The barrier to entry to Embedded Finance is too damn high

Updated: Sep 14

When I was leading the product team at Bond, my vision was to significantly lower the barrier to entry for brands to embed financial services into their products.


What does this mean?


Imagine you are a product manager at Nike, responsible for the online e-commerce store. What are the ways you could increase sales and distribution of footwear products? Common answers might be:

  • NPI (new product innovation): Special edition sneakers using new technology or designs. e.g., Nike Go FlyEase Easy On/Off Shoes. Nike.com

  • Partnerships: Work with a famous persona, such as Michael Jordan, to release a specialized line of shoes. e.g., New Jordan Shoes. Nike.com

  • Personalization: Offer the product in different styles and colors. You might also have more diversity in your models to attract a broader range of demographics.

  • Marketing: Techniques such as viral promotions, discounts, limited editions, co-brand marketing, and so on. The list is limitless.

My theory was that there was a >$20BN opportunity for large brands such as Nike to offer financial services to their loyal customers.


Imagine this, a lucky teenager is gifted their first pair of Air Force 1's, and inside the box is a QR code to create a Nike wallet. The pair of shoes comes with a checking account, and she gets rewarded through the Nike app for having good financial habits. And those rewards could be used to buy her next pair of shoes.


It has been two years since that vision was dreamed of, and we are still far from achieving it.


For that product manager at Nike, despite the accessibility of APIs and integration times now as short as a couple of weeks, these kinds of projects just don't get prioritized.


How about FinTech startups and tech-enabled innovators? I want to spend the rest of the article exploring my journey trying to use BaaS (after years of being on the building side).


Turbulent market dynamics in Tech

I've been working on this article for over several weeks now. There's so much I have written and wanted to share. In this process, I want to respect all hardworking founders and team members who are toiling away at building these infrastructure products.


When I was ready to publish, I realized I had written many words about how I got into FinTech. My passion for banking infra was important, so I extracted that part and published it as a separate post. It is a helpful prerequisite to continue reading but not required.


Here are some concerns faced by founders considering using a BaaS provider.

  1. Regulatory Scrutiny: One BaaS provider has stopped onboarding new customers because one of its partner banks is undergoing regulatory scrutiny.

  2. Running out of Cash: As FinTech funding has dried up, some BaaS providers have struggled. Some have been forced to make workforce reductions and manage their expenses to extend the runway.

  3. Lack of Differentiation: Behind all the marketing, it is hard to differentiate between most BaaS providers. Unique API endpoints have not been created yet - as they are wrapping other point solutions such as KYC providers, processors, and funding protocols. Unless the BaaS providers specialize in a certain financial product type, they're on the road to commodity.

So as a founder, do you BaaS or not? Depends on what you're building. If you're creating tools/services for the banks themselves, as described in the thread below, you might be best served to go directly to a bank.

As a founder, if you're building a consumer or B2B FinTech product, you can't necessarily go to the bank as they might not be fast enough or capable of serving you.


This is the BaaS sweet spot - speed to market and various financial products under a single, developer-friendly API. Let's explore this further.


Building a consumer FinTech: Nimi Kash

In January of this year, I started the journey of transitioning from idea to execution on one of our NimiX accelerator projects: Nimi Kash.


Quick shameless plug: Nimi is a premier product development agency. We specialize in building API services, enterprise web applications, and self-service developer platforms. We also implement and maintain API and web test automation frameworks. We have a lot of experience in FinTech. We'd love to send you a few case studies after a brief chat. Schedule a conversation with our team today.


The vision behind Nimi Kash is to put as much money into the wallets of Sri Lankans and provide them with the tools to improve their financial wellness.


Even though the government fixed the exchange rate to be approximately $1 = 200 LKR (Sri Lankan Rupee), the cost of imported goods continued to increase, and buying power was reduced. When the central bank let the Rupee float, the currency lost more than 44% of its value, causing an inflation spike and an economic fallout everyone worldwide has heard of by now.

