How Payment Gateways Work: An Example and Explanation

What is a Payment Gateway?

A payment gateway is a digital service that facilitates secure and encrypted transactions between a merchant and their bank and/or processor after a purchase is made. In other words, it’s the bridge that enables the transfer of funds from the customer’s preferred payment method to the merchant. A payment gateway covers not only the physical card-reading devices found in brick-and-mortar retail stores but also the payment processing portals found in online stores.

Simply put, a payment gateway is a technology that allows merchants to receive electronic payments such as credit or debit cards from online customers for their products or services.

Main Features of a Payment Gateway

A payment gateway is responsible for the secure transfer of any payment information. It also offers data encryption for security, compatibility with different payment modes, and instant transaction processing.

In essence, a payment gateway acts as a safe link between the merchant and the customer to ensure smooth financial transactions. It enables the secure movement of funds from the customer’s bank account to the merchant’s account.

The Framework of a Payment Gateway

A payment gateway has different frameworks depending on whether it is used for online or in-store payments.

Online payments need to be hosted on the website either by a third-party service provider or by the merchant using an API that allows the website to communicate with the payment processing network and get a response from the issuing bank.

In-store payments use a payment gateway through a physical card reader or a POS terminal that connects to the processing network with a secure internet connection.

The Players in the Payment Gateway Ecosystem

Merchant or Seller

A merchant is an online seller of products or services.

To receive online payments, the merchant requires a merchant account, which is a special bank account that enables them to collect money from online transactions. Connected to the payment gateway, this account ensures the safe processing of transactions. In other words, the merchant account is the destination of all the money after settlement.

To get a merchant account, you will need to find and select a provider that meets your needs.

Customer

Customers are the most numerous actors in the payment gateway system. They use various online payment modes such as credit or debit cards, net banking, UPI, or online wallets to buy products or services.

Acquirer and Issuer Bank

A payment gateway involves two different types of banks.

The acquirer bank, as the name implies, receives the payment for the merchant. This means the merchant account is located at the acquirer bank. This is where the financial transactions go through the payment gateway. In other words, this is the final destination of the money.

The issuer bank, on the contrary, is the source of the transaction. This account belongs to the customer who is paying for the product. The issuer bank represents the customer and supports the various payment modes such as credit cards, debit cards, or net banking.

Payment Gateway

A payment gateway is the link between the merchant’s website or app and the banks involved in the payment process.

When the customer buys something on the merchant’s website, the payment gateway enables the payment to be completed. It ensures the safe transmission of payment data and the approval and finalization of transactions.

Payment Processor

A payment processor handles the technical connections among the payment gateway, the merchant’s bank, and the customer’s bank. It checks and directs payment transactions safely. The payment gateway and the payment processor are essential elements in processing online payment transactions.

How Payment Gateway Works?

Now that we know what a payment gateway is, let’s explore the detailed process of how a payment gateway operates.

Step 1: Adding a Payment Gateway

The first step after setting up your online store is to add a payment gateway. A payment gateway integrated with your online store ensures that all transactions are secure and encrypted. This way, both the merchant and the customer have full information about the process.

To add a payment gateway to your website or mobile app, you need to choose a suitable payment gateway service provider and integrate the technology into your website’s checkout process. You can adjust it to accept as many or as few payment methods as you prefer.

API Integration: This allows for the maximum amount of customization and is ideal for businesses with custom websites or apps.
Plugin Integration: This is ideal if you use platforms like WordPress, Shopify, WooCommerce, Wix, and others.
SDK Integration: This allows developers to create their version of the payment gateway for their mobile app or website.

Step 2: Customer Makes a Purchase

A payment gateway makes the buying process safer and simpler.

Customers choose the products they want and click on buy. They are prompted to pick a payment option and fill in their payment information. For example, if they choose a credit or debit card, they’ll need to enter their card number, cardholder’s name, expiry date, and CVV.

Step 3: Website/App Directs Customer to Payment Gateway

This is the most crucial step for the customer in the process.

When customers want to buy something, they go to the payment page to finish the transaction. They fill in their payment information such as their card details or their UPI ID on the payment gateway page.

The payment gateway safely encrypts the card details, checks for fraud, and sends the transaction details to the acquiring bank. The acquiring bank passes the information to the card provider (eg Visa, Mastercard, or Rupay) and then to the issuing bank for approval.

One of the key functions of the payment gateway is that it automatically detects fraud. This is a vital part of the process and it is where payment gateways like Razorpay can make a significant difference. It validates the payment details entered by the customer using methods like IP geolocation, pattern recognition, and velocity checks. Some platforms also offer advanced fraud detection methods like machine learning and AI.

