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March 30, 2021

Impacts of BaaS Intermediation on Embedded Finance

In our last article, we looked at some of the market forces affecting financial institutions' decisions about how best to jump into the fintech game (if at all) and whether those strategies are growth-oriented or survival-oriented.

While new market entrants have the freedom to choose how (if at all) to be API-first, most of the banks at the bottom of the stack are still playing catch up. The gap is becoming rapidly filled by a new plumbing layer—Banking as a Service.

BaaS providers sit between consumer apps and "real banks" and do what many banks are still struggling to do: provide portable, pluggable banking services out in the wild where consumers need and want them the most.

Read all seven parts here:

Part 1: APIs are Everywhere — An Intentional Choice: Being API First

Part 2: On APIs and SaaS Unit Economics

Part 3: On Market Power — Who Reads, Who Writes, Who’s SOL

Part 4: A Fork in the Road for Traditional Banks

Part 5: Impacts of BaaS Intermediation on Embedded Finance

Part 6: API-first development: fuel for regulations, Open Banking and Standardization

Part 7: The No-Code/Low-Code Accelerant

The rise of BaaS makes the ecosystem far more complicated than the API-derived power struggle between full-stack challenger banks and traditional banks. Tongue in cheek, the BaaS layer is a powerful series of tubes that will have an effect on banks' response strategies, M&A activity, and perhaps—eventually—a shift from transaction monetization to API monetization itself.

Market Shape

First, let's take a step back and understand BaaS's velocity and trajectory. According to Pitchbook research, companies focusing on APIs, infrastructure and BaaS within the fintech sector have been on a tear, growing from nine venture deals totaling $45 million in 2016 to 14 venture deals totaling $130 million in 2020. The data below represent aggregate statistics for the trailing nine years.

What the aggregate data does not tell you, however, is just how diverse BaaS is, encompassing technologies that enable non-banks to offer core banking services such as deposit, checking and savings accounts, or loans to end-users to name a few. BaaS fundamentally bridges the divide between consumer-facing companies needing to integrate financial features and the institutions that can underwrite those features.

BaaS is ballooning precisely due to the market forces we described earlier—BaaS providers offer highly desirable APIs to which stack participants can write. In the majority of these cases, the participants doing the writing have a lock on the consumer experience (e.g. Chime, Shopify) or a lock on being an "Actual bank" (e.g. Bancorp).

BaaS & Embedded Finance: Upsourcing and Downsourcing

There have been countless think pieces about embedded finance taking overall corners of the Internet as digital transactions rise to meet new methods of monetization. You can't miss it: the Apple card, Amazon loans, Uber cash, Facebook messenger payments. All of these phenomena rely on native integration of financial services into non-banking products. Sophie Guibaud of Openpayd, in a recent interview with FinTech Finance, speaks at length about the new realities of embedded finance.

It boils down to two interlocking sources of value that drive embedding.

First, consumer facing brands—whether the FAANG’s, emerging giants of the gig economy—have all paid a lot to win you as their customers. And once they have you, they’re desperate to keep you engaged, a combination of delight and ubiquity. “Want a ride? We got that. Want a hotel? Here we are. Want some food? Yes that’s us. Other recommendations? We can do itdon’t move to the next app, here we are!” So-called “super apps” like Gojek in Southeast Asia and Rappi in Latin America are extreme versions of this with the usership to match.

Second, consumer facing brands have defined themselves by a relentless reduction of potential friction in the customer experience.  Here the quintessential leaders are the direct to consumer brands that are defined most importantly by their checkout funnel. The time between a customer loading a page and finding what they want and then paying for it is positively correlated with funnel attrition. Quick and painless—ease—is good business. Looking back some years, Amazon’s one-click buy stands out; nowadays you see third-party providers like Fast powering one-click login and purchase experiences across multiple web properties.

Engagement and Ease. These are both straightforward forces facing consumer tech companies. But here’s the fundamental truth: payment is the ultimate form of engagement.

So when the consumer says give me convenience or give me death, companies want to become banks without having to worry about being banks. Enter Paypal, Stripe/Fast, Klarna, Affirm, Afterpay, whose robust APIs stave off customer attrition in the purchase funnel and enable far more spending both per-order and over time. And when there’s a chance to increase engagement by including a bank account, rewards program—heck, even stock grant—as part of the consumer experience, there’s the rise of embedded finance.

To date, embedded finance has mostly been a story of payments. But the rise of banking as a service is starting to redefine this landscape. Embedded finance players are an API-driven set of methods that allows fintech companies to provide regulatory or transaction infrastructure to non-finance companies across the whole range of money movement and financial risk. With that part of the product effectively outsourced—“downsourced”—non-finance companies re-focus effort on building differentiated customer experiences. It is a highly effective implementation of both 'not my problem’ and ‘just give me the answer.’

