Rewards-as-a-Service: The New Frontier of Embedded Finance
FinTech is eating the world…and it is not showing signs of satiation.
FinTech is eating the world…and it is not showing signs of satiation.That is because of Embedded Finance, a once in a century business opportunity. Embedded Finance companies, including those pivoting into the trend, will reach a market cap of $7.2 trillion globally by 2030. Every company will need to become a FinTech company as non financial institutions realize the need to build financial relationships with their customers. Yet there is a hidden sub-category within Embedded Finance waiting to be unlocked. It is already larger than Embedded Payments, Insurance and Consumer Lending combined and analysts have not discovered it yet. It is the convergence and covariance of Embedded FinTech and a massive rewards and loyalty industry already undergoing disruption. The demand for innovate rewards programs are being driven by brands and issuers and compounded by the advent of Open Banking and A2A payment adoption.
The State of FinTech Financing
While a lot of uncertainty continues to rattle public markets many are waiting for the lag in private markets to be realized. Most financial and economic indicators suggest a potential slowdown in overall fundraising activity, however FinTech is still going strong. Data from Q1 2022 doest not indicate any slowdown for private FinTech companies. In fact it represented the most active quarter ever for FinTech financing activity with nearly 1,100 capital raises led by the Crypto & Blockchain sector (280 deals) globally. Raises announced in Q1 were most likely agree upon some months before so Q2 deal flow and sizes will be a strong indicator for the year(s) ahead.
Is the average $20 million+ Series A financing round over now for startups? Not exactly, at least for FinTechs anyway. Average deal sizes from seed to Series B continue to outperform FY 2021 with average FinTech Series A at $24.5 million. Series B financings rounds also hit peak round sizes at $50 million+ and growing. What is interesting is the difference between the average and median deal size from Seed to Later Stage is compounding each year suggesting larger outlier deal sizes at each stage over time.
Exogenous factors such as market pricing aside, FinTech will continue to grow rapidly in market size over the next 10 years. Yes a regression of public equity markets will close IPO doors for many later stage FinTechs and reduce financing valuations but innovation will continue to propagate through the industry. Yes there will be a bifurcation in venture financing where VCs will reserve cash to support existing portfolio companies and to invest in early stage companies with an exit horizon that aligns with the next bull market.
However, FinTech is eating the world…and it is not showing signs of satiation. Once in a century technologies like Blockchain are inarguably leading the way for FinTech and creating new trillion dollar categories such as Web3, DeFi, the Metaverse (~$ trillion by 2030), etc., but there is a once in century business opportunity that is creating a market in FinTech that will be larger than all of them combined — Embedded Finance. Hence, why FinTech and more specifically, Embedded FinTech is eating the world. Every company will need to become a FinTech company as non financial institutions realize the need to build financial relationships with their customers.
The $7 Trillion Opportunity
Embedded Finance is growing astronomically at a CAGR faster than any other industry. Make no mistake about it: Embedded finance is a full-blown gold rush, and everyone and their mother is jumping on the bandwagon. Embedded Finance companies, including those pivoting into the trend, will reach a market cap of $7.2 trillion globally by 2030. Additionally, the embedded finance market will reach just under $230 billion in terms of new revenue volume by 2025 in the US, versus $22.5 billion in 2020, an increase of 922%.
Embedded Finance companies, including those pivoting into the trend, will reach a market cap of $7.2 trillion globally by 2030.
Most estimates size the global market with an average implied CAGR between 50–70% over the next 10 years. A combination of industry, consumer, and macroeconomic factors will power the rise of Embedded Finance in Europe, the UK, and the US over the next decade. Most of all, Embedded Finance will become mainstream thanks to increasing consumer trust in Big Tech firms to manage their finances, as well as these firms’ growing footprint in finance.
The United States’s Embedded Finance revenue is expected to grow by 39.3% on annual basis to reach $67 billion in 2022 alone and another CAGR of 23.5% during 2022–2029. They will continue to increase from $67 billion in 2022 to reach $212 billion by 2029.
But What is it? No its not just banking as a service (BaaS). Non-financial companies are increasingly looking to offer financial products via their platforms. Embedded Finance is a term for when non-financial companies offer financial products and services to their customers while retaining complete control over the customer experience. Today, the space primarily entails Embedded Payments, Insurance, Lending, and Wealth Management in order of market dominance in addition to BaaS.
