What Are Payment Rails? A Beginner-Friendly Guide
Transferring money may not seem too complex. After all, it only takes a few seconds to set up an electronic bank transfer or swipe a debit card. Improvements in digital technology make all kinds of transactions faster and simpler. However, in reality, digitization has made it increasingly complicated to transfer funds. As more customers and businesses rely on virtual payments, banks need new ways to safely send non-physical assets.
To provide secure and seamless digital transfers, financial institutions now rely on networks called payment rails. Recent estimates suggest billions of yearly transactions occur, totaling trillions of dollars on popular payment rails such as an automated clearing house (ACH). So what are payment rails, and why are they so significant in today's financial system?
What are payment rails?
Payment rails are virtual networks that connect financial institutions. Banks, card issuers, and fintech companies use payment rails to transfer digital funds between multiple accounts. While every payment rail has unique regulations, most use a centralized system of checks and balances to verify each transaction. Once both banks receive info for deposit and credit requests on a payment rail, they issue the appropriate payments.
Although payment rails handle the literal transfer of funds, they also send vital information to relevant authorities. For instance, when you swipe a credit card at a grocery store, the payment instructions need to pass through the card issuer’s bank and the merchant’s bank address. The credit card processor records these transactions in its ledger once they’ve cleared the network.
Examples of payment rails
All payment rails are designed to transfer money from point A to point B. However, not every payment rail follows the same protocols. There are dozens of payment rails to choose from, each of which has different pros and cons.
- Automated clearing house (ACH): Introduced in the ’70s, ACH is a dominant payment rail that connects financial institutions in the U.S. Not-for-profit organization Nacha oversees the operation of the ACH network. When U.S. companies, government agencies, or customers use ACH transfers, their requests go to intermediary firms called "clearing houses" before any funds are transferred. Although this clearing process typically takes a few business days, ACH now offers instant and one-day settlement features for select financial institutions.
- Card rails: Credit and debit card issuers such as Visa, Mastercard, and American Express use their private card networks as payment rails. As long as a merchant links their bank account with a company like Visa, they can accept payments from customers who use Visa cards. In this case, Visa’s card network will connect the merchant’s bank account with the bank that issues the customer’s card.
- Real-time payment (RTP): Launched in 2017, RTP is one of the newest payment rails for electronic funds. Financial services company The Clearing House created RTP to offer clients instant payment finality. To provide these rapid transfers, The Clearing House only works with U.S. institutions that meet its high standards for on-hand reserves. The increased liquidity in the RTP network allows it to process transactions instantly. However, since RTP is new, it’s not as widely adopted as payment rails like ACH.
- SWIFT: Short for Society for Worldwide Interbank Financial Telecommunication, SWIFT is an international payment rail operating since the ’70s. It now connects 11,000 banks worldwide using its proprietary "Swift Codes." Transfers on the SWIFT network often take a few days and cost more than domestic services such as ACH. However, people who use SWIFT can choose from multiple fiat currencies.
- Fintech apps: Digital finance apps such as PayPal, Zelle, and Venmo often use banking rails like ACH to connect users’ bank accounts with their e-wallets. However, when people spend or send money within these apps, they use each company’s internal payment rails. And, when people transfer money between the fintech app and a bank account, the company uses ACH rails.
How do payment rails differentiate?
Each payment rail is optimized for a different set of circumstances. Some of these networks are built with international laws in mind, while others focus on offering the fastest transaction speeds. Businesses, governments, and customers need to review a few key factors when choosing the right payment rail for their transfer.
- Average settlement time: Settlement time refers to how long it takes to confirm a transaction on a payment rail. Some payment rails such as RTP offer instant finality, but most take a few days to process. For instance, a standard ACH transfer takes 1–2 business days to clear. Cross-border payment rails like SWIFT often take the longest, with average settlement times of up to five working days.
- Geographic limitations: Some payment rails only focus on one country or region, while others can handle international transfers. For instance, the Single Euro Payments Area (SEPA) only works with European banks, while the Faster Payments Service (FPS) is only available in the U.K. Anyone interested in sending payments outside these zones must use an international payment rail like SWIFT.
- Transaction fees: Payment rails aren’t free to use. Although some networks such as ACH have low transaction fees, there are costs associated with transferring funds on these networks. Often, international payment rails charge the most for cross-border payments.
- Maximum transfer volume: Governments or businesses that need to move large volumes of capital must review their payment rail’s maximum transfer levels. For instance, in 2021, Nacha announced it increased the same-day ACH transfer limit to $1 million. While these limits won’t affect day-to-day retail purchases, they could influence how large institutions transfer funds.
- Accepted fiat currencies: Domestic payment rails such as FPS and ACH only accept their associated fiat currencies like the Pound Sterling and the U.S. dollar. However, people who send money to a foreign nation need to know what currency will end up in their final destination. International payment rails are more accommodating for those who need to exchange foreign currencies.
Is cash a payment rail?
There’s debate over whether physical cash should be considered a payment rail. Since today’s rail networks are closely associated with digital transfers, cash doesn’t fit the standard image of a payment rail. However, exchanging physical cash has the same function as a payment rail (i.e., to transfer money from point A to point B). In fact, since cash is the most liquid asset, using physical cash as a payment rail offers the fastest transaction finality.
On the contrary, unlike the payment rails mentioned above, physical cash transfers aren’t recorded on a centralized bank ledger. Once cash leaves the bank, it’s virtually untraceable. For this reason, cash remains the preferred method in money laundering, totaling roughly $800 billion to $2 trillion annually.
Is crypto a payment rail?
Cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH) use blockchain technology as their payment rails. Unlike all other rail networks, blockchain doesn’t rely on a central authority. Instead, cryptocurrencies use a decentralized network of “nodes” that validate and post transactions on a publicly viewable ledger.
- PoW blockchains like Bitcoin use large computers to solve complex algorithm problems and verify a new batch of BTC transactions. The first ASIC rig to solve this puzzle every 10 minutes gets BTC rewards and transaction fees.
- In PoS networks, validators lock their crypto on the blockchain to get the chance to confirm transfers. Like on PoW networks, whoever validates a new “block” of transactions receives crypto rewards. A few examples of PoS cryptos include Ethereum, Solana, and Cardano.
A benefit of using crypto payment rails versus other methods is that the former is open 24/7 for peer-to-peer trading. Many cryptocurrencies also offer fast finality and relatively low fees. Plus, since no centralized organizations control cryptos, they’re naturally censorship-resistant.
However, there are potential drawbacks to using crypto payment rails. For instance, using crypto wallets requires a higher learning curve than sending cash through networks such as SWIFT or ACH. Crypto is prone to volatile price swings, hacks, and scams. Also, some nations like China have banned crypto transfers.
Without the infrastructure that payment rails provide, it would be impossible to safely transfer digital funds. Whether a domestic ACH deposit or a long-distance SWIFT transfer, these rail networks make it simple to transfer funds electronically. Plus, thanks to the innovations in blockchain technology, cryptocurrencies offer a decentralized payment rail alternative.
At Worldcoin, we believe blockchain will become a dominant payment rail in the future economy. To ensure everyone can access the crypto revolution, we’re airdropping DAI stablecoins to anyone who downloads our app. Subscribe to our YouTube channel to learn more.