What is a payment gateway: With examples & real definitions

Payment gateway is a tech for reading cards and payment information. Discover all you need to know so you can follow the payment processing transactions.

In the world of e-commerce, a payment gateway is software that allows merchants to accept credit cards, debit cards, and other types of electronic payments. They act as the middleman between your business, its customers, and the payment processing companies and ensure every transaction is secure. This article will explain what a payment gateway is, the different types of gateways, and how they work with real examples and definitions. If you're just starting your online business, this is the perfect post for you!

Here’s what we’ll cover:

What is a payment gateway?

How does a payment gateway work?

What are the different types of payment gateways?

What are the features of a gateway?

Difference between payment gateway vs. payment processor

Difference between a merchant account and gateway

What are the benefits of payment gateways?

Are payment gateway services secure?

What is the real definition of a payment gateway?

A payment gateway is an online version of a point of sale (POS) terminal that enables merchants to accept online payments. It’s a front-end software application on a website that captures and sends credit card data to a payment processor and communicates approvals or rejections to you, the merchant, and your customers.

How does a payment gateway work?

Payment gateways involve the following key players:

  1. Merchant - the business selling products or services
  2. Cardholder - the customer buying the product or service
  3. Issuing bank - the bank that issued the credit or debit card to the customer
  4. Acquiring bank - the financial institution used by a merchant to accept customers’ debit and credit card payments. 
  5. Credit card networks - the card companies like Visa, Mastercard, and American Express

When customers pay for goods or services through your website, they fill in their details and click “buy” or “checkout.” The payment gateway then relays the encrypted card information to a payment processor. The payment processor transfers this transaction information to the credit card network to verify the customer’s details are correct, and the transaction is either approved or rejected.

The payment processor communicates this outcome back to the payment gateway then sends an approval or decline back to the customer. If the transaction is approved, the specified transaction amount is withdrawn from the customer’s account, and the funds are transferred to the merchant’s bank account.

Define the different types of payment gateways

There are three different types of gateways - hosted, self-hosted and API-hosted. Each requires different integrations and comes with varying maintenance demands and support levels. It’s essential to understand which type is right for your business before you commit, so there are no surprises.

Hosted gateway

Many business owners need to accept credit cards online but don’t have the budget or technical expertise to set up, maintain and pay for their own gateway system. If this sounds like you, a hosted payment gateway is likely the right option for you. Hosted gateways are really easy to set up and offer good security and fraud protection, but they also have significant drawbacks

When customers purchase on a website with a hosted gateway, they are redirected to a third-party payment service provider (e.g., PayPal) on a separate web page to fill out their payment details. After completing the form, they are redirected back to the merchant’s website, where the sale is completed. 

This redirection process increases the time it takes to make a purchase, which often leads to reduced conversion rates. It also doesn’t look as professional as there is no control over branding and the overall checkout experience. 

Self-hosted gateway

Instead of taking customers away from your website to complete a purchase, a self-hosted gateway enables customers to stay on the website for the entire checkout experience. This provides a seamless, faster, and more professional experience and puts you, the merchant, in control of the customer journey. However, one significant drawback with this option is that you’ll need to handle integrations and maintenance. If something malfunctions, you’ll need to find a solution or seek assistance from a payment professional to fix the problem.

API-hosted gateway

An API-hosted payment gateway processes payments using an API and enables customers to stay on your website for the entire checkout experience. They allow for full customization and control over UI and design and can be integrated with mobile and other devices. The main drawback for this type of gateway is that they require merchants to be responsible for security. That means potentially paying more for SSL certification and ensuring PCI compliance.

What are the features of a gateway

When it comes to picking a payment gateway, it’s easy to get overwhelmed as there are so many options. To make this decision easier, here are three essential features to look for.

Merchant tools 

The best gateways provide detailed reporting features and analytics that allow you to view all transactions, gain customer insights and identify trends and preferences. With access to customer payment data, merchants can get a deeper understanding of what can be improved to increase customer satisfaction, revenues and reduce costs.

Tokenization

Tokenization is a process that replaces sensitive payment information, like credit card numbers, with unique identifiers. Gateways that enable tokenization stop merchants from storing sensitive payment data in their system, helping to minimize PCI scope and liability and protecting against data breaches.

Security, fraud detection and PCI DSS compliant

Not all payment gateways are created equal when it comes to security and fraud detection. With cybercriminals getting smarter and constantly evolving their methods, the gateway you choose should have several tools to protect you from fraud. 

These include Address Verification Service (AVS), Card Verification Value, device identification, Payer Authentication (3-D Secure), and risk scoring capabilities. The gateway should be able to detect high-risk countries and flag/limit