop app offers 1-click checkout, or a department store offers loyal customers branded credit cards. The embedded finance market grossed $54B globally in 2022, and according to Future Market Insights it is projected to grow to $248B in the next 10 years.
According to Plaid, 88% percent of companies that implement embedded finance capabilities report increased engagement, and 85% say that it helps them acquire new customers. Embedded finance has become a necessary part of non-financial companies’ tech stacks in order to provide superior customer experiences.
Current state of embedded finance
Embedded finance is already all around us. Retailers, software firms, marketplaces and platforms, telecom companies, and Original Equipment Manufacturers (OEMs), to name a few segments, have all seamlessly incorporated financial products to provide better customer experiences and increase customer wallet share and engagement.
Some core products these companies have deployed include deposits, payments, card issuance, and lending. For example, buy now pay later (BNPL) grew exponentially over the past 5 years, a core product offering within the unsecured lending vertical that has allowed marketplaces and retailers to attract new customer segments and incentivize stronger spending behavior.
Source: McKinsey & Company
These core embedded finance product offerings are not all created equal from a revenue generation perspective. Consumer payments has led the way historically as the greatest revenue driver within embedded finance.
Source: Bain & Company
We are excited about emerging embedded finance applications (many in the B2B sphere) that stand to grow substantially given new technology advancements and untapped market opportunity. Some include insurance, investing, customer loyalty apps, digital wallets and DeFi, accounting software, and many more.
Embedded Finance Value Chain
A few key buckets of distributors have emerged that have adopted embedded finance products in meaningful ways. However, they do not have the capabilities to deliver end-to-end solutions themselves given their specific core competencies, difficulty associated with standing up complex technical financial solutions, and time needed to develop strong capital sources in cheap and regulated ways. For those reasons, they typically work with technology providers and balance sheet providers to complete the value chain.
Source: McKinsey & Company
Technology providers (fintechs) provide the platform through which distributors can access, customize, and offer embedded-finance products. Companies like Marqeta, Unit, Bond, and Alviere operate platforms that offer distributors products such as deposits, money movement, and lending. DayDream Ventures has made its own bet that technology banking providers are not serving much of the long-tail of the distributor ecosystem, and thus invested in Lynk (alongside Tribe Capital), a Banking-as-a-Service (BaaS) platform to enable startups, SMEs, and mid-size enterprises access banking products.
Balance sheet providers (banks) offer access to capital for financial products. They often partner with technology providers (and in many cases are leveraged through open banking) to create an integrated embedded-finance offering for distributors, and also are building their own technology solutions for distributors. For example, Stripe partners with Goldman Sachs and other banks to offer payment solutions to platforms and third-party marketplaces.
The race between banks innovating and fintechs disrupting
Fintechs are successfully inserting themselves in the finance value chain between balance sheet providers and distributors due the speed, ease of use, digital nature, and technical sophistication they offer. The fintech vs. bank war to acquire market share draws parallels to Marc Andreessen’s infamous article Why Software is Eating the World: fintechs are gobbling up customers quickly while the legacy, large incumbents struggle to innovate and adapt to changing consumer preferences.
Where does this war stand today? Banks still dominate most segments of the financial services market, according to a report from Boston Consulting Group titled "Embedded Finance and BaaS: Unlocking the Full Potential of Open Banking". BCG found banks hold 70% share of higher margin segments such as mortgages, loans, and credit cards. Banks also have an 80% share of lower margin businesses such as savings accounts and checking accounts. However, the tide is slowly shifting in favor of the newcomers as fintechs continue to capture more market share due to their speed of execution, ability to cheaply and efficiently acquire customers, and nimbleness to adapt to changing market trends.
Company Spotlights
We already shamelessly self-plugged our portfolio company Lynk as one of the exciting startups in embedded finance. Below are a few more we have come across that are shaking things up:
Debbie: Debbie is helping people pay off debt. Debbie is partnering with banks and credit unions to enable their users to make more sound financial decisions. This in turn helps their balance sheet lender partners better underwrite and assess risk for these customers. Debbie also acts as a natural customer acquisition engine for balance sheet lenders, thus bringing tremendous value to both sides of the debt consolidation ecosystem.
