What Are Payment Gateways and How Do They Work?

There are many ways to bill your client, but the easiest one for both parties is if you’re connected to a payment gateway. Let me explain the meaning of a payment gateway and how it will make your billing process easier.

What is a payment gateway?

A payment gateway is a service that allows you to accept credit card payments and electronic checks on your website. Payment gateways encrypt sensitive information (e.g., account holder information, credit card information, etc.) to ensure that information passes securely between all the parties involved in the transactions.

Examples of commonly used payment gateways include:

• Stripe: A widely adopted online payment gateway popular among e-commerce platforms and merchants globally.

• PayPal: A well-established payment processor offering a variety of services, from credit card payments to person-to-person transactions.

• Square: A comprehensive platform for in-store and online transactions, featuring point-of-sale systems and inventory management.

Types of payment gateways

There are two main types of payment gateways: hosted and integrated.

Hosted payment gateways

A hosted payment gateway is a service that hosts the payment page on its own servers. This means that when a customer goes to checkout, they will be redirected to the payment gateway’s website to enter their payment information.

Hosted payment gateways are often used by small businesses because they are easy to set up and don’t require programming knowledge. Additionally, hosted payment gateways typically have lower transaction fees than integrated payment gateways.

The benefit of hosted payment gateways is that they typically don’t require your business to acquire PCI compliance since the customer’s card information is stored on the payment gateway’s servers, rather than on your own secure server. However, hosted payment gateways can be less customizable than integrated payment gateways.

Integrated payment gateways

An integrated payment gateway is a service that allows you to embed the payment page into your own website. This means that the customer never has to leave your website to enter their payment information.

Integrated payment gateways are often used by larger businesses because they offer more security, scalability and flexibility than hosted payment gateways. Additionally, integrated payment gateways typically have lower transaction fees than hosted payment gateways.

The downside of integrated payment gateways is that they can be more difficult to set up and require some programming knowledge. But this isn’t always the case—customer billing solutions such as SPP make the integration process as simple as clicking a few buttons.

How do payment gateways work?

A typical payment gateway transaction involves up to six parties, including:

1. Merchant: This is you!

2. Client: The individual or business purchasing your services.

3. Payment gateway: A service that encrypts and processes the client's payment information.

4. Acquiring bank: The bank that partners with the payment gateway to provide merchants with account details and services.

5. Issuing bank: The financial institution that provides the credit or debit card to the customer on behalf of a card scheme.

6. Card scheme: Payment networks linked to physical cards that any certified bank or financial institution can join (e.g., Visa, Mastercard, etc.).

There are various types of payment gateways, as you will see in the following sections, but they all share a common feature: they offer a secure connection between your website and the payment processor.

Now, the way payment gateways work is usually the same, but there’s a slight difference between physical and virtual payment gateways:

1. Once products or services are added to the basket, the checkout process begins.

2. The buyer selects their preferred payment method, typically a debit or credit card.

3. The gateway forwards this information to the bank to identify the card issuer (Visa, MasterCard, etc.).

4. The request is directed to the appropriate network.

5. Fraud detection measures are activated to verify the legitimacy of the payment (such as checking CVC, address, 2FA, etc.).

6. The bank either approves the payment or denies it, providing an error code if applicable.

For offline payments, it is common for payments to remain pending until the merchant reconciles them, whereas online payments typically process immediately unless there is an issue with payment processing.

Are payment gateways secure?

Those accepting payments often worry about security and protecting against fraud or chargebacks.

To understand consumer behavior, consider a survey by the European Central Bank. It shows Europeans value privacy, hence the increasing preference to pay in cash.

Most payment gateways offer procedures to ensure users own their payment methods. Providers often allow activation of extra security options. For example, the billing address must match the card issuer’s. In Europe and some other regions, mandatory two-factor authentication greatly reduces fraud risk.

Here are the main security features your payment gateway of choice should have:

• Encryption: Credit/debit card data should be encrypted during checkout to ensure that these sensitive details are protected.

• SSL: Any website dealing with sensitive information should secure the data transit between the user and the website via Secure Sockets Layer.

• PCI DSS: Anyone who handles card data must be compliant with this standard. Stripe, for instance, is a PCI Level 1 Service Provider.

• Tokenization: Card data and bank account details cannot be kept in plain text; they have to be securely stored, namely in form of a token.

• 3D-Secure: Additional customer authentication for online payments, such as 3DS, reduce the risk of fraud.

How to choose the best payment gateway

When it comes to choosing that will process all your debit and credit card transactions, there is no definitive answer to which payment solution is the best one.

However, there are a few things you can think about to make the best choice:

• Client preferences: do your clients mainly pay via credit and debit cards, do they use ACH transfers, or prefer mobile payments? Depending on the answer, you should choose a payment gateway that offers many alternative payment options.

• Easy integration: take a look at existing technology. Many payment gateways look great on paper, but once you look into the tech behind it, you’ll realize how difficult the integration will be.

• Fees charged: features such as fraud detection and churn recovery cost extra. Are they worth the money? In most cases, yes, even if you have additional costs. They do prevent higher costs such as chargebacks, which are $15 if you use Stripe.

Payment gateways FAQ

Select a long-term payment service

Payment gateways are a necessity these days if you want to make sure that your clients can purchase your services effortlessly. They also make it easy for companies to do business, even though payment processing costs are involved.

With that said, it’s your responsibility as a business owner to ensure that transactions are secure and the risk of fraudulent payments low.