Growing demand for protected experiences by customers in their online transactions has pushed Insurtech firms to offer personalized insurance in the United States. Small and mid-sized businesses based in the United States are finding it difficult to acquire bank loans. Therefore, an increasing number of businesses are looking to alternate sources of finance, resulting in the growth of the embedded lending market.
The global pandemic has further accelerated this trend, and the demand for Embedded Lending is expected to grow at an incredible pace in the upcoming years. The landscape for real-time payments services in the United States has changed dramatically in recent years. Revolution and advancements in technology are fueling the demand for real-time payments and changing the way money travels between financial institutions, governments, enterprises, and consumers.
Yet there is a hidden sub-category within Embedded Finance waiting to be unlocked. It is already larger than Embedded Payments, Insurance and Consumer Lending combined and analysts have not discovered it yet. It is the convergence and covariance of embedded FinTech and a massive rewards and loyalty industry already undergoing disruption.
Rewards-as-a-Service: The New Frontier of Embedded Finance
Every year over $620 billion of gift cards is issued globally, with half of this value being purchased by corporates to reward or incentives their employees or customers. This market is growing strongly and is expected to reach $1.9 trillion by 2027.
The global market size for rewards solutions is estimated at $200 billion , touching everything from loyalty programs to e-learning curriculums. As of 2017, 65% of companies surveyed are using rewards programs to drive revenue, and 85% of those have seen their revenue increase as a result. . The global market for loyalty programs is expected to reach $215-$216 billion growing at a CAGR of 5–6% between 2017 and 2022. That is a combined global market size of just over $400 billion and growing. Rather than take a single approach, suppliers are focusing on providing a range of loyalty programs depending on their customers. These include loyalty card schemes such as card rewards, affinity programs, cashback programs, and point-based card rewards.
The Convergence of FinTech and Rewards
As FinTech continues to propagate and new types of value add services and disruptors such as Neobanks ($550 billion by 2028) and BNPLs emerge, they too fuel the growth in the rewards and loyalty space.
Neobanks are launching card-linked rewards program to stay top of wallet and will seek innovate rewards experiences to differentiate. BNPLs like Klarna and Affirm have already launched low value rewards programs to incentive users to pay “on-time” by earning points or cashback. These programs will be transformed to FinTech rewards program once the BNPL market is saturated and low value rewards do not add competitive value or help retain customers.
That is why the story here is not just the increase in demand for rewards and loyalty programs by new FinTechs but also an increase in demand for new types of rewards programs (FinTech Rewards) such as Crypto and Stock Rewards. The traditional loyalty programs have been facing some challenges from the customer perspective, such as the need to register and create accounts, geographical limitations, rules, limited rewards choices…
A growing number of rewards programs are offering crypto instead of typical rewards points. A recent Gartner report says 20% of large enterprises will use digital currencies by 2024. This extends to reward programs that are being modernized to meet consumer needs and trends. By offering digital currencies as rewards, retailers are leveraging their rewards programs using crypto and bringing shoppers back to their stores.
In 2021 alone, major cryptocurrency exchanges BlockFi and Gemini announced they would launch credit cards offering bitcoin rewards. Major consumer brands are also getting into the cryptocurrency rewards world. Shake Shack (SHAK) is now offering rewards in bitcoin for those who use Cash App to buy food. Even airlines are experimenting with cryptocurrency as a loyalty reward. When Northern Pacific Airlines launches, the carrier will reward frequent flyers with its flyCoin token.
Another recent example is a partnership between Landry’s — a restaurant operator whose roster includes more than 60 award-winning brands such as Saltgrass Steak House, Bubba Gump Shrimp Co. and Rainforest Café — and NYDIG, a leading bitcoin company, so appetizing. The partnership, touted as the first of its kind in the hospitality industry, will allow members of Landry’s Select Club to earn bitcoin as points when dining at any of its 500 locations nationwide.
Mastercard will also integrate crypto into its loyalty solutions, enabling its partners to offer cryptocurrency as rewards and create fungibility between loyalty points and other digital assets. This means that consumers can earn and spend rewards in cryptocurrency instead of traditional loyalty points and seamlessly convert their crypto holdings to pay for purchases.
Card Issuers also leverage value added services like incentives and rewards to compete for banking and merchant business. For example, Marqeta (NAS: MQ) is a leading issuer with an enterprise value over $3 billion enabling clients to instantly issue and provision cards into digital wallets. They enable clients to provide crypto rewards on debit and credit card purchases. More interesting are platforms like Cardless that power cobranded credits cards for sports brands to build deeper relationships with their fans.
In short, rewards and loyalty programs are offered as value added services at virtually each stage of the card issuance ecosystem and they are just beginning to scratch the surface of FinTech rewards.
The incumbents are beginning to offer Crypto rewards powered by mostly 2 API providers in the space. Yet, Crypto is only one type of FinTech reward and issuers are only part of the story as their disintermediation continues to progress. DeFi is leading the way but traditional alternative methods of payment are gaining traction (i.e. Klarna, Stripe, PayPal, etc) and are realizing a better way for merchants to build deeper relationships with their customers while accepting alternative methods of payment — open banking.
Open Banking Rewards
Incumbents and new entrants to Open Banking will need to incentivize a change in consumer behavior in order to increase consumer adoption especially for A2A payments. Incentivizing consumers with fractional amounts of Stock Rewards can increase Open Banking conversion rates by up to 80%.
Open Banking has revolutionized the finance industry in every possible way, with every segment having so much to gain from it. It’s astonishing that by simply giving users secure and easy access to their financial data, it becomes possible to develop an endless amount of new platforms and services to solve everyday struggles. As a result, businesses and customers can benefit from more efficient financial tools, the ability to automate payments, and greater visibility of their finances.
Open Banking uses APIs (application programming interfaces) as a way for one piece of software to speak to another. These APIs can connect a bank with third-party providers, enabling the direct movement of money from a payer’s account to a merchant — again, with the payer’s permission. This means that account-to-account (A2A) payments can now be made at the point of purchase instead of card payments, offering speed and convenience without excessive data entry or intermediaries adding to the cost of transacting.
Payers also have the opportunity to use digital wallets for everyday transactions, something which is becoming increasingly popular across Europe as it is predicted that payments made via open banking will grow at a CAGR (compound annual growth rate) of 78% per year in the EU. We’re still only at the beginning of A2A payments’ potential, however, the Worldpay Global Payments Report has predicted that by 2023 they will account for 20% of all e-commerce payments in Europe — surpassing card payments.
A2A payments can underpin a digital wallet, QR payment or even a cryptocurrency transaction at a fraction of the cost of the card networks.
Recent big announcements in this space include Stripe Financial Connections and Klarna Kosma. With the growth of A2A payments, this is a well-timed move for Stripe to launch Stripe Financial Connections as A2A payments have lower fees than card payments, which can improve Stripe’s profit margins. They will likely embed other financial services as it builds a one-stop shop for customers looking for a seamless service for all their payment needs.
“With Kosma we are opening up the power of our proprietary open banking platform and technology to banks, merchants and fintechs who share our dream of a world where consumers own their data and banks compete for customers by delivering value, not by locking in data,” explains Yaron Shaer, CTO, Klarna.
Klarna’s move to open banking is less about A2A payments and more about consumer segmentation. Consumers will own their own data but they will agree to share it with Klarna’s merchants and open banking API clients and the date will be used to help segment customers for Klarna’s merchant partners. Changing consumer behavior will remain a challenge for most use cases of Open Banking such as account & ID verification, account aggregation, payments, etc. The average Open Banking conversion rates (users opting in), for example, are between 20–30% for most FinTechs and even less for Merchants.
With A2A up to 90% cheaper for merchants, if a proportion of this saving was passed onto the consumer it would could incentivize the consumer to switch. The key to success is changing consumer payment behavior and that will not happen organically. Although A2A payments have many obvious benefits to the consumer, they will require incentives from the merchant to drive behavioral change. It takes, on average, 66 days to get a consumer to change habits, with payment behavior one of the most difficult habits to change — hence the longevity of cash. Incentivizing consumers with fractional amounts of Stock Rewards can increase Open Banking conversion rates by up to 80%.
FinTech rewards and loyalty programs will be like the standard cashback and points rewards and loyalty programs of today, for our posterity.