- Stage: Pre-Seed
Ascent: Ascent is building the no-code underwriting platform for balance sheet providers to better assess risk for their SMB customers. Ascent incorporates bank and credit union data, 3rd party data, and company-specific financial data to provide a better snapshot of SMB company risk. This technology is key for all parties to more effectively and expeditiously assess risk and access financing.
- Stage: Seed
Pave: Pave is helping banks and fintechs turn financial data into reliable credit decisions. Pave works with these partners through their Cashflow APIs to rapidly build underwriting models and predict payment information for consumer clients. This platform is invaluable to banks and fintechs to help them accurately assess risk quickly and extend credit judiciously.
- Stage: Seed
Looking to the Future
We at DayDream Ventures are consistently monitoring trends within the embedded finance space to find startups that are building within sub verticals that stand to benefit most from fintech disintermediation. Below is a figure that describes well how some industries have effectively incorporated embedded finance applications, while others are more nascent and open to disruption.
Source: Bain & Company
For us, we still see tremendous opportunity in the space. At the intersection of experienced and passionate founders, novel technology advancements, product-led growth, and undisrupted large markets that stand to benefit from fintech disruption - that is where we are excited to invest next in embedded finance.
Companies Raising
All are companies that we've chatted with that are mainly raising their pre-seed/seed/Series A rounds from angels and VCs. Happy to make any intros to any of the companies below. Shoot us an email!
Pearl (Consumer) - Pearl is building a social network of fan communities—organizing communities around all of the world's hobbies, passions, interests, and talent. Pearl emerged out of his desire to meet fellow fans of history YouTube Whatifalthist who's launch was so successful it blew out their database. 37% of all users who sign-up for Pearl are MAU's 6+ months later and their engagement stays high throughout. Pearl is backed by Y Combinator, Paul Graham personally, and Naval and the founder Matt is a Thiel Fellow.
Sincerely (Consumer) - Sincerely is a gen-z mental wellness app where users anonymously support each other. In 3 months, we've reached 14k DAU / 47k MAU with 78% Day-1 retention. Every night, users respond to 3 letters and write their own to get things off their chest. The team has built 6 apps together and our apps have close to 1m users in total (the technical cofounder's last startup raised $13m from USV). Our vision is to be a positive teen platform offering both wellness and community, under one wholesome consumer brand. We are now raising a $1m SAFE at $7m post-money cap - Brooklyn Bridge Ventures is leading.
Moment AI (AI) - Moment.ai is on a mission to reinvent the human and vehicle connection. Moment uses AI to prevent distractions and accidents for automobile drivers. They’re building advanced AI systems to detect, monitor and analyze human behavior and physiological changes. Their proprietary AI technology combines driver and passenger biometrics with vehicular data to detect more complex cognitive states, interactions and behaviors than competitors to make roads safer.
Debbie (Fintech) - Debbie is a fintech company solving the consumer debt issue to help transition borrowers into wealth builders. Debbie partners with financial institutions who help qualify users for lower rates, be preapproved for new rates, and reward users for paying off debt. Debbie makes money off of these same financial institutions as they help with motivating customers, lead to increased deposits and more.
Bean (Ecommerce) - Bean is on a mission to make ecommerce carbon neutral by helping people shop sustainably. Their wedge into the space is a chrome extension that makes all your online shopping carbon neutral, for free (think Honey for sustainability). Ali has a background in consumer growth at Google, and most recently has launched new ventures out of Upwork Labs (the company's incubator). That's where he met his CTO, Dan - who has been building startups for over a decade. They've become great friends while working together for the past year and are quitting their jobs to tackle the climate crisis. They’ve already onboarded 300+ brand partners (Footlocker, Levi's, Champs, and more.,) and are launching their beta soon.
Now Hiring
A list of some of the coolest startup & venture job gigs that we've seen! Some including our own portcos.