Dynamics raises $35M round for computerized smartcards and payment systems

Dynamics, the big winner in the 2010 DEMOfall conference, has raised $35 million in funding to accelerate its business of making computerized smartcards and payment systems.

The funding led by Bain Capital Ventures is the largest second funding round in the payments business this year and is the largest round in the history of Pittsburgh, Pa., where the company is based. That says a lot about the potential of Dynamics, which is seeking to bring old-fashioned credit cards into the modern computer age.

In the U.S., most credit cards use magnetic stripes that are read by 1970s-era card readers. Dynamics uses those same magnetic-stripe readers, but it has features built into the plastic of its Card 2.0 credit cards that enable more innovative features without requiring a multibillion-dollar upgrade in the payments infrastructure.

For instance, as you can see in the top image, a user can press a button on the card in order to switch it from a credit card to a debit card or vice versa. This “multiaccount” card can rewrite the numbers on the magnetic stripe as needed. That allows credit card issuers — who spend $20 billion a year on marketing — to truly differentiate themselves from the rest of the pack, said Jeff Mullen (pictured right), chief executive and founder of Dynamics, in an interview.

Mullen said the company is also preparing to expand beyond its first major customer, Citibank, to other credit card issuers. And it is also working to expand into new markets around the world, including the contact-chip card market in Europe, the radio frequency identification (RFID) card market in Asia, and the phone-based payment systems that are beginning to launch with smartphones.

“Our goal is to innovate in payments and be agnostic about the platforms,” Mullen said.

Bain Capital Venture’s Jeff Schwartz, managing director and founding partner, will join the board of Dynamics. Mullen said the round was oversubscribed and “Dynamics had a lot of suitors.” He said he chose to go with Bain because of its experience in financial technology investments.

Previously, Dynamics raised $5.7 million from Adams Capital Management, which also participated in the new round. Mullen said the company will use the money to more than double its workforce of 30 by the end of the year. Mullen said the company’s current customers are increasing their unit purchases of the cards and that Dynamics is arranging for high-volume manufacturing of the cards in the U.S. and abroad.

“The 40-year business model cycles at card issuers are turning into 3-year business model cycles,” said Joel Adams, General Partner, Adams Capital Management. “As such, the industry is demanding a fast-cycle payments platform. With this investment, Dynamics will have the first fast-cycle, high-volume consumer electronic manufacturing capability in the payments industry.”

He said payment systems have evolved slowly over time, but there’s a lot of money to be made if even a small percentage of the world’s consumers switch over to new kinds of payment systems. The incentives include better options and more security.

Scwhartz  at Bain Capital Ventures said, “Dynamics’ technology and product applications have been enthusiastically validated by several top card issuers, payment networks, and consumer groups, and we believe this will be the most impactful technology company in the payments industry.”

Here’s more of what we’ve said about Dynamics before:

Dynamics hopes to upgrade magnetic stripe cards to computerized smartcards with better security and multiple accounts per card — without making any changes to the existing infrastructure of magnetic stripe readers in 60 million locations.

The ultimate goal isn’t just to upgrade credit-card technology. It’s to transform the existing credit-card business, with cookie-cutter cards and offers, into ones where consumers can give voice to their needs and banks can respond with personally customized offers.

The development could be very significant for credit-card issuing banks that have wanted to upgrade their service to engage and reward customers, only to be stymied by the limitations of magnetic-stripe cards. Every bank aims to be “top of wallet,” or the card that a person will use for 70 percent or more of their transactions. The second card down will likely be used only 15 percent of the time, and the third card, 5 percent. If a bank can offer better rewards, make a card more secure, or otherwise convince someone to use a card more often, the financial gains can be enormous over the life of the customer relationship.

The Electronic Stripe is the brainchild of Mullen, who put himself through business school as he was starting his company in 2007. He has recruited a crack team of payment specialists such as Philip Yen, a former executive vice president at Visa.

If all goes well, the company hopes to move on from ordinary credit cards to security cards, medical cards, gift cards and other prepaid cards.

To the old-fashioned magnetic-stripe readers which still handle 90 percent of today’s transactions, the card looks like any other. But each sliver-thin card has 70 electronic components and can be modified on the fly. That means the company can change the numbers that are fed to the magnetic-stripe reader.

For instance, if you press a button on one of Dynamic’s cards, it will switch from one credit card number to a different one (and change the indicator light so you know which account is active). You can thus have multiple credit-card accounts from one bank, such as a personal account and a business account. The purchase is processed on Visa, MasterCard, or other card networks as a normal transaction.

Another type of card can offer improved security. Instead of a full 16-digit credit-card number, the numbers are interrupted by a display. The display will show the remaining numbers in the account only after the user types in a personal identification number on a set of five small buttons on the surface of the card. If a card is lost, a thief can’t use it at all unless he or she knows the pin code. If the result is fewer fraudulent transactions, then the banks can see improved profits.

Dynamics stands a great chance at getting past the barrier of older infrastructure. Radio frequency identification tag (RFID) readers are being put in more places in order to accommodate electronic cards, but they still account for only about 3 percent of all of the readers in the market, even after billions of dollars in infrastructure investment. Another innovation, near-field communications, requires chips to be built into cell phones and it also means that merchants have to adopt new readers. But Dynamics’ strategy has the most benefit for the least pain. A programmable card fits with the strategies of a lot of banks, which are issuing different cards for loyalty programs or budget management.

Mullen’s company will sell the cards to banks. It hopes to manufacture tens of millions of the cards in the coming years and it is lining up multiple manufacturing sources so that it can do so. Mullen says each device has a small microprocessor and a certain amount of memory. The cards cost more than typical cards, but they also have more revenue potential for the issuers.

While the cards could disrupt older card makers, Mullen said his goal is to help the current ecosystem of banks and credit card companies, which is an easier sell than tearing up the entire landscape.

Mullen has put a lot of thought into the problem. He was trained as an electrical engineer at Carnegie Mellon and wanted to be a patent attorney after graduation. He went to law school and was a prolific inventor himself, with more than 150 issued and pending patents. But he wanted to start his own company, so he went back to Carnegie Mellon for his MBA and set up Dynamics in 2007 across the street from the school. By day, he ran the company and found time to get course work done when he could; his teachers accommodated his crazy schedule. The company won various grants in business school contests, adding up to more than $400,000.

Yen, the former Visa executive, worked for years in the payment innovation space and saw how it could take 15 years for a new innovation to work its way into the system. When he met Mullen, he decided to join and he helped recruit other payment professionals.

Dynamics Inc. launched at DEMO in Fall 2010. Check out their video here and more at DEMO. Got six minutes to launch your game changer? We’re finding top shelf thinkers from around the world ready to showcase their products at DEMO Fall, on the same stage where companies like Netscape, TiVo, E-Trade, and Java got their start. After you sweat out your six minutes of fame, head off the the DEMO pavilion to chat with potential investors, partners and show off the goods.  Apply for your spot here. Demo Fall 2011 is located at the Hyatt Regency in Silicon Valley, September 12-14.