What's important in the context of our thesis is that BaaS providers exist because the interconnections between consumer app and bank must cross a digital divide that neither bank nor consumer brand want to traverse.

Embedding allows these interconnections to happen anywhere you can point an API. Market participants want banking services and demand performant, robust APIs so they can focus on adding tightly-defined features and functionality, no one (well almost no one) wants to build bank infrastructure.

Meanwhile, the banks are largely floundering on the Open API front and just as importantly don’t want to let 1,000 tiny companies integrate with their systems. So, BaaS providers facilitate a vital marketplace between the companies above them (any company) that need to downsource smart pipes to focus on user experience and those below them (banks) that need to upsource smart pipes to survive. BaaS providers have outsized potential because they’re the missing link.  Neither user-facing apps nor “real banks'' want an intermediary, but everyone wins when the intermediaries are this good.

Why's this so critical? BaaS marks an important turn in the larger story for two reasons:

  1. It holds the promise of collecting money from all customers in the journey—payor, the app and the bank.
  2. It lets user-facing apps act as if they’ve got the money. And consumers won’t forget to come back to them if they do.

Smart Pipes, Happy Customers

This exchange obviates the need for the app in question to develop anything except what is strictly necessary to (a) differentiate it as a business and (b) integrate with the requisite providers to deliver the expected services. In other words, embedding is the outgrowth of the build-vs-buy decision. BaaS customers build the experiences that they want, but do so from best in class tools that represent constantly evolving feature functionality—rather than static functions. Done right, embedding makes for low friction, lovable products.

This is why, for instance, Shopify Balance (via Stripe Treasury) is so powerful: the banks at the bottom of the stack are never going to try to individually support all the shops or build all the experiential features to ensure happy consumers. Instead, Stripe supplies standardized banking to all of the merchants at the top of the stack and the merchants and Shopify deliver the happiness.

So let’s re-ask an earlier question: should we fear that banks will become “dumb pipes?” If we look at the connection between Shopify and Stripe Treasury, we can see a rich relationship between nearly-full-service customer engagement layer for banking that delivers customer expansion and deposit growth on one hand and a pathway to incremental fee income for Goldman, Citi, Barclays and Evolve on the other.

Both the engagement layer and banking layer benefit from data exhaust throw off from such an integration, driving value-add services ranging from risk diagnostics to machine learning to automation, all in the name of more personalization and less friction—i.e. more revenue. Everyone wins.

Recall that the core value proposition of banks is their ability to use government guarantees to take levered bets on the real economy and sell many products to maximize lifetime value. Having any API-led ability to acquire deposits from higher up in the stack, take a slice on a transaction, and build smarter opportunities to make well-informed lending decisions starts to look pretty smart.  

BaaS allows banks to do what they do best across a much wider market and propagate it via API-first methods while minimizing what they don’t do as well. As such, BaaS solutions need to be modular to stand in where banks lack the API connective tissue to plug into specific user-required cases—deposits, bill-pay etc.—to deliver on user engagement.

Modular offerings Amount, Treasury Prime and Moov are granting underlying bank partners the superpower to plug into more parts of a burgeoning universe. In fact, at QED we’ve learned through our investment in Treasury Prime that the best BaaS players know that in a marketplace business the core metric is not volume, but creating happiness.

Treasury Prime treats banks as a core customer set, not just a charter to rent. They are architected to enable the bank’s brand to survive the API transformation. For example, many lending relationships, particularly in business banking, require that a borrower also open a bank account. In these cases, the mere gathering of deposits is not sufficient; banks want to participate in the customer relationship—after all, banks also have noticed the value of engagement, cross-sell and lifetime value.

But in the meanwhile, for embedded finance to mean anything other than low complexity payments, banks must be happy participants. Simple payments, especially domestic payments for goods and services, create almost no compliance overhead or capital charges. But lending, working capital, lines of credit and treasury management services require real banking resources in capital, staff and systems. In these situations, BaaS must also facilitate the banks’ ability to provide its services.


Amias Gerety is a partner at QED Investors, a leading fintech venture capital firm.  His investing has focused largely on back office and infrastructure themes.  Prior to QED, Amias was Acting Assistant Secretary for Financial Institutions in the Obama Administration.

Nate Soffio is an MBA Candidate at Wharton focusing on fintech, regulation, and financial inclusion. There, is the co-chair of Wharton’s Fintech Conference taking place April 22-23. Hailing from Stamford, CT by way of Medellin, Colombia, he spent a decade building (and breaking) things in the infrastructure and regtech worlds with a focus on Know-Your-Customer and identity management. Before Wharton, he helped lead product at Arachnys, a London-based regtech and QED portfolio company. Nate holds a B.A. with Distinction in Linguistic Anthropology from Yale University.  In his spare time you can find him road cycling, rock climbing, and cooking.

Media inquiries:

Ashley Marshall, Director PR and Communications, QED
(518) 577-9984