Automated Clearing House (ACH) was created in the 1970s, as an electronic replacement for paper check transactions.

The checking system is one of the oldest payment systems in the US. A check is essentially a piece of paper that instructs a financial institution to pay funds from one specified account into another specified account (whether in the same or different financial institution).

Clearing Houses were established to help banks clear settle checks between each other. They facilitated the exchange of checks and calculated daily net settlement amounts per bank. The use of Clearing Houses makes checking an open loop payment system. Open loop systems, such as checking or ACH rely on intermediaries (banks, credit card networks, etc) to connect end parties (individual accounts).

In the late 1950s, magnetic ink character recognition (MICR) became widespread. This technology encodes the check number, account number, and bank routing number at the bottom of a check.

ACH became a natural extension of MICR use: it was created as a way to exchange MICR data directly, rather than extracting MICR data from paper checks.

Early ACH focused transactions that were:

• High-volume
• Low-risk
• Repetitive

Over time, ACH expanded to all US financial institutions, becoming so ubiquitous that it is not connected to every US demand deposit account. This popularity is not particularly surprising, because ACH was designed to be a low-cost utility, giving banks a profitable alternative to processing and storing paper checks.

ACH is the only payment system in the US that is capable of handling both push and pull transactions. The difference between these two types is as follows:

• Push transactions (ACH Credit): the customer initiates the transaction by pushing the money out of their account.
• Pull transactions (ACH Debit): the payee (typically a business) pulls the money out of a customer’s account by using their account and routing numbers.

In both cases, ACH works as follows:

1. A bank originates the transaction. This bank is called an ODFI (Originating Depository Financial Institution). Banks send ACH entries in batches, on some predetermined schedule.
2. An ACH operator (The Federal Reserve or The Clearing House) sorts the entries into deposits and payments.
3. Once the entries are sorted, the ACH operator sends the relevant entries to the RDFI (Receiving Depository Financial Institution).
4. The RDFI receives the entries and debits or credits its customers accordingly.
5. Money is settled between the banks at the end of the day.

Since 2001, ACH payments have been available online.

In 2015, NACHA (the organization regulating the ACH network) created Same Day ACH, which would settle transactions within the same day, rather than the previously standard 2–3 working days. However, while it is a big improvement, Same Day ACH is not real-time, it still depends on batch processing.

Currently, in 2021, ACH remains the best option for low-cost payments, especially as it has become faster than the checking system it was built to replace. However, because ACH is owned by the participating banks, financial institutions can block certain kinds of transactions, forcing consumers and merchants to use alternative, more expensive payment methods.

When ACH was developed, it was imagined as a radical improvement over antiquated technology (paper checks). Today, half a century later, both ACH and checking remain among the most used payment systems in the United States. A few years ago, a new payment system — Real Time Payments (RTP) was developed, allowing for even faster electronic money transfers. As technology moves forward, so will payment systems, as consumers and businesses both want payments to be faster, cheaper, and more convenient. We are excited to see what the next phases in payment systems are going to be.

A Short History of ACH was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.

FedWire, the main wire transfer system used by the United States, crashed last week. Let’s talk about why that happened and what it means for payments.

What is Fedwire?

“The Fed”, made up of the Federal Reserve Board and the Federal Reserve Banks, plays three main roles:

• Creates payment regulations for banks and other financial institutions
• Operates multiple payment systems, including the largest check clearing house, an ACH switch, Fedwire, and provides cash to banks
• Manages the National Net Settlement System for multiple private clearing houses

Wire transfer systems are also known as “large-value systems”, because they are the primary money transfer mechanism for large transactions. The US has two wire transfer systems: FedWire and CHIPs.

FedWire is a service offered by the Federal Reserve Banks (known together with the Federal Reserve Board as “The Fed”). It is available to all nationally-chartered banks and most major state-chartered banks.

As wire transfers are responsible for the majority of dollar value processed, it is no surprise that FedWire processes massive amounts of money. In December of 2020, it is estimated that FedWire processed a daily average dollar volume of $3.4 trillion.

Wire transfers work in real time, which means that payments are sent and settled immediately. These payments are also fully guaranteed, because they cannot be reversed or charged back.

