Dwolla is a relatively new online payment system that's designed to hit PayPal where it hurts: the transaction fees.

PayPal transactions, as well as credit-card payments, incur fees based on a percentage of the transaction amount in addition to a transaction fee. Dwolla transactions cost 25 cents each.

The whole idea is to move cash cheaply--for businesses and for consumers. Dwolla founder Ben Milne says his retail payment kiosk is cheap, too. It's virtual, relying on Web-connected point-of-sale systems on one side and consumers with smartphones on the other. A consumer selects the store he or she wants to pay and enters the amount on the smartphone app' the register clerk can see a payment come in and close the transaction. In the future, Dwolla's mobile app, which is currently very bare-bones, will get location awareness so it will know what store you're in when you go to use the system to send a payment.

But Dwolla is about more than saving consumers and retailers money on fees, Milne says. It's also closely tied in to social networks, today's de facto address books. From the Dwolla site, you can pay anyone in your Facebook or Twitter circle. All you have to do is start typing in their online name to find them.

With Paypal, you can pay people if you know their e-mail address. Back in 1999, the company that eventually became PayPal had a strong person-to-person angle, except instead of relying on smartphones and the Web, the original PayPal made it possible for Palm Pilot users to "beam" money to each other over their devices' infrared links.

Assuming I fund my Dwolla account, I&39'll be able to easily send money to Facebook friends.

Can Dwolla become the next PayPal--the scrappy payment company that's more convenient, more personal, and cheaper to use than the big guys (debit cards, credit cards, and PayPal itself) And, more importantly, when you're dealing with a service that connects to your bank account, is scrappy what you want

The companies funding Dwolla have well-established relationships with the banking industry, at least in Iowa, where the company is based. The Veridian Credit Union gives the company a footprint in banking, and The Members Group does financial transaction processing and serves as Dwolla's backbone for executing money transfers.

In Dwolla's hometown of Des Moines, a small number of businesses (like the Mars Cafe and Crown Cleaners) are currently taking payments with the system. Milne seems proud to tell me that the service has over 2,000 active users. In other words, it's barely off the ground.

But Milne believes that lowering transaction costs and making it easier and cheaper for people to pay one other and small businesses is the right pitch for today. He says that people of his generation--he's 28--don't carry much cash around for incidental day-to-day expenses. He adds that the popularity of services like Mint, which tracks everything you spend electronic money on, highlight a problem of paying with cash: you can't track what you've spent. (On the flip side, when you don't want to leave any sort of record, that's cash's big bonus.)

Dwolla does have a scary element: it can reach into your bank account. But then again, so can Mint, and it's doing pretty well. Other than that, it's a low-risk service to try. There are no fees unless you use it, and when you do, the 25 cents per transaction is close enough to free to not dissuade people from trying it out. For day-to-day cash transactions, Dwolla has the potential to become a major service. It will be interesting to see if the organizations behind existing electronic payment systems lower their rates or launch competing flat-fee services to keep this new and smart start-up at bay.

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