We foresaw this happening, so our mission was to pay our employees in a foreign, more stable currency such as USD. Our approach was to create a "USD" wallet for our team members where we could deposit their salary in USD, and they could spend their earnings on a card or convert them to LKR for cash expenses by partnering with an ATM network.


In my mind, we had a trivial solution. I would partner directly with a BaaS provider and offer a neobank for IT professionals called Nimi Kash.


Why was Embedded Finance "crazy hard" for us?

Most of the BaaS vendors are fairly young, and it would be fair to say that what they offer is a function of what their banking and technology partners offer. Especially when it comes to types of financial products and the risk appetite, the sponsor bank(s) pretty much dictate it.


In the future, this might change, as the BaaS platforms have a significant customer base and can pressure the sponsor banks to make changes for the better of the ecosystem.


Nevertheless, after speaking with 18 BaaS vendors, I could only get two to agree to work with me, with significant cutbacks in the MVP scope making the product less compelling.


One of the BD leaders Thomas Kang, gave me sage advice:

What you are trying to do is an "impossible" challenge. I want to help you build this. But you must break them down into smaller chunks. Build one piece at a time. Little by little, you will learn as you progress.

That's the key part here - learning. Over the rest of this article, I want to share with you my learnings.


Limitations of the global banking infrastructure

Below are the major roadblocks I faced as I designed my solution over the last three months.

Challenge

Possible Solution

Reality

Impact

To conform with BSA, every onboarded user needs an SSN or EIN, and must be a US Citizen or legal resident.

We could use a provider such as Firstbase.io to create a business for each user via API and use that EIN for onboarding.

It can take a few weeks for the EIN to be created. It is costly at $400 per user for the first year and $99 each year going forward.


Users will end up with much less money in their wallet and will also need to pay US taxes and returns.

Even if we could create USD wallets, physical cards cannot be issued in Sri Lanka.

Certain BaaS providers could create wallets and issue cards in Hong Kong or Singapore. These cards work in Sri Lanka.

The card networks impose expensive cross-border fees and generally do not like this, and could block the BIN at scale.



At best users are charged high fees each transaction.


This is a high risk for users if their funds get locked in a wallet.

We could store and send the funds as a stablecoin such as USDC.

Certain vendors like ZeroHash could convert USD to USDC and send it to any wallet anywhere.


Coinbase, Gemini, Robinhood don't support wallets in Sri Lanka.

Once the USDC is received, there is literally no off-ramp available to convert the currency to LKR.

Users will have funds locked in a wallet, and unusable.


It is also possible our banking partners would cease business with us if we worked with Crypto.

Due to the lower spending power in Sri Lanka and total addressable market size, interchange economics do not work.

We could charge a small payout fee instead each time the user needed to take money out of the wallet.

These payout fees could be as high as 1% and the Rupee would need to devalue continuously at more than 1% for this to be financially wise for the end user.

This creates misaligned incentives for us. We don't want to force our users to convert their USD to LKR to offset our costs -- our goal is for them to save.

Here's a perfect example of where the "middleman tax" can thwart innovation. It stems from the fact that very few providers completely own the stack (they use other vendors and, in some cases, use each other), so the cost basis is higher.


Since writing this article, I received some great ideas for what I could do to continue building within the constraints of the existing US banking infrastructure.


Here's what Adam Gering from LexDAO had to share:

You can generate a Series of a Delaware Series LLC and reduce the cost for a US legal business entity with EIN to a free IRS form. But a 2007 change in US tax law means the non-resident owners must file IRS Form 5472 with a Pro-forma Form 1120. Alternatively, a Money Services Business (MSB) creating accounts for non-residents is no problem. The funds are omnibus'ed with financial institutions. A fintech without its licenses (non-MSB) has to rely upon another financial institution to create end-user sub-accounts (or sub-ledgers).

According to Grimes Law PLLC, the costs of being an MSB (in all states) start at $180k, with an ongoing $140k commitment. Certainly cheaper to work only a few states, and you will need additional funds for the surety Bonds. As you will find later in this article that some BaaS providers will be cheaper than this.