How do Wire Transfers Work?

1. The sender instructs their bank to send a wire transfer to a receiver
2. The bank debits the sender’s account and sends a message to Fedwire
3. The relevant Federal Reserve Bank debits the bank’s account and credits the receiving bank’s account
4. The receiving bank credits the receiver’s account

What Went Wrong?

On Wednesday, February 24, 2021, FedWire services were down between 12:40 and 3:15 p.m. EST. The Federal Reserve claimed that the crash was due to an “operational error”. No further details were provided.

This is not the first time FedWire services have gone down in the last few years. In 2019, FedWire’s interbank funds transfer service also went down for multiple hours. This previous outage was attributed to “an internal technical issue”.

Clearly, there are some issues with FedWire’s infrastructure maintenance. Many users took to berating FedWire on Twitter, claiming that the outages show the downsides of centralized money processing systems, compared to decentralized cryptocurrency rails, such as those for Bitcoin.

FedWire: What Went Wrong? was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.

The Real-Time Payments (RTP) system from the US Clearing House is going to disrupt the financial landscape in 2021. While these newest payment rails were launched in November 2017, this coming year looks like it might see the widespread adoption of the system. At the moment, the network reaches 56% of US direct deposit accounts. Why do we think its prime time is about to come, and what’s the big deal about RTP anyway?

Why RTP is a Game-Changer

The RTP system is the only payment network that allows for instant and cheap money transfers in the US. We covered the current state of the US system in depth in our previous blog post here. In short, currently businesses have to choose between cost and speed in their payment methods. Fast payments are possible with credit/debit cards or wire transfers, but both come with hefty fees. Cheap methods like ACH and paper checks, on the other hand, are slow and inefficient.

RTP is the system to liberate businesses from their current Catch-22. Network fees are small, at $0.045 per transfer, and settlement occurs in seconds, 24/7. This is faster than credit card payments or wire transfers, at a fraction of the cost!

Furthermore, RTP comes with increased security, since it is the only US payment system built specifically for the Internet age. Merchants can also depend on guaranteed payment, without the threat of chargebacks. (Read our thoughts on chargebacks here)

The system works for all kinds of transactions — P2P, B2B, B2C, C2B. Consumers, businesses, and government entities can all use RTP.

Lastly, RTP offers more communication tools for its transactions. These include real-time messaging between the receiver and sender and remittance data.

Why is RTP not widely used?

Given this wide variety of benefits, why has RTP not caught on as a mainstream method of payment? While there are complex reasons for this, we think there are two main factors.

First, lack of incentives. Until 2020 there weren’t that many incentives to explore alternative methods of payment to widespread paper checks and cash. With the pandemic, however, there has been a push to contactless methods of payment. The most popular are credit and debit cards. However, after months of increasing dependency on them, businesses are learning that card fees are expensive and simply not worth it. Because of this, we believe that in 2021 more businesses and consumers will be open to trying out new payment rails, such as RTP.

Second, difficulty of integration. While businesses can integrate payments directly into their systems, they need to integrate with each bank individually. With more than 4000 banks in the United States, RTP integration becomes impossible for small and medium size businesses. This means that for RTP to become more widespread, a simpler, unified integration method needs to become available.

How RTP Will Change Payments in 2021 was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.

We are used to thinking of financial services as the domain of banks and specialized firms. But what if we imagine a different setup? Embedded finance is the concept that financial services can be provided by traditionally non-financial software and applications.

For example, Uber allows customers to pay for their rides within the application, instead of having to physically take out their card or pay with cash. Some e-commerce vendors are offering Buy Now Pay Later options, which function as automatic loans from the store rather than a third-party provider.

The idea is that extra products or services related to the primary product can be bundled together. This removes reliance on third parties for financial transactions. Finance is no longer a separate, mystical domain. Instead, financial services become simply another part of the product offerings.

There is a wide variety of applications for embedded finance. These include:

• E-commerce merchants offering loans and payment processing
• Ridesharing companies offering digital wallets and debit cards
• Fintechs providing loans and cards
• Tech companies offering digital wallets and P2P payments, and cards
• Car dealerships directly providing embedded insurance options.

Benefits of embedded finance include improvements for both businesses and customers. Businesses can open up new revenue streams and broaden their offerings. Modern financial technology is also low-cost and efficient, allowing for profitable margins. Embedded finance is also better for user convenience, since applications can create a more unified customer journey and use big data to provide personalized products.

Overall, it seems that embedded finance is the future. Traditional financial institutions, such as banks and insurance companies, will need to evolve or die in face of robust competition.

Embedded Finance was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.

Chargeback abuse (otherwise known as “friendly fraud”) is when a cardholder files to reverse a transaction without a valid justification. Friendly fraud cost merchants an estimated $35 billion in 2019. This number is only projected to have grown over 2020 with the rise of online shopping.

Given these immense costs, what is friendly fraud and what options do merchants have to protect themselves against it?

When a cardholder reports a transaction as fraudulent or requests a chargeback because the product purchased was never provided, the card network (Visa, MasterCard, or AmEx) would take the money for that transaction back from the merchant. The merchant can dispute the chargeback with a receipt and proof that the transaction was not fraudulent, which would make either the cardholder or the bank liable for the cost.

In theory, chargebacks are a good way to protect the consumer from fraudulent transactions. The process works as follows:

• Bill logs onto his bank account and sees a transaction from Corgi Pizza Co. that he does not recognize.
• Bill calls his bank, reporting the transaction as fraudulent.
• The bank consults Corgi Pizza Co, asking about the nature of the transaction. During this process, the funds from Bill are frozen from Corgi Pizza Co.
• If the bank decides to move forward with the chargeback, it moves the funds back to Bill.
• MasterCard (Bill’s card scheme operator) processes the chargeback and charges Corgi Pizza Co. a chargeback processing fee.
• If Corgi Pizza Co. want to contest this decision, they need to deal with MasterCard’s arbitration process.

It may not be apparent from this description, but both banks and card networks usually take the cardholder’s side. This means that if a merchant wants to contest a chargeback, they need to invest a lot of time and resources to submit the relevant paperwork. Disputes can also only be contested over a limited amount of time, typically 45–60 days.

Because the burden of proof falls on the merchant, many businesses simply do not contest chargebacks at all. This means that they lose the value of the original transaction and $20–100 in chargeback fees.

In addition, even if a merchant manages to win the dispute, the chargeback may impact their business. If a merchant gets close or over 1% chargeback rates (percentage of chargebacks within monthly transactions), they may lose the ability to accept card payments altogether.

None of this would be a problem if the system worked as intended and chargeback claims were mostly valid. However, it is estimated that over 85% of all chargebacks are actually friendly fraud.

This problem is only getting worse, as chargeback requests are known to increase in times of economic uncertainty. The current economic situation caused by the pandemic is making people desperate, and more likely to claim transactions as fraudulent in efforts to get items for free.

This means that if Bill did get a pizza from Corgi Pizza Co., he could have claimed that the pizza never arrived or that somebody else logged in his card details on Corgi Pizza Co.’s website. As MasterCard is likely to take his side, Bill will probably get his money back, leaving Corgi Pizza Co. trying to contest the chargeback.

Card networks are unlikely to change their perspectives and begin protecting merchants anytime soon. Thankfully, chargebacks and all of their associated problems do not exist with bank transfers. This means that if your business uses Dapi, you never have to worry about friendly fraud and chargeback fees ever again.

The Threat of Chargebacks was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.

To disrupt financial services, fintech requires international scale. Fintech companies that operate in regional markets will most likely fail. Why is that?

Uberization of Financial Services

What is “Uberization”?

Regional fintech companies will fail because of the “uberization” of financial services. So what does that buzzword mean?

Uberization is when an industry begins shifting from owning products to providing services. This means that companies focus on connecting those that can provide services with those who seek them. If you have ever heard a start-up pitched as “an app that connects people looking for…” then you have seen uberization in action.

In the last decade, companies like Uber and Airbnb have shown that many industries are ripe for disruption. Any industry filled with middlemen who contribute only by checking boxes is currently vulnerable. These bureaucratic industries are slow and inefficient.

Disruptive technologies can change that. Uber bypassed the hassle of dealing with traditional taxis by providing a sleek, intuitive, and fast technology.

