Hi all,
I did a dive into how Radix can be used for Embedded finance, including things like “what’s embedded finance,” “why radix?” and “what will it look like.”
Hope someone enjoys the read.
[Radix & Embedded Finance] (Embedded Finance on the Radix Decentralized Ledger - Google Docs) (nicely formatted, but all text copied below)
- What is Embedded Finance
- Infrastructure First
- Why Radix
- Open Source Playground vs Walled Gardens
- Competitive Products, Cooperative Assets
- Exchanges, Market Makers & Liquidity
- Radix & Embedded Finance in Practice
I. What is Embedded Finance
In one piece, embedded finance or embedded banking is referred to as “[i]ncorporating specific financial services into nonbank companies’ products or software, becoming part of a bigger bundle of services.” (The Financial Brand) However, most of the literature to date still only explores adjacent opportunities, such as integrating more consumer payment points into workflows so new products or services can be pitched at different points of the customer journey. This limited approach does a huge disservice to the potential of embedded finance, as delivering this type of infrastructure to an industry or company ecosystem can have far reaching impacts.
One example is that embedded finance can be utilized not just to make payments more efficient, but also to make auditing, oversight and regulatory compliance easier. This should do things like open access to better types of services such as equity crowdfunding.
Imagine a local bakery that opened via raising funds via equity crowdfunding. This would be prohibitive (in the US) right now due to the amount of due diligence and compliance work to offer equities to the public. However, the regulatory bar may be lowered if the company relies on a substantial amount of embedded finance. For example, customer payments, rent, employee payroll + dispersal, accounting, inventory payments, loyalty programs, affiliate programs, marketing operations and any other operation within the business that uses money can be run on embedded financial systems. What this means is that the bakery can quickly access systems designed by other partners to facilitate all of these tools in a regulatory compliant way and in a fashion that is transparent to investors. This substantially reduces the risk of fraud, and makes it an investment vehicle that governments could conceive of as something ready for the general public and retail investors.
Some literature also refers to this as “Dynamic Finance.” In the future, finance will not just be an operational aspect of your business or something that happens purely behind the scenes. New market mechanisms will be created and if your company, organization or self is unable to put these new tools and incentives into practice then you are likely to be left behind.
II. Infrastructure First
Two key topics for embedded finance are unbundling and cross pollination.
Unbundling means that financial services are not a stand alone product anymore, nor do the use cases need to be just new ways of implementing old practices. In today’s world a company needs to resort to full packages or external offerings - such as linking to PayPal to make a purchase with a retailer. In the future a retailer may be able to do something like use SAM Email by Airto to embed dynamic product browsing and purchasing functions directly into customer emails.
To go further, imagine the power of a bank providing an API to make calls and change the assets within its accounts to mark new owners. Now imagine something like infrastructure that can be linked into any application or tool created by any intermediary, with things as creative as integrating a toolkit into Microsoft Excel so that when you design a new business function using spreadsheets or VBA that creation is then used to actually interact with the underlying infrastructure and move the assets, not just report on them or study them. The access to infrastructure and customization in the latter example is disproportionately more valuable than the former, as it is giving anyone access to the tools to create their own systems, or create new intermediaries to compete with the API approach and in-house technology offered by the bank.
The second key concept is cross-pollination. Chase Bank is opening a new travel website, open to anyone, not just bank customers or through its rewards program. This is showing them dive into new ways of exchanging value and integrating into a broader ecosystem that offers their customers more value than if Chase limited itself to just payment, investing and lending services. Meanwhile, many airlines in the US would have a negative market cap if you removed their loyalty programs, which have extended into agreements with credit card companies to spread their influence, and also work with other players in the travel space, such as hotels and car rental companies in agreements where the other companies can reward their customers with airline loyalty points (which must be purchased by the hotel or rental car company and paid to the airline.) We also see cross pollination with companies and the crypto space, with Coinbase announcing that it will start offering access to DeFi products through its platform, or Robinhood announcing that they will be making a crypto wallet.
These two trends - the debundling of services into specific functionality that can be picked from a toolkit, plus the cross pollination of industries, means that the focus right now should be on the most foundational layers of infrastructure for enabling this type of work, and Radix is the key platform for this. Not developing on the key platform risks companies creating underperforming, poorly integrated assets, or accumulating large amounts of technical (and actual) debt. It also risks your company just turning into a product, not a business.
III. Why Radix
Radix is the best solution in the space for several reasons, including 1) Transactions Per Second, 2) Composability, 3) Blueprints, Royalties & On-Ledger Instantiation. Know Your Customer solutions and the benefits of the Radix Engine are also discussed later, which further the case for Radix.
Transactions Per Second
Traditional banking services, such as AliPay, have already eclipsed 120,000 TPS during times of heavy usage. If companies start deploying more financial infrastructure directly to their operations, such as customer payments automatically routing to payroll dispersal or repaying advance loans for an inventory supplier, while als controlling the flow of loyalty points and affiliate rewards involved in the transaction, then it is clear that in embedded finance there is no such thing as a simple transaction. There will be massively more demand for transactions per second to enable the future embedded finance ecosystem.
