How Do Online Payment Gateways Work?

This article will decode the particulars of online payment gateways' functioning, helping you become more well-versed in the components, systems, processes, and security provisions involved in their implementation.

Key Components and Players

Online payment gateways involve multiple key players and components, each playing a crucial role in ensuring smooth and secure transactions.

Merchant

Merchants are businesses responsible for all sales of goods or services to customers while covering the costs of any primary payments. They initiate the payment process by providing a platform, like an online store, where customers can make purchases using their bank cards or digital wallets. The merchant requires a particular "merchant's account" account to accept electronic payments. This account holds the funds from transactions before they are transferred to the merchant's regular business bank account.

To receive online payments, merchants must connect their website or using a gateway. During this process, payment information is securely transmitted to the payment processor to authorise the purchase. Once a transaction is authorised, the payment processor transfers the funds to the merchant account. After processing fees are deducted, the remaining funds are deposited into the merchant's business bank account. Merchants must comply with various security standards, such as PCI DSS, to protect customer data and prevent fraud. They also need to ensure their payment systems are secure and up-to-date to maintain customer trust and avoid financial losses.

Customer

The payment process is initiated when a customer picks something up in the online store and moves to checkout. Customers provide payment details in the checkout form, such as credit card numbers or digital wallet credentials. These days, it is also common for customers to be required to use 3D Secure or authenticate a purchase through a generated token or app on the phone.

After a successful transaction, the customer typically receives an order confirmation and payment receipt.

Issuing Bank

The issuing bank provides credit and debit cards to customers on behalf of major card networks like Visa, MasterCard, Discover, and American Express. In essence, issuing banks are responsible for verifying the cardholder's details to prevent fraud. Also, issuing bank checks whether the cardholder has sufficient funds to cover the transaction amount and either approves or declines the transaction based on this check.

The issuing bank assumes the financial risk of issuing cards, including covering losses in case of fraud or if the cardholder defaults on payments.

Acquiring Bank

An acquiring bank is a financial institution that processes credit and debit card transactions on behalf of merchants, enabling them to accept electronic payments. The acquiring bank validates cardholder details, receives transaction information from merchants, and facilitates the transfer of funds from the customer's issuing bank to the merchant's account.

Acquiring banks assume the financial liability of transactions and implement security measures and fraud detection systems to protect merchants and customers. Acquiring banks oversee the settlement process by transferring authorized funds to the merchant's account and providing detailed transaction reports and analytics.

Payment Processor

Payment processors serve as intermediaries that facilitate the transfer of funds between merchants, credit card companies, and banks during transactions. They manage authorization, clearing, and settlement processes to ensure secure transfer of payments, implementing security measures such as encryption and fraud detection. Additionally, they handle the transfer of funds to the merchant's account and provide transaction reports and analytics.

Card Networks

Card networks act as intermediaries, connecting issuing banks and acquiring banks to facilitate global transactions and ensure interoperability. They provide the infrastructure and rules for authorising, clearing, and settling card payments between merchants, customers, and financial institutions.

Card networks establish and enforce security regulations, like PCI DSS, to safeguard cardholder data and deter fraud. They impose assessment fees for these services, which form part of the overall transaction expenses for merchants. Open networks (e.g., Visa, Mastercard) allow third-party card issuance, while closed networks (e.g., American Express, Discover) issue their own cards.

How It Works: Step-by-Step Process

Understanding the step-by-step process of how online payment gateways work can demystify the complexities involved and provide clarity on each stage of the transaction.

1. Customer Initiates Payment

The process starts when the customer picks items or services on the seller's website and moves to the checkout page. Here, they input their payment information, such as credit card details or digital wallet credentials, into the secure online payment form provided by the seller. Customers can select from different payment methods the seller offers, like credit cards, debit cards, or alternative methods such as PayPal or Apple Pay. After confirming the purchase, the customer sends their payment details, which are then securely sent to the payment gateway for processing. Sometimes, customers may have to complete an additional verification process, such as 3D Secure, to confirm their identity and authorize the transaction.

2. Encryption and Secure Transaction

The payment gateway secures the customer's payment details by encrypting them to prevent unauthorized access during transmission. This encryption transforms sensitive information like credit card numbers into an unreadable code, thus protecting it from potential hackers. By utilizing SSL/TLS protocols, the payment gateway establishes a secure connection between the customer's browser and the payment server. This measure is essential for maintaining the confidentiality and security of the customer's payment information and helps in building and maintaining trust while also preventing data breaches.

3. Authorisation Request

After the payment information is securely sent, the merchant's payment gateway requests authorization from the payment processor, including transaction details like card information and purchase amount. The payment processor then sends the authorization request to the relevant card network linked to the customer's card. The card network forwards the request to the customer's issuing bank, which verifies the card's validity, available funds, and potential fraud. Based on the verification results, the issuing bank decides to approve or decline the transaction and sends a response through the network. The authorization response, containing approval or decline status and relevant codes, is sent back to the merchant via the payment processor and gateway.

4. Payment Processor Verification

The payment processor has a crucial responsibility in checking transaction details to ensure they are complete and accurate. They confirm that all necessary information is included and correctly structured. They use sophisticated algorithms and risk assessment tools to identify potentially fraudulent behavior by analyzing transaction patterns and customer actions. The processor confirms with the bank that the customer has enough funds or credit to complete the transaction.