How the Financial Industry is Cutting Middlemen

The financial industry is no exception to these trends. Financial services rely on many intermediaries, such as insurance agents, bank tellers, and financial advisors. In many places, you cannot open a bank account without physically going to a branch! Complex financial operations, such as refinancing a mortgage, sometimes consume weeks of time and tons of paperwork. Well, fintech promises to change that.

Fintech companies replace middlemen with efficient algorithms and make financial products and services more accessible to consumers than ever.

This trend is occurring with several applications:

• Robo-advisors are replacing financial advisors and agents.
• Physical branches are being swapped out for mobile and online banking.
• Peer-to-peer (P2P) payments are replacing traditional wire transfers.
• P2P lending is making loans available to those who couldn’t traditionally access them.

Companies that make money by enabling simple financial transactions, will fail when other services can provide the same access at nearly zero cost.

The Race for Financial Products and Services

One might wonder, who will win this race between fintechs and banks?

The Role of Data

Well, for an answer, let’s look at Uber.

Services like Uber work by collecting vast amounts of data. For that, they need a large population of smartphone users and the capacity to gather and process a large amount of data. The more data and service providers Uber gets, the more efficient it becomes, making it more attractive to consumers. Uber continues dominating the market because of its scale.

We are going to see the same trends play out in financial services. Companies that have vast networks of users are more convenient for P2P payments. Robo-advisors trained on large datasets can give better suggestions, bigger lender pools enable P2P lending, etc.

In financial services, big data is going to win.

Diversifying Product Offerings

In addition to larger data sets, the financial industry itself is partial to economies of scale.

Multiple studies have found that increases in the banking sector output result in lower costs. By their very nature, banks tend to diversify their product offerings because large amounts of financial products and services can be offered using the same distribution network. A bank becomes the one-stop financial solution for a vast majority of its users, providing credit, savings, money transfers, and loans.

Fintech companies can compete with banks by bundling up products from multiple providers. This way, a fintech company can become a one-stop financial solution. In fact, it can provide better quality services because they are maintained by specialized providers. A large fintech can continue diversifying, becoming more and more lucrative in the eyes of the consumer.

Geography

Disparities in Size of Fintech Markets

The last considerations are geographical. Not all fintech markets are created equal.

Countries with well-developed economies have much larger fintech markets, for three main reasons. One is the simple availability of venture capital and entrepreneurship support.

Large and developed economies like that of the United States provide more funding to new businesses and support to promote their growth, such as accelerator and incubator programs. In these countries, regulations also tend to be more favorable towards the creation of new businesses, with less red tape required to start and develop a new venture.

The second factor is that more developed economies, by their very nature, have more demand for financial services. In more developed economies, residents tend to have more access to capital and thus need access to more services to help them manage that capital, such as asset management and financial education tools.

More developed economies tend to have more active stock markets, which increases the demand for relevant fintech solutions and pour more money into venture capital.

The third factor is the availability of technology required to make fintech work. Not everyone around the world has easy access to smartphones and fast, reliable internet connections. People in richer countries are more likely to have phones and be able to use fintech applications.

Because of all of these factors, fintech companies operating regionally in most markets (with the notable exceptions of the US and the EU) are doomed to remain small.

Why an International Play is Key

Given the apparent limitations of emerging markets, why would a fintech company even want to expand beyond developed countries?

There are three main reasons.

First, the markets of developing economies are growing, with more people becoming potential consumers for fintech solutions. More and more people gain access to mobile phones and banking services every day. A player that can come in and meet that demand as it arises, will win significant market share and get a competitive advantage.

Second, an expanding network of fintech services across regions is valuable in and of itself. A large international player can create a large distribution network of financial services that cater to the needs of each region, with better security and infrastructure powering the technology behind those services.

Third, legal divisions between emerging market countries and lack of common economic zones for financial services makes it very difficult to expand beyond the scope of an original region. A startup would need to acquire licenses for every region it would wish to operate in, which with already narrow revenue potential could be impossible.

But a company that can succeed at expansion, wins. By combining the data of multiple regions, a fintech player can gain access to more data and provide more sophisticated financial solutions, than any company operating only in developed markets.

A company with a presence in multiple countries can offer services regional players cannot, such as cheap international transfers or stock portfolios across multiple stock markets.

It is inevitable that a few Uber-like large players are going to emerge on the global fintech scene and capture all or most of the small markets, continuing to enjoy the increasing benefits of scale.

Why Fintech Needs Scale was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.

Version 2 of Dapi’s systems brings with it a number of improvements that will make your integration process and continued use of our services easier and faster.

We have made a number of improvements to our backend in order to serve you better. We have improved the time that each API call spends on our system by moving from JavaScript to GoLang. This allows us to use fewer resources and scale our infrastructure better. This cuts our processing time by one-third! In addition, these changes to our system bring the following improvements:

• Parallel processing
• More stability
• Better testing
• Better detection of errors
• Better logs

We have also added caching. This allows us to fetch information faster by utilizing short-term storage, so that consecutive calls with our API don’t need to access the same endpoints over and over again. This change will cut the money transfer processing time down up to two-thirds!

Finally, the most exciting change is the introduction of our new product, Deploy with Dapi. Deploy with Dapi will allow you to integrate with us faster than ever before. The new integration process may take as little as two or three hours. How can we do this? Deploy with Dapi introduces three main changes:

• Adding new endpoints that require less data input and do more processing for you, decreasing the amount of logic you need to code into your application.
• Reducing back-end requirements — you no longer need to handle any data or backend work, Deploy with Dapi will take care of everything for you.
• Queuing of requests to eliminate errors related to banks’ inability to handle parallel processing.

With these changes, you as a client no longer need to handle any bank-related logic (such as beneficiary creation or payment initiation) or bank-related exceptions, instead you can focus on building your application while we make financial data and payments work for you. Both APIs will be available for the foreseeable future and transition to V2 will be smooth even for clients that don’t use the SDK. The clients that are using our SDK will simply have to update the SDKs to use Dapi’s new system. Dapi engineers will be working with clients during the transition process to make the process as easy as possible.

Dapi System V2 was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.

As a business, you have a few options to receive payments electronically from customers, but they all come with trade-offs. Surprisingly, in 2021 businesses still face the choice between either speed or cost. There isn’t a single available payment option that’s both cheap and fast.

If you want fast transfers, you have two choices: cards or wire transfers. Credit and debit cards are the most widely used form of payment. But there is a catch — anytime a customer swipes their card, merchants incur several fees for the transaction. These fees include a processing fee charged by the payment processor such as Stripe, a card scheme fee charged by Visa, MasterCard, or AmEx, and an interchange fee charged by the customer’s bank. Altogether, these fees can average from 1.7–3.5% of each transaction your customers make online or in a store. For many retailers, these fees can eat up a significant portion of already thin margins.

Wire transfers are a type of bank transfer, moving money between two bank accounts directly, instead of between cards connected to those accounts. Wire transfers are real-time and typically processed the same day. However, they require bank employees to input the information manually, and so they can be quite expensive, costing up to $60 a transaction. Unless you sell luxury goods or real estate, you probably cannot ask your customers to pay such extravagant fees.

If you wish to preserve your margins, you can sacrifice speed. This allows you to use checks or the ACH network. Checks, whether mailed-in or e-checks, are appealing because they are free and a familiar payment method for most of your customers. However, checks can get lost in the mail, and e-checks, while faster, still take multiple days to process.

Your last option is to use the ACH network, which operates e-checks as well. ACH (Automated Clearing House) is a batch processing system set up within the United States that banks can use to aggregate and automatically process transactions. It is secure and fully electronic. Its rules and regulations are standardized across the country and overseen by Nacha, an organization formed specifically to administer the ACH Network. ACH payments have been available online since 2001.

There are two types of ACH payments: ACH Pull and ACH Push. In ACH Pull, also known as ACH Debit, your customer provides you with their account and routing numbers and authorizes you to pull the appropriate amount of money from their account, but ultimately you initiate the transaction. On the other hand, in ACH Push, also known as ACH Credit, your customer initiates the transaction themselves by pushing the money out of their account into yours.

In both cases, the process is as follows:

1. A bank originates the transaction. This bank is called an ODFI (Originating Depository Financial Institution). Banks send ACH entries in batches, on some predetermined schedule.
2. An ACH operator (The Federal Reserve or The Clearing House) sorts the entries into deposits and payments.
3. Once the entries are sorted, the ACH operator sends the relevant entries to the RDFI (Receiving Depository Financial Institution).
4. The RDFI receives the entries and debits or credits its customers accordingly.
5. Money is settled between the banks at the end of the day.

ACH payments typically take 2–3 business days to be cleared because they are typically processed in batches. Additionally, ACH Pull payments are risky because they can bounce just like paper checks if your customer withdraws too much money and forgets to maintain the necessary balance to clear your promised transaction. These risks don’t exist with ACH Push because the transfer is initiated by the sender, which makes it potentially the best payment option.

However, there are still issues even with ACH Push because many top US banks impose limits on them. Even though the network allows free transfers of up to $100,000, many banks limit the amount of ACH withdrawals a month or require their customers to link accounts and restrict the number of links to those external accounts. Some banks only allow transfers to checking accounts, while others may prevent your customers from sending you money at all by only enabling ACH Push transfers to external banks if the customer owns both accounts. These restrictions with ACH Push transfers from consumers to merchants only exist in the United States of America, every other country in the world facilitates this movement without any issues.

We at Dapi understand how tough navigating the payment landscape can be. We are working tirelessly to help fix the broken payments system and give businesses a real solution. A payment solution that preserves your margins and provides a convenient payment route to your customers so that they will want to come back to you again and again.

US Payments Are Broken — Here’s Why was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.

When Ahmed got on the plane, he didn’t think much of it. This flight was going to be a quick trip to the United States for Y Combinator Demo Day, after which he would be back in the UAE to continue what he started.

This “quick trip” began back in March of 2020, and Ahmed’s company, Dapi, had just moved cities from Dubai to Abu Dhabi. The office was still empty, with some boxes piled up in the corner and a pile of CVs of promising intern candidates. The small team was mostly scattered around the other emirates where they lived previously, waiting for company issued apartments near the new office. There was a lot to be done, but it could wait until Ahmed got back. Or so he thought.

As Ahmed sat on the plane, he got a call from his wife in the US. “Things are crazy here,” she told him, her voice filled with worry, “People are stocking up on supplies, and things might be shutting down.”

“It will be fine,” Ahmed told her, “I will be there soon.”

Both Ahmed and one of his cofounders, Hesham, only packed a carry on suitcase each. Surely, that would be enough for a two-week trip. But after this call, Ahmed began to worry that things might not turn out as planned.

A few days into their stay in the US, the world turned upside down. Countries across all continents began imposing lockdowns, citing the rising cases of a new virus, COVID-19. The new office back in Abu Dhabi, still not fully set up, was shut down with notices sent to employees that everyone would be working from home. Then, just as suddenly, planes stopped flying.

The carry on suitcases would have to last Ahmed and Hesham multiple months.

Trying to make use of this new situation, Ahmed decided to look into business opportunities in the US. Dapi was still a young startup, not quite sure of its value proposition. They just launched with the first client back in the UAE, with plans to expand across the Middle East and some other emerging countries. The United States wasn’t even on the table.

Nobody has ever expanded from the Middle East into the US, Ahmed thought. But what if we could do it?

The results of his research shocked him. The United States, the world’s largest economy and a modern superpower, turned out to have a completely dysfunctional payment system. Card payments charged exorbitant fees, and in many instances, there was simply no way to transfer money from a customer’s bank account to a business’s bank account without resorting to the use of a paper check.

Ahmed couldn’t believe it. Businesses had to choose between waiting for weeks to receive notice of payment or giving up their hard-earned margins to the likes of Visa and American Express. All this even though the United States provided native bank payment rails, ACH. The majority of banks prevented ACH use except to other bank accounts belonging to the same user.

After consulting with his cofounders, Hesham and Mohammed, and the engineering team, Ahmed realized that he had his hands on a golden ticket. Dapi’s system, built to initiate payments and access financial data, could solve the catch-22 scenario faced by American businesses, the ability to receive payments instantly that are at an affordable cost. The startup might just be the key to solving America’s payment problem.

It may be fate or a less poetic lucky coincidence, but when Ahmed got on the plane from the UAE to the US, he couldn’t have predicted any of this. Now, Dapi is dreaming of revolutionizing America’s payment industry and giving businesses back their hard-earned margins.

“The system has been abusing merchants,” Ahmed says, “We are going to make a new system that plays fair. With Dapi’s revolutionary system and zero-fee payments, businesses are getting their money back.”

Why Did Dapi Enter the US? was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.

When you, as a merchant, accept a credit or debit card, you have to pay a number of fees. These fees usually come in three categories that benefit different parties providing the service:

• Processing fee — charged by the payment provider
• Card scheme fee — charged by the card schemes (Visa/MasterCard/American Express)
• Interchange fee — charged by the cardholder’s bank

In this post, we will take a closer look at the last category, interchange fees or interchange reimbursement fees. These are charged by all card schemes, but take note that while Visa and MasterCard both refer to them as “interchange fees”, American Express refers to them as a “discount rate”. Nonetheless, both are essentially the same charge. Interchange fees are paid by you, the merchant, or any entity that accepts credit or debit card payments. They are calculated per-swipe, as in every time that a credit or debit card is used.

Historically, the fee was justified by banks as a compensation for them handling the risk of accepting customer credit, as well as a way to make up for charges inherent in card transactions. The banks used this fee to reimburse any lost interest from cardholders repaying their debt. Nowadays, the justification is not as clear cut. On Visa’s official website it states that “Visa uses interchange reimbursement fees as transfer fees between acquiring banks and issuing banks for each Visa card transaction. Visa uses these fees to balance and grow the payment system for the benefit of all participants.” As you can see, the specific rationale behind these charges (especially as opposed to processing and other existing fees) is not clear.

The process of how interchange fees work is as follows:

1. You accept a credit or debit card.

2. The issuing bank (the cardholder’s bank) withdraws the money from the cardholder’s account.

3. The issuing bank deducts interchange fees from the amount withdrawn and keeps them as its fee plus any markup.

4. The issuing bank deposits the difference into the acquiring bank (your bank).

5. The acquiring bank charges you the difference between the original amount withdrawn and the amount that was deposited by the issuing bank plus a markup.

This means that the interchange fee is paid by the acquiring bank to the issuing bank, and then the acquiring bank charges you the cost of those fees plus potential interest. The amount you pay is referred to as a “merchant discount” to your financial institution. It’s common both for the acquiring bank to charge extra interest and for the processor to “pad” interchange fees by adding to the fee without informing you. Because there are very few regulations in credit card processing in the US, both markups are legal.

Interchange fees change biannually, in April and October. They are decided by the card schemes themselves, so Visa, MasterCard, and Amex all decide what to charge, even though the money is paid to banks. The specific fees vary based on transaction type, location, sales channel, and business model. For American Express the fee is calculated based only on the type of business being charged. Usually the fee cannot be changed, although larger companies can supposedly negotiate with Visa and MasterCard for lower rates.

Different card types get charged different rates. In general, debit cards have significantly lower fees as compared with credit cards. Additionally, high-end reward credit cards usually have higher fees as compared to non-reward cards. The fees also change depending on the processing method used. The method can be either card-present or card-not-present. Card-present methods get charged lower fees. These methods are when a card is used directly, such as swiping, using a chip, or tapping with contactless payment methods. Card-not-present methods are usually those where you have to enter card details manually into a machine or online portal, such as with online checkout systems or invoices.

The fee itself is usually charged as a flat fee plus a percentage of the transaction value. Debit cards have standard fees of 0.05% + $0.21. On the other hand, credit in the US is unregulated, so the fees vary wildly. As of September 2020, the fees for Visa vary from 0.8–2.95% and $0.04–0.20 flat fee. For MasterCard the fee varies from 0.19–3.25% and $0.05–0.10 flat fee.

Overall, interchange fees can be a pretty significant part of your expenses, especially if you operate a low margin business. However, if you want to accept credit or debit there is nothing you can do, especially because you can’t fully control what kinds of cards your customers use and thus what kinds of fees you will be charged.

Finance Concepts — Interchange Fees was originally published in Dapi on Medium, where people are continuing the conversation by highlighting and responding to this story.