I have noticed an increasing casual use of the term “rails” to describe payment systems, in particular “card rails”, “ACH rails”, and even “blockchain rails”.
But do payments move on rails, are there wagons of cash moving around the country on rails between banks and other institutions when payments are made? Obviously, in the literal sense this is not the case, but even as a metaphor it is not accurate, because
nothing actually moves when an electronic payment is made.
To explain, in my mind there are two types of payments, “double entry ledger payments” and “cash” payments.
Double entry ledger payments
In double entry ledger payments, the sending account is debited, and the receiving account is credited an equal amount.
For example, in the simple case of customer A of a bank paying another customer B of the same bank, customer A’s account is debited and customer B’s account is credited.
However, if customer B is at another bank B, connected with Bank A through a clearing system, then
- Customer A’s account is debited
- Bank A credits its own internal clearing account
- Bank B debits its internal clearing account and credits customer B’s account
- Bank A debits its settlement account, for example at the central bank and Bank B credits its settlement account at the same institution
The order and timing of these actions and the type and number of accounts used depend on the clearing system (real-time, batch, cheque, same day, correspondent, card etc), its (scheme) rules and the participating institutions - but the principle of a series
of matching debits and credits remains the same.
A payment is just an instruction to execute these series of debits and credits across a set of static accounts held in different institutions, but nothing actually moves. It is similar to a lightshow where static lights turn on and off sequentially – nothing
moves, but it gives the illusion of a moving light. It is the same for all types of payments between bank accounts – even a paper cheque is only an instruction.
I suspect that a key misunderstanding is a mistaken belief that an account is debited, a transaction is credited, the transaction is sent to the beneficiary, the transaction is debited and the beneficiary account is credited. In this case, the transaction
could be seen as a transportation mechanism to move payment funds, and may be why “rails” is used, but it is not how electronic payments work.
In the case of physical cash, obviously there is movement – if I pay Jane £10, I hand her a £10 note, or I might send it to her by post. The money has moved from me to her, but even so, no rails are involved (except perhaps if the postal service uses railways).
There is however, a twist – electronic cash is also a form of cash, the best example is Bitcoin.
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
This is the first line of Satoshi’s white paper.
But again bitcoins don’t move on rails either, not even “blockchain rails”. In fact, bitcoins don’t actually exist, they are not unique digital character strings as some believe. A bitcoin is simply a number, held against a private key. When person A pays
person B in bitcoin, a transaction is created (and held in a block), signed by B’s private key to show that B is now the owner of that bitcoin amount. I have oversimplified the actual process for clarity, but again, no movement, no rails, just the addition
of a transaction to the Bitcoin blockchain.
Cash, both physical and electronic, is much easier to understand than double entry ledger payments. It is straightforward and uncomplicated, and is one reason why Bitcoin, or more generally, blockchains have considerable potential to simplify payments (although
some see the lack of double entry book keeping as a weakness in blockchains, a backward step).
I am not railing (ho, ho) against the use of “rails”, but in my opinion, it is not a helpful metaphor when describing or understanding payments.
Instead, I much prefer to use “network”.