Composability
Going to the same example above, none of those transactions are operating in isolation - they gain substantial value because they are all linked together. Being able to compose the transactions into one coherent action is crucial, both for simplicity, cost, efficiency and security, plus making sure that none of the customers get stuck with an ‘intermediary asset’ that was necessary for the transaction, but not desired as part of the outputs.
Further, DLT’s will not fully replace intermediaries. There will be people that work directly with on-ledger tools, and there will be people who prefer to have various types of intermediaries acting between them and the underlying network. In the business sense, this can be new types of financial service consultancies who are experts at deploying Radix solutions for companies based on need, and it will be imperative for these intermediaries to combine multiple on-ledger components in order to create a valuable offering for the end user or client. This would be similar to how a consultancy may help deploy Linux implementations for a client. Linux is open source, but hiring experts may make sense given your business’s level of sophistication.
Blueprints, Royalties, and On-Ledger Instantiation
Just as the new functions of finance will be unbundled, so will the development. To fully embrace how radical the new generation of finance will be, the world needs an open source movement with as many builders as possible.
Blueprints are how code is published to the Radix ledger. After publication someone can then make a call and instantiate a component of it on-ledger for someone to interact with. There are different settings and rights for these blueprints, such as who can use it, or what royalty fee needs to be paid for usage. This means that no matter how discrete someone’s creation is, they can earn money from it via blueprints as it gets deployed throughout the ecosystem by other components or companies who are pulling from the blueprint library/toolkit to compose new solutions in the market.
IV. Open Source Playground vs Walled Gardens
Radix also has a unique feature regarding it’s Single Sign On (SSO) Know-Your-Customer (KYC) compliance tool, Instapass, which deserves its own space.
Not every application or asset on Radix requires Instapass. However, any application that wants to use it can opt in and deploy natively on ledger using Instapass’ SSO tools.
This has an underappreciated benefit as it means that any completely decentralized blueprint has the potential to also be instantiated as a completely KYC compliant component elsewhere on the ledger. For example, OciSwap does not use KYC (to my knowledge.) However, as Coinbase continues its push to make DeFi tools available to users they can do something akin to creating a walled garden, in which users can only interact with copies of popular apps like OciSwap which have been instantiated in a restricted environment that Coinbase has some degree of control over, rather than being at the whims of the broader and more innovative open source and decentralized ecosystem that OciSwap itself exists within.
Again, this may not appeal to everyone, but it creates a gradient in which consumers and companies can select what type of offerings and risk levels they want to interact with, while deploying the tools in different ways but still letting blueprint royalties accrue to the Radix ecosystem builders. This both means that Radix is a universal infrastructure solution, and that it should be extremely accessible and functional.
The walled garden approach, especially after piloted by one company like Coinbase, could also lead many others to follow suit, such as Robinhood getting into the space, or airlines offering a OciSwap exchange for new types of loyalty points issued by various partners in their networks with various rewards and promotions each partner may offer over time.
V. Competitive Products, Cooperative Assets
Another thing to note about Radix’s place in the ecosystem. The network is likely to be the easiest place to build, and the most efficient place to transact. However, the origination need not happen on the Radix ecosystem. Someone can do something like tokenize a real estate deed or car title, or create a loyalty point, and do so in their own system. But, it is in the best interest of both parties if an asset made on Radix is available to be used off-ledger, and vice versa, for off-ledger assets to be brought to the Radix ecosystem for incorporation into any new embedded finance tools or ecosystems.
Thus, Radix will be home for competitive products on how to handle and trade assets, and ideally Radix will win this arms race by offering the best infrastructure for building, but that does not mean that they need to compete with the assets that others are using, which should be something bridged as seamlessly as possible so all parties may benefit.
VI. Exchanges, Market Makers & Liquidity
With Radix being the foundational infrastructure for the products that trade assets, it will be necessary for people to hold the native token, XRD, so that they can participate in all the embedded finance components built on the network.
This places Radix in an ideal position for working with exchanges as this is a premier asset for enabling the use of the most foundational tools in the future of finance and not being able to provide it means that your customers will be in the cold, likely looking for a better solution that helps them bridge the gap between static/siloed//traditional finance and dynamic/embedded/decentralized finance.
Further, with the low transaction costs offered by Radix, this will be the ideal place to execute exchanges. This means that any market maker, for any asset (again, originating on or off Radix), will also be concerned about the liquidity of the XRD token, as an illiquid XRD token could inject friction into the transaction mechanisms for whatever other asset they are providing liquidity for.