Shaul David at Railsr suggested that I could work with an EU provider and get my own EMI rather than relying on the US banking infra.


Banking regulations need to flex for cross-border use cases.

"The upside of standing up an international program with potential geopolitical risks vs. spinning up a national program doesn't make sense for most BaaS players in the current market. I'd say that... most US Banks would come to the same analysis. Too many unknown risks with an unknown reward." said Marcus Lobendahn at Bond.


Marcus had a solid point, and I wanted to explore this further. The sticking point was the BSA rules to mitigate risks in Account Opening (AO) fraud. Rules state that to KYC, a user; this information must be provided to the bank (or their vendor) for verification and monitoring purposes:

  • Full Name

  • Date of Birth

  • SSN or EIN

  • Identify card

  • and other items as mandated by the sponsor bank

As an employer in Sri Lanka, law states that we need to collect all the above information about our employees, including creating an HR file that contains:

  • Detailed Employment History

  • Attested copy of National Identity Card* (NIC)

  • Police report

  • Grama Sevaka report

  • Verified copies of National Identity Cards for both parents

*Anyone in Sri Lanka 15 years or older must have a NIC. All activity for citizens is tied to this number, from getting a phone number to opening a bank account or applying for a passport.


As you observed in the previous section, one workaround for us to work with a BaaS provider is to create dummy LLCs or EINs to pass KYC.


What would you prefer to have as a compliance officer at a US bank? Dummy LLCs, or access to verified identity data that users are happy to provide to access financial services out of their reach?


This is where the global banking system has fallen short. It wasn't designed to be "borderless"; as a result, innovators are struggling to piece together solutions that give access to the global underserved population.


Very far from the AWS of FinTech

I've heard this term thrown around quite a bit. Who am I kidding? I've said it so myself.


But it is just not true.


Below you will find my monthly billing for a small web app I created. The app works fine, accepts visitors, creates accounts, stores some basic customer information, and has been running satisfactorily for the last few years. Keeping this site running costs me a little over $1 monthly.

No BaaS provider can give a barrier to entry as low as this because the regulatory red tape and parties involved add complexity and cost.


So what does BaaS cost, and what do you need to know?


Note: I have decided to anonymize the below providers. Given the nature of the business, it is only fair that I do this.


*Some providers have an onboarding fee of $20,000 to $25,000.

BaaS Provider

Monthly Pricing

Core Strength

Challenges

A

n/a - rejected use case

Money movement

Cannot work outside the US. Need to partner with two or more partners to offer a workable solution, which balloons the cost.

B

n/a - rejected use case

Forex

Can transfer funds via SWIFT. Requires >$10MM in monthly volume to consider.

C

$50K annual fee, $0.15 and 15% per transaction.

Treasury

Doesn't work with my current banking partner (Chase).

D

$10 per onboarding, $1 per currency wallet, $2.50 per payout

Digital wallets

Does not support cards at all.

E

n/a - rejected use case

Card issuing

Not interested in our program since it was cross-border.

F

n/a - rejected use case

Card issuing

Not interested in our program since it was cross-border.

G*

$10k monthly, $0.10 per user monthly, 0.5% APY on reserve funds

Bank marketplace

Requires EIN for each user.

H

$35k monthly minimum platform fee

Bank marketplace

Not interested in cross-border programs. Interestingly sales rep said this was the first inbound lead in weeks.

I

n/a

Bank marketplace

Not onboarding any new clients.

J*

$6k monthly. $0.15 per user monthly.

Cross border

Cannot issue physical cards in the first version.

K

n/a

Digital wallet

Only 10% chance this is possible. Had to fill a lengthy due diligence form and it didn't go anywhere.

L

n/a - rejected use case

Bank marketplace

Their banking partners are community banks and they are not experienced to pull off a program like this.

M*

​$15k monthly, $10 per onboarding, $1.50 per user monthly

Bank marketplace

Requires EIN for each user. Physical cards can only be shipped to a US address, but virtual cards can be used anywhere.

N

n/a -rejected use case

Bank marketplace

Not interested in new programs.