If necessary, the issuer and acquiring bank may request 3D Secure approval from the cardholder before approving the transaction. 3D Secure is an additional layer of authentication for online card transactions, which helps protect against fraudulent activities by requiring the cardholder to verify their identity through a password, PIN, or a one-time code sent to their mobile device.

When they receive the authorization response (approval or decline), the processor informs the merchant of the outcome through the payment gateway.

5. Approval or Decline

The payment processor sends a response to the merchant's payment gateway indicating approval or rejection of the transaction. If declined, possible reasons include lack of funds, suspicious activity, or inaccurate card details. The payment gateway then notifies the merchant of the transaction status, usually within seconds. The merchant's website or app shows the customer the transaction outcome, confirming success or requesting alternative payment methods if declined. If the transaction is approved, the merchant fulfils the order; if declined, customers may be prompted to retry or use a different payment method.

6. Settlement and Funds Transfer

After a transaction is authorized, the acquiring bank transfers the approved funds to the merchant's account, minus fees, usually within 2-3 business days. The acquiring bank confirms transaction details, validates the information, and computes the final settlement amount considering different fees. Merchants review transaction records from the payment gateway, internal records, and bank statements to address differences. The duration for funds to reach the merchant's account depends on the payment gateway and the bank's settlement process. Payment gateways offer comprehensive settlement reports and analysis, enabling merchants to oversee transactions, monitor funds, and handle financial records effectively.

Security Measures

Security is of utmost importance when processing online payments, and numerous safeguards have been implemented to safeguard confidential payment details.

Encryption

Encryption transforms sensitive payment data into indecipherable code, protecting it from unauthorized access when transmitted and stored. SSL/TLS protocols, standard encryption methods, create secure links between customers' web browsers and payment servers. Encryption safeguards the entire transaction process, ensuring information security from the customer's device to the payment gateway and financial organizations.

Tokenization

Tokenization is a method that substitutes sensitive payment data with a unique token that has no value or connection to the original information. When a customer makes a transaction, their payment details are replaced with a token, which is then used during the payment process without revealing actual card information. Tokens cannot be reversed or decrypted, making them useless to hackers and reducing the risk of data breaches. By minimizing the amount of sensitive data handled by merchants, tokenization eases compliance with Payment Card Industry Data Security Standards (PCI DSS). It can be used in various payment scenarios, such as e-commerce platforms and mobile wallets, to improve security without impacting user experience.

PCI DSS Compliance

The Payment Card Industry Data Security Standard (PCI DSS) is a set of security rules for organizations dealing with credit card information. It aims to prevent fraud and data breaches through 12 key requirements involving network security, data protection, access control, and regular testing. PCI DSS has four levels of compliance based on transaction volume, each with its own validation criteria. All entities handling cardholder data must adhere to PCI DSS, regardless of their size or transaction volume.

3D Secure

3D Secure is a security protocol for online card transactions created by leading card networks like Visa and Mastercard. It mandates that cardholders furnish added authentication, like a password, one-time code, or biometric information, to finalize online transactions.

It plays a significant role in lowering the risk of unauthorized charges and fraudulent transactions, especially in situations where the card is not physically present. Its implementation shifts the responsibility for fraudulent chargebacks from the merchant to the card issuer, providing businesses with added protection. The updated 3D Secure 2.0 enhances user experience, enables mobile transactions and employs risk-based authentication to minimize checkout obstacles.

Fraud Detection

Detecting fraud in online payments is crucial and involves using sophisticated methods and advanced techniques to identify and prevent fraudulent activities. Payment processing platforms employ advanced algorithms to analyze real-time transactions and identify suspicious activities such as unusual spending patterns, multiple failed attempts, or geographical inconsistencies. They assess various transaction parameters and customer information to assign risk scores and utilize artificial intelligence and machine learning to adapt to new fraud patterns and improve accuracy over time. Payment gateways also track device information and IP addresses to detect anomalies and collaborate with banks and card networks to enhance their fraud detection capabilities and stay ahead of emerging threats.

Handling Refunds and Chargebacks

Payment gateways enable retailers to handle full or partial refunds through their system, typically integrating with the retailer's platform for seamless transactions. These gateways provide resources for retailers to address and challenge chargebacks, often including automated systems for handling common dispute reasons. Refunds and chargebacks are subject to specific timeframes and restrictions set by payment networks and gateway providers, which retailers must follow. Payment gateways also offer reporting capabilities for retailers to monitor refunds and chargebacks, aiding them in managing their financial records and identifying trends. Additionally, many gateways include fraud detection tools to help prevent unauthorized refunds and chargebacks, safeguarding retailers from financial losses and harm to their reputations.

Conclusion

Online payment gateways are crucial for making safe and easy transactions between businesses and customers. Fintech companies, banks, and online stores must understand how these systems work and how to keep them safe before deciding whether and how to use them. For a customizable and branded solution, explore our White Label Payment Gateway.

Consult with DECTA's payment experts today and uncover how our solutions can elevate your business operations.