A Payment Upstart Still Trying to Catch On

“You could call it stupidity. Or naïveté.”

Ben Milne is looking for the word to describe what made him think he could take on the multi-trillion-dollar payment industry back in 2009, when he launched his company, Dwolla. At the time, he had been running a successful business selling audio speakers, but he was annoyed at spending tens of thousands of dollars a year to process payments. So he started looking for, and then building, an alternative.

“I didn’t know we were taking on a system as big as we were when we started,” he says, shrugging. “I was trying to solve my own problem.”

The solution Dwolla came up with uses the Internet to move funds digitally and nearly instantaneously. But while the resulting system saves money and time, Dwolla is becoming something of a case study in how hard it is to do anything new in payments.

Dwolla’s system bypasses decades-old payment arrangements. One of those arrangements relies on credit cards and carries 2 to 3 percent fees to execute a payment instantly; the other is far less expensive but processes payments in batches, meaning it can take two or three days for money to reach the recipient.

The new technology primarily serves as an alternative to the slower system, commonly called ACH, for “automated clearing house.” A network run by banks and credit card consortiums, ACH processes bank-to-bank transactions like direct deposits or bill payments from an online checking account.

Any consumer who has an account with a bank using Dwolla’s payment platform can directly pay a merchant in real time. It’s also possible to store value on a Dwolla account, just as you might with PayPal or Venmo, and pay a merchant from that balance. Dwolla charges 25 cents per transaction of $10 or more. Transactions under $10 are free.

Milne still doesn’t look much like a banker. In Las Vegas for a payment industry trade show last November, he wore a sports jacket and tie for a panel discussion with executives from Bank of America, the Federal Reserve Bank of Chicago, and other industry heavyweights. But his large-rimmed glasses and long beard set him apart from his fellow panelists, as did his frank message: Not every transaction requires real-time execution, but the biggest winners in the expanding payment business will be the companies meeting customers’ increasing expectation of rapid execution.

Dwolla has had the benefit of building its network in the modern era. Its open system is accessible to developers for free. The company supports the network and its connections to financial institutions, but it does not hold customer deposits, allowing it to sidestep a host of regulatory requirements. Milne describes building the network as “reverse-engineering a mountain of payment spaghetti” bank by bank, trying to work with bank staffs that were not always anxious to help Dwolla decode each unique system.

The problem is that banks have not been quick to sign up, in part because revamping their existing systems is an expensive proposition. And one or two days to process a payment is in many cases fast enough, explains Kuba Zielinski, a partner at Boston Consulting Group who specializes in the payments industry. Also, most banks issue credit cards, a lucrative business they’d undercut if they embraced Dwolla’s approach and moved away from the networks of Visa, MasterCard, and others.

New digital payment systems have taken off in some countries, including the United Kingdom and Switzerland, but only after regulatory mandate. In the U.S., Dwolla’s home market, there has not yet been such a requirement.

As of late 2013, the last time the company disclosed numbers, Dwolla had 500,000 customers. But the list of merchants accepting the firm’s virtual payment app remains dominated by niche firms selling things like small-batch perfume and heritage-bred pork.

To establish his rapid and inexpensive way of moving funds as a legitimate alternative to traditional networks, Milne needs to rack up bigger partners and customers. His home state of Iowa—the company is based in Des Moines—now allows citizens to pay taxes using Dwolla. And in early 2015, Dwolla will launch a real-time payment system with BBVA Compass, a bank with nearly 700 branches across the southern United States. That’s an important expansion because customers can’t do real-time transactions unless their bank or credit union accepts Dwolla’s network.

Dwolla has raised $32 million from investors such as Bain Capital Ventures, Andreessen Horowitz, and Union Square Ventures. But a recent investor, CME Group, could also become the kind of landmark customer Dwolla needs. CME Group operates derivatives markets where millions of trades are executed each day. It operates on a scale that could really benefit from—and demonstrate the value of—Dwolla’s speed and low cost.