O*

Annual fee starting at $200k all inclusive.

Card Issuing

Said they can do the program, but I wasn't confident they understood the complexities of this program.

P

No fees

Crypto

No B2B Enterprise product, so everything needs to be done with consumer accounts with tax and reporting implications.

Q*

$1.50 per onboarding, $3.50 per user monthly

Cross border

Cannot issue physical cards in the first version.

R*

$20k annual platform fee

Crypto

Unable to off-ramp the funds into LKR

So, the question again. What does BaaS cost? For our use case, it could range from $80,000 per year to almost $7MM per year.


Without interchange as a potential revenue model for us, and given that we are a bootstrapped company, we had to think of a different solution for our product design.


A Brief BaaS buyers guide

Within the first 12 hours of sharing this article, I had a few slacks, emails, and text messages stating that I was taking a dig at the entire BaaS industry when the limitation really comes from the global banking ecosystem and the way the card networks (Visa and Mastercard) apply regional constraints on the use and distribution of card products.


So it was only fair for me to provide a brief buyers guide for when BaaS does indeed work, and what you should look out for when buying.


If you are a growing brand or a tech-enabled innovator building a product for the US market, you will find that you have no choice other than BaaS. Why?

  • You could work with a bank directly, but it will take months to find the right contact willing to give you a chance. Even if they do, you will quickly find that there are API limitations, and it takes a very long time to build your initial prototype and test the market.

  • Getting your own MSB, staffing compliance, and legal to manage your risk will be expensive.

  • You're venture-backed, and you have the funds to get your product to market very quickly to test the hypothesis, and at some point, in the future, you can optimize for the cost (think Chime, Cash App).

So if those above criteria apply to you, what should you be looking for to pick the right BaaS partner?

  1. Personalized Service: You want to pick a partner who is specialized in the products you want to bring to market, and are able to advice you on what to build first. If a provider rejects you that's actually a good thing - they know where they want to focus. If a provider gives you a large platform fee such as the one that gave me $35k a month, that is indicative that they don't want to touch the use case. Any provider who says they can do "everything" is a warning to dig deeper.

  2. Speed to Terms: At this point, all the BaaS companies are at, least one year old and they should have their operations nicely streamlined. Irrespective of the feasibility of the use case, providers should be able to give high level pricing in the first call or within 24 hours. If they're dragging you through documentation and cannot give any pricing, it means they are pretty inefficient as an organization, which will go straight to the price.

  3. Powerful Sandbox and Demos: One of the providers I talked to, Nium, was able to give me access to a NiumPay app preloaded with funds within a few days of the first sales call. This was powerful, and used my phone to pay for goods in Sri Lanka. This gave me confidence that the solution is real. Alternatively, you could build and test in sandbox yourself. One provider refused to give me API keys, and that was a bad sign.

  4. Aligned to your Success: Many providers are very eager to have you sign a term sheet days from the first call. Are they asking hard questions about your funds flow? Are they pushing you on the feasibility of your product, and how will you achieve your growth numbers? The ones who do are incentivized by your product's success rather than making a quick buck from the onboarding fees.

I'm confident those questions will help you find the right BaaS provider to go with.


How will we build Nimi Kash?

I hoped that by late 2022, BaaS providers could enable Products like Nimi Kash.


I think too many BaaS companies were funded in a short window. So they had to compete heavily with each other rather than putting their heads down and building.


Since they couldn't differentiate on the tech, they have differentiated on the variety of banking partners, developer experience, and strength of their sales, marketing, and operations teams. All this costs money that shows up in the platform fees.


As a result, there is quite a long way for them to go to enable small companies like us.


Until then, they will continue to focus on larger VC-backed companies. They will work hard to educate brands like Nike to consider embedded finance. As the adoption grows and each BaaS player claims some turf, the costs decrease. I still believe in BaaS very much, and Shamir was right; I'll need to wait a few more years to see this happen.


For us here at Nimi, we are determined to build Nimi Kash. We haven't given up. We must find our path there.


I'm looking forward to sharing our progress in a future post.



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