Making Sense of Payment Rails in the U.S. in an Increasingly Decentralized World
Money movement is the foundation of any financial use case, whether it be checking accounts, cards, or crypto on- and off-ramps. And while Venmo and other fintech innovators have convinced some consumers that money instantaneously bolts from one account to another, the reality of modern payments is far more complex. Each transaction involves a litany of steps — from initiation to clearing, receipt, and settlement, varying levels of credit, liquidity, and fraud risk, and an ever-changing regulatory landscape. For any stakeholder, the anatomy of a payment is incredibly difficult to digest.
These complexities are only magnified in the U.S. where the country’s payment rails lag well behind peers around the world. Whereas new, modern systems like PIX in Brazil and UPI in India have brought about ubiquitous and convenient real-time retail payments in their respective countries with sophisticated overlay services and API infrastructures, the U.S. is playing catch-up, relying on decades-old schemes that present major challenges around security, cost, interoperability, and speed.
Builders and regulators in the U.S. are taking notice, though, and on the back of the Faster Payments Task Force established by the Federal Reserve in 2015 and the momentum behind Fintech 3.0 and decentralization, the urgency and pace of innovation around payments systems has accelerated dramatically across the country. Besides the adoption of real-time rails like RTP and FedNow, the transition to ISO 20022 payment messaging standards — the global benchmark for data-rich payments — and continued efforts by fintechs across the payments landscape all represent major steps forward. ACH, cards, and wire remain king, but a new, more seamless world of payments and commerce is firmly on the horizon.
Fundamentally, there are currently four key payment rails in the United States (for our purposes, we’ve excluded traditional paper-based systems like checks and cash):
Wire transfers are reliable electronic payments between domestic and international bank accounts designed for urgent and high-value transactions. Dating back to the 1800s when Western Union established a telegraphic funds transfer scheme, wires are made directly through settlement systems like Fedwire and CHIPS and a global network of banks and money transfer services, bypassing any clearing houses. And unlike ACH, wires leverage a real-time gross settlement (RTGS) model where each transaction is processed individually, enabling access to funds within 24 hours (as long as the payment is made within the sending and receiving bank’s cut-off time each day). Wires have some drawbacks, though: they are guaranteed and irrevocable, making them prime targets for fraudsters and scammers, and because of the liquidity risk created by the RTGS model, banks charge significantly higher fees for wires than for ACH or other rails. Despite these shortcomings, wires are still an effective and reliable tool, particularly for institutional, cross-border, and high-value transactions.
ACH payments are electronic, bank-to-bank transfers made via a network of financial institutions in the U.S. called the Automated Clearing House (ACH). First launched in its current form in the early 1970s when a number of check clearing houses came together to build a national alternative to paper checks, the ACH network is used by a vast array of businesses, consumers, and organizations across the country (and, rarely, internationally via “IATs”), serving as the backbone of any account-based fintech offering. Facilitated by banks, credit unions, or third-party payment processors on behalf of payers / payees and processed by middlemen dubbed ACH operators (the Federal Reserve or the Clearing House), the network enables both debit (pulling money from another account) and credit (pushing money from one’s own account) transactions and powers a variety of use cases like payroll, tax refunds, and bill payments.
Generally, ACH payments are considered inexpensive and reliable, particularly when compared to the paper checks they replaced. They are far cheaper than wire transfers or credit card transactions, have universal coverage across U.S. financial institutions, and, because of the deferred net settlement model that ACH employs, they are safer and more secure (no liquidity risk). However, this batch-oriented settlement means that funds may not be available in the receiver’s account for 2–4 days depending on the bank, and transfers can be reversed or rejected at any point in the process. Moreover, like wires, the ACH network does not operate on weekends, holidays, or outside business hours.
In an effort to bridge some of these gaps, NACHA, the trustee and governing body of the ACH network, introduced Same-Day ACH in 2016. This iterative evolution of the ACH system added new settlement windows and brought about same-day processing and settlement of credit and debit transfers, improvements which are particularly helpful for high-priority use cases like insurance payouts and payroll.
Card Networks (and Push-to-Debit)
Long the most popular channel for retail and point-of-sale payments in the U.S., the card networks are a fundamental piece of almost every American’s financial life. Underpinned by Visa, Mastercard, American Express, and Discover, the four major networks, and a web of gateways, processors, and acquiring and issuing banks, merchants can easily (but not cheaply) accept prepaid, debit, and credit card payments, receiving actual funds within 2–3 days. Crucially, when a consumer makes a card payment, the merchant’s bank (the acquiring bank) pays a small fee, called interchange, to the consumer’s bank (the issuing bank) to compensate them for bearing the risk of the transaction. In part because of the enactment of the Durbin Amendment in 2010 that capped rates for larger banks, interchange has served as the primary revenue driver — absent any significant interest rate hikes — for fintechs like Chime and Current that rely on the sponsor bank model. Now even crypto giants like BlockFi and Coinbase have deployed cards — the networks play in every arena.
Perhaps feeling the pressure from other faster payments initiatives, though, Visa and other card networks have invested heavily in their own infrastructure. Push-to-debit payments, which are credit (or push) transfers essentially sent backwards through the same debit networks used for traditional card payments, are a particularly effective example of this work. Deployed by Cash App, Tabapay, and other players, push-to-debit allows businesses and consumers to initiate push payments directly to a debit card, with the funds available for use within minutes, albeit with settlement not completed for a significant period of time.
In November 2017, the Clearing House launched the first new payment rail in the United States in the last forty years: RTP. While it has struggled to gain adoption, particularly with community banks, and operates under the shadow of the forthcoming, Fed-backed FedNow network, RTP clears and settles in real-time 24/7/365, eliminating many of the risks associated with ACH and wire. It supports a wide array of use cases and far more data-rich payments, vastly improving the experience for businesses and consumers at an affordable price. It does only support fully irrevocable push payments, though, and its bank-centric infrastructure makes it very difficult for third parties to integrate with the service.
The Future of Payment Rails
While current U.S. payments infrastructure, even with the introduction of RTP and more robust push-to-debit rails in recent years, may not be as capable or user-centric as other schemes around the world, there are several emergent solutions that look set to disrupt traditional channels. Blockchain-based offerings, including cryptocurrencies, stablecoins, and Central Bank Digital Currencies (CBDCs), are already making waves, disintermediating legacy banks and institutions. Fintech infrastructure platforms like Rize are working towards bridging the gap to this new decentralized world, with crypto-linked debit cards made popular by Coinbase and Crypto.com, a tangible example of the momentum behind this movement. The fiat world is not exempt from payment innovation either, though — most notably, the Federal Reserve plans to launch FedNow, its real-time bank-to-bank payments system, in 2023. While many details still have to be sorted, the FedNow service will operate 24/7/365 and, because it’s a non-profit, will be highly cost-effective. The system is expected to support a wider array of institutions, including community banks, and will be far more accessible for third parties.
Ultimately, the payments landscape is quickly evolving, and each system and rail offers unique benefits and disadvantages. For businesses, consumers, and even regulators, navigating this web of processes and stakeholders is incredibly difficult — the mismatch between how users think about and use money and how payment rails actually work is stark. Understanding and effectively leveraging these rails is critical to any successful fintech offering, though, and platforms like Rize help abstract these complexities for builders, allowing them to focus on what they do best: customer acquisition and creating engaging, impactful products. To learn more, please contact us at firstname.lastname@example.org.