What Fintechs Need to Know About Payment Rails
The most essential use for money is paying someone — which is why the ability to do so is a core component of any financial service. But as basic as payments are in concept, there are a lot of different ways you can send them. Understanding these payment rails is central to maximizing the platform you want to build.
Top fintech companies will have multiple commonly accepted payment rails enabled. Many payment options — such as ACH (automated clearing house) transfers, wire transfers, and checks — require bank accounts. That means partnering with a chartered bank to offer real bank accounts to customers is crucial. To make that possible, banking as a service (BaaS) providers create the APIs that connect fintechs to banks.
This post will run through all the major payment rails, how they work, and who uses them, so that your fintech company can better determine the right payment options for you.
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The simplest of all payment rails is cash. This refers to physical currency, meaning bills and coins. Cash payments are generally not recorded in a ledger the way checks, payments with cards, and money transfers are. So while a bank can see when someone has withdrawn cash from their account, and while a vendor records when they have received cash, there isn’t usually an official record of the specific person that spent cash on a specific product or service.
Automated Clearing House (ACH) transfer
An ACH transfer — or ACH rails payment — is a type of Electronic Funds Transfer (EFT) universally accepted at U.S. banks, and is inexpensive as far as payment rails pricing goes (they cost pennies.) Under the standard ACH process, it can take a few days for a payment to clear. This is because funds go to a clearinghouse where they sit in a batch with other transfers and await pre-scheduled transfers to receiving accounts. Many banks now offer same-day ACH, which is a faster, more streamlined option that allows ACH payments to be processed within the same day.
ACH transfers can be debited from, or credited to a user’s account. When an ACH transfer is debited from a user’s account, that means the user has initiated the transfer of money from their account to another account. When an ACH transfer is credited, that usually means the user has requested the bank credit money to their account, by pulling it from another account (with account holders’ consent).
Sending money by ACH is a fundamental feature of accounts. Not all accounts have cards attached, and not all accounts can wire money, but in the U.S., almost all accounts can send and receive ACH transfers. And while savings accounts typically can’t have cards attached, they can send and receive ACH transfers. This means that a fintech app built without bank accounts and focused exclusively on a credit or debit card will not be able to send ACH transfers.
A Real-Time Payment, or RTP, is basically an instant ACH transfer, which eliminates settlement risk. This form of payment is the first new payment rail introduced into the US financial system in decades. It is still very early in adoption and most community banks can’t yet use it. Even when one bank has it enabled, few other banks will accept it at this time. While RTP is becoming more broadly used, it still has its drawbacks. For example, to minimize the risk and allow for real-time settlement, RTP rails do not allow a “pull” transaction and only give the ability to push funds to another account at this time.
Once upon a time, checks were commonly processed through a tedious manual process. While some banks still do this, paper checks are now typically processed electronically. The receiving bank may send an electronic image of the check to the bank of whoever wrote the check, sometimes through an intermediary such as a clearinghouse. Or, the receiving bank may convert the check to an ACH transfer that it withdraws from the account of the check writer. In any case, money sent by check comes out of the sender’s checking account.
A wire transfer is a highly reliable form of payment because the bank or financial services company handling the transfer guarantees its delivery. Unlike an ACH, if someone initiates a wire transfer, then empties their account, the recipient will still get their money. Since banks take on this risk, wires are pricier to send — usually around $10–$20 for a domestic wire and $20 or more for international.
Every bank has wire capabilities, but not all accounts can send wires. Companies like Western Union and MoneyGram also make wire transfers, within their own networks, and from their networks to banks. In addition to wiring money from an account, one can wire cash by bringing it to the bank or company that will handle the transfer. Unlike an ACH payment, wire transfers are direct and do not go through a clearinghouse. Once a wire transfer is initiated, you can’t stop it from happening; it is irrevocable. Wire transfers are popular for large transactions — such as property sales — where sellers want to ensure they are guaranteed the funds.
Mastercard? American Express? Visa? These are examples of card networks. These networks charge merchants fees to process payments using their payment infrastructures. The bank or company sponsoring the card is called the issuing bank or sponsor bank.
A debit card can be linked to a checking account or can be prepaid with no account attached. A credit card is a card attached to a credit, or loan, account. This account could belong with a bank or at some other business or financial institution. In the case of card transactions, the ledger that records transactions could be held by the issuer such as a bank or fintech, the network, or the card itself.
Cryptocurrency refers to currency that bases its payment rails on blockchain technology. With cryptocurrencies, each block is the permanent record of a transaction. Unlike fiat currency, which gets its legitimacy from a government, cryptocurrencies are validated by a network of computers — often belonging to private individuals — that run calculations to create each block.
Each cryptocurrency is essentially its own payment rail with its own distributed system of validation. So Bitcoin is only compatible with Bitcoin, and Ether is only compatible with Ethereum — you can’t directly exchange one for the other. This is a little bit similar to how card networks work, except that card networks belong to one central company as opposed to a distributed network of strangers. And, of course, card networks generally handle fiat currency — although there are some new crypto-linked debit cards on the market.
Because cryptocurrency validation happens on a distributed network, a single bank or banking as a service (BaaS) provider cannot hold the ledger or official record of transactions. You also can’t store cryptocurrency in a traditional, Federal Deposit Insurance Corporation (FDIC)insured bank account because, by definition, cryptocurrency exists outside of fiat or government-validated systems of currency. That said, BaaS providers like Treasury Prime and some banks have ways to work with crypto and work with companies that offer crypto products.
Which payment rails are best for your fintech?
Payment rails are methods of transferring money between point A and point B. Each rail has characteristics that can make it either a great or not so great fit for your fintech’s particular use cases. What matters most is building your offering using bank accounts because as long as you have real customer accounts at the center of your fintech app, you will have access to a wide spectrum of payment rail options.
To decide on the best rails for your needs, you will want to consider what technology each rail requires, who you are exchanging money with, how widely a certain rail is accepted, any fraud concerns you might have, and how much you are willing to pay to use a particular payment rail.
To summarize the payment rails we have discussed here:
- Automated Clearing House (ACH) transfers are fairly cheap and widely accepted.
- Wires are guaranteed to get to the recipient, but cost more to send.
- Cards offer convenience for customers, and can be attached to bank checking accounts, credit accounts, or they can be prepaid.
- Cryptocurrency is a new form of currency, and each type of crypto is its own payment rail unto itself.
Centering your fintech around accounts will grant you the flexibility to choose whichever payment rails best suit you and your customers' needs. A card-centric approach, conversely, does not offer this flexibility. It’s also very difficult to shift from a card-centric to account-centric approach — which means it’s better to launch your company with bank accounts from the very beginning.
Have more questions about payment rails? We’re happy to chat. Please feel free to get in touch with our sales team. And developers interested in using Treasury Prime’s tools can familiarize themselves with our offerings by visiting our Sandbox.