Step 4: Authorisation and Bank Response

When the acquiring bank gets the transaction details, it checks several factors to confirm that the transaction is valid. For example, the customer’s identity and their bank details. Sometimes, for big amounts, the customer’s spending habits can also be taken into account.

When the payment gateway gets a response from the issuing bank, it informs the acquiring bank if the transaction is accepted or rejected.

The merchant then sends the customer to show the final status of the transaction. If the payment is successful, the customer will see a payment confirmation message with their order details. If the payment fails, they will be prompted to try the payment again with different methods.

This step is hidden from the customer. Only the outcomes of this step are shown on the website.

Step 5: Settlement

After the payment is confirmed, the acquiring bank starts the settlement process. The payment gateway gets the money from the customer’s bank and then pays the merchant, usually in a few business days.

When this process is done, the customer receives a confirmation message of the order being placed.

Payment Gateway vs. Payment Processor

A payment gateway and a payment processor are different services that handle online payments.

A payment gateway gathers payment information like credit card details, and approves a payment using various payment modes while the payment processor connects the customer’s bank and the merchant account at the acquirer bank. The payment processor acts as a communication link.

How does a Payment gateway keep information secure?

A payment gateway protects the information you enter by converting it into a secret code. Now that you understand what a payment gateway is and how it operates, let us see what a PG does to safeguard your data:

Firstly, the payment gateway transaction flow uses an HTTPS web address, which is secure.
A hash function checks the transaction request, using a secret word that only the merchant and payment gateway know.
The IP of the server that requests the transaction is checked to prevent any possible malicious activity, making the payment page safe.
Virtual Payer Authentication (VPA) is a feature that acquirers, issuers, and payment gateways offer to improve security. VPA, which is part of the 3-D secure protocol, provides an additional level of verification for online buyers and sellers.

How Does a Payment Gateway Benefit My Business?

Adding a payment gateway to your online business can bring many benefits:

Security: Payment gateways ensure safe transactions, preventing fraud and data breaches.

Customer trust: A payment gateway creates a sense of security. If the payment gateway is familiar to the customer, it is even better. It can automatically build trust in the brand, motivating them to buy a product or service without fear of data theft or fraud.

Global reach: This enables merchants to grow their business and reach customers worldwide. Payment gateways can provide features like multi-currency transactions to allow your business to accept payments from other countries.

For example, you can accept payments from more than 100 currencies from all over the world. You can get a T+1 settlement in Indian rupee. This means you don’t have to worry about currency conversions or exchange rates; your payment gateway will do these automatically in real-time.

Various payment options: Providing different payment methods like credit cards, debit cards, net banking, UPI, and digital wallets gives customers more options.

Quicker transactions: Payment gateways allow fast approval and settlement of payments. This can help increase conversions and lower the cart abandonment rate.

Easy to use: Most platforms have advanced dashboards that let you monitor and manage the whole process.

You can access real-time data so that you can solve any problems directly. For example, if you notice that a specific product has been selling very quickly, you can restock it right away to avoid running out.

You can also spot inefficiencies in your operational process. For example, if you notice that customers have been leaving their cart when they get to a certain product, it could be a sign to improve that product page.

Payment Gateway Security Features

Tokenization: Card Tokenisation replaces the card details like the card number and expiry date with tokens before sending them through the system. This way, even if there is a data breach, the information will be safe.

Fraud Prevention: Payment gateways use various advanced fraud detection tools that examine transaction patterns and behaviors in real-time. This means that the system can detect and stop fraud if it happens.

PCI DSS Wallet: These wallets follow PCI DSS standards to store cardholder data securely for any recurring transactions.

White Label Wallet: This feature is designed for mobile wallets. Most payment gateways provide white-label integrations for any payment methods through mobile wallets. This makes the transaction more secure and convenient.

3DS Authentication: 3DS or 3D Secure adds an extra layer of security before the transaction is done. Usually, this is done through an OTP sent to the customer’s mobile or email.

Key Takeaways

A payment gateway is a technology that enables merchants to receive credit or debit card payments from customers for their products or services.

Payment gateway can gather payment information, and approve or reject transactions In a physical store, the payment gateway can operate through a card reader or a point-of-sale system that can take credit card payment through a card or a smartphone In online stores, the payment gateway is the payment processing portal used during checkout to process payments through various payment modes like credit card, UPI, or digital wallets Payment gateway protects payment information like credit card details and detects fraud before sending the card data to the acquiring bank.

The acquirer passes the information to the card networks or banks which send the payment data to the issuing bank for approval.