Square -- the San Francisco mobile payments startup -- has some high-profile backers (Vinod Khosla, Ron Conway) and entrepreneurs (Twitter co-founder Jack Dorsey) behind it. But the company is facing some new competition from scrappy Seattle startup Inner Fence, which today is launching a rival technology that allows merchants to quickly swipe credit cards from an iPhone.

“We’ve already seen great success with keyed transactions on the iPhone,” said Inner Fence CEO Derek Del Conte in a statement. “I believe that the addition of a magnetic stripe reader will help us attract a new segment of merchants who require the speed and reliability of swiped transactions.”

Inner Fence unveiled its Credit Card Terminal application for the iPhone in 2008, and in recent months it has been covertly working on ways to incorporate hardware to allow swiped transactions. The new hardware accessory attaches to the iPhone's dock connection.

And its release comes after Square disclosed ongoing integration and hardware problems with its technology. In a message on the company's Web site from last June, Dorsey conceded that "we’ve let our excitement get the best of us and have released parts of Square before they were fully baked."

Meanwhile, Inner Fence is pushing ahead. The company -- led by former Microsoft developers Del Conte and Ryan Johnson -- is being provided free to merchants, with additional units available for $79. Credit Card Readers for the iPhone 3G and 3GS are shipping immediately, with a unit for the iPhone 4 expected to debut later this year.

You can see how the new Inner Fence service works in this video: