The Rise of Embedded Finance and the Multi-Armed Bandit Problem: Unveiling the Future of Fintech

Glasp

Glasp

Aug 07, 20233 min read

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The Rise of Embedded Finance and the Multi-Armed Bandit Problem: Unveiling the Future of Fintech

Introduction:

In the rapidly evolving world of fintech, a shift is taking place. Consumer-focused fintech companies, once the darlings of investors, are now being overshadowed by a new wave of startups that are poised to become the backbone of financial services innovation. This new breed of fintech companies, known as embedded finance providers, is gaining traction among investors who recognize their potential to shape the future of the industry. This article explores the rise of embedded finance and its connection to the multi-armed bandit problem, shedding light on the strategies and solutions that will drive the next phase of fintech evolution.

Embedded Finance: The Infrastructure for Innovation:

Embedded finance, as opposed to consumer fintech, focuses on providing the underlying infrastructure that powers financial services. Companies like Stripe and Plaid have already established themselves as pioneers in this space, while newer ventures like Apiture and Yapily are emerging as promising players. These startups offer solutions that allow businesses to seamlessly integrate financial services into their existing platforms, creating a more efficient and streamlined financial ecosystem. By targeting businesses instead of consumers, embedded finance providers can tap into a larger market and leverage software integration to reach customers where they are already engaged in their work. This approach minimizes overhead costs and accelerates the transition towards a fully digital financial landscape.

The Multi-Armed Bandit Problem: Balancing Exploration and Exploitation:

To understand the strategies employed by embedded finance providers, we turn to the multi-armed bandit problem. This classic problem exemplifies the dilemma of exploration versus exploitation. Imagine being in a casino faced with multiple slot machines, each with an unknown probability of yielding a reward. The question then becomes: What is the best strategy to maximize long-term rewards?

Exploration is key in the multi-armed bandit problem because information is valuable. There are several strategies that can be employed to strike a balance between exploration and exploitation. One approach is to focus solely on short-term returns and forego exploration altogether. However, this strategy may lead to missed opportunities for long-term gains. Alternatively, occasional random exploration can be employed to gather information about the machines' reward probabilities. This approach provides some level of exploration but lacks a systematic approach.

A more sophisticated approach involves exploring selectively, prioritizing actions with higher uncertainty. By favoring options with higher information gain, embedded finance providers can strategically gather valuable insights while still capitalizing on the most promising opportunities. This selective exploration allows companies to adapt and refine their strategies over time, leading to higher long-term rewards.

Actionable Advice:

  • 1. Embrace the Power of Infrastructure: As the fintech industry continues to evolve, focusing on providing the underlying infrastructure for financial services can be a winning strategy. By enabling businesses to seamlessly integrate financial solutions, embedded finance providers can tap into a larger market and establish themselves as key players in the industry.
  • 2. Strike a Balance Between Exploration and Exploitation: Just as the multi-armed bandit problem requires a delicate balance between exploration and exploitation, embedded finance providers should adopt a strategic approach to gathering information while capitalizing on the most promising opportunities. By prioritizing actions with higher uncertainty, companies can gain valuable insights and maximize long-term rewards.
  • 3. Leverage Software Integration: One of the key advantages of embedded finance is the ability to reach customers where they are already engaged in their work through software integration. By leveraging this integration, companies can minimize overhead costs and create a seamless and efficient financial ecosystem.

Conclusion:

The rise of embedded finance marks a shift in the fintech landscape, with investors recognizing the potential of infrastructure-focused startups to shape the future of financial services. By understanding the principles of the multi-armed bandit problem and its solutions, embedded finance providers can navigate the exploration vs exploitation dilemma and maximize long-term rewards. Embracing the power of infrastructure, striking a balance between exploration and exploitation, and leveraging software integration are actionable strategies that will propel embedded finance companies towards success in the evolving fintech ecosystem.

Resource:

  1. "Consumer fintech is out. Embedded finance is in.", https://www.protocol.com/fintech/embedded-finance-venture-capital (Glasp)
  2. "The Multi-Armed Bandit Problem and Its Solutions", https://lilianweng.github.io/lil-log/2018/01/23/the-multi-armed-bandit-problem-and-its-solutions.html (Glasp)

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