VII. Radix & Embedded Finance in Practice
“Banks will also need new business models, such as pay-for-use monetization, B2B2C and B2B2B distribution capabilities, and a careful consideration of branding.” (McKinsey)
First, pay-for-use monetization is already built into the Radix ledger in two fashions: 1) the XRD token is needed to utilize the protocol infrastructure and execute a transaction, and 2) for higher level functionality the technology relies on ‘blueprints,’ which include on-ledger royalties for the original developer whenever the blueprint is owned, meaning the rewards for developing that technology are directly linked to the usage of that software. Additionally, Radix can enable more first gen DeFi pay-for-use monetization as projects can make ‘utility tokens’ on the ledger, as native assets, which are required for using a specific component, meaning that businesses or actors looking to use the component as a pay-for-use service will need to acquire or hold the utility token for the component.
Second, McKinsey’s B2B2C and B2B2B interactions are only the tip of the iceberg. This combination of letters makes no sense: B2B2C2B2C, but something like this is possible with the composability of the Radix engine and its components. The software tools, actors, assets, and currencies or tokens involved in individual transactions will be orders of magnitudes larger (in some use cases) than they are today, and to be able to execute finance at this level of complexity requires all assets to be treated the same way and in the same ‘finance engine’ throughout the value chain. Traditional finance institutions and some DLT projects may be able to accommodate a “B2B2C” transaction with an understandable level of complexity and what they see as acceptable transaction costs, but the truly new innovation of not just new means of financial interaction but new types of financial interaction make Radix the only solution with a roadmap to fulfill this type of potential.
For those who think a financial interaction like “B2B2C2B2C” is nonsensical, a more sober and deeper dive into the topic would be McKinsey’s piece on “Ecosystem2.0,” which dives into how the operations of many players in many industries are expanding both horizontally and vertically throughout the economy to stay at the cutting edge of competition.
An example from the McKinsey paper uses the UK’s ZPG, which is “trying to create end-to-end ecosystems that may span search, property comparisons, mortgage shopping, household moving, switching phone and cable companies, and access to home-improvement professionals.” This iea can be expanded even further, with ideas such as linking in furniture shopping so you can fill your home in an efficient manner, and even more decentralized idea like a home-improvement professionals union that can build custom furniture based on design blueprints traded in NFT’s, which the union ensures its professionals know how to build, opening up many more types of integrated actions within a broad ecosystem purpose built for you to have the best housing experience possible.
The McKinsey report further encourages going deep and thinking strategically, not just making incremental gains or small features. Similar to how finance is “failing people in 1,000 different ways” (source: Piers Ridyard every other day), the ways it can be integrated vertically or horizontally in ways that make better experiences is something that can be vastly better and in many different ways.
Additionally, foundational infrastructure like Radix is crucial for this, as no one entity needs to solve the problem, and the gradient of interaction with other more specialized actors can provide benefits to both parties and compound the significance of their ecosystems. Again, from McKinsey:
“We know of many cases where two CEOs, keen on duplicating the marquee successes
of digital leaders, launched ecosystem initiatives with a burst of enthusiasm and bold
visions of combining forces along value chains or pursuing attractive new markets.
Invariably, however, their plans foundered on details such as which points along the
value chain the company is best positioned to control versus those that partners should
own, how participants could mesh capabilities, or how they will jointly manage the novel
operating model of their ecosystem.” (id.)
This demonstrates that a broad canvas, with the ability of anyone to contribute according to their abilities, is the critical piece of advancing embedded financial infrastructure, not incremental solutions that move one step outside of a current method or company’s abilities.
Further, Radix is particularly well positioned because of its Radix Engine, which models how assets should work in finance and trade so developers can focus on business logic, rather than tech infrastructure that is capable of facilitating transactions. McKinsey outlines the transformation that banks must undergo, and consider the vast reaching implications of the below as the BaaS services lines will not only proliferate throughout the baking sector, but also across any industries which can make a horizontal play into the banking sector, similar to how airlines have inserted themselves throughout the hospitality industry via their loyalty programs which function almost as a bank:
Many banks are concerned that distributing their products through partners threatens their client relationships, but if end users begin adopting embedded finance in significant numbers, banks may have little choice but to launch BaaS business lines. The good news is that enabling partners to distribute banking products can be a low-margin, high-volume business for banks. Banks often struggle with their cost structures, which are frequently based on legacy technology and enabled through manual processes and operations. To offer BaaS, banks must undergo digital transformations, but many already have. My work with incumbent banks suggests that more than two-thirds have undergone the digital transformation and modernization necessary to be competitive in BaaS. (McKinsey)
What’s also critical in the above quote is the need to have cost efficient, low margin but high volume business models. If someone is not using pre-built infrastructure or relying on blueprints from the Radix ecosystem, then they are increasing the cost of the go-to-market offerings they want to enable for embedded finance. This means that people who build from the ground up will be spending more money, while also being less flexible, decreasing their competitiveness in the long run.
Also, it’s key to note that in the McKinsey report, they talk about how having more data on customers and industries is a benefit of the broader ecosystem (for the company.) By building on Radix or other DLTs, customers can be much more protective of their data, and only share and disseminate what they need, when it’s needed, and only as needed as per the circumstances. In a world with cross industry competition as fierce as what “ecosystem 2.0” will enable it will be critical for services and intermediaries to begin servicing these consumer demands rather than relying on monopoly power to abuse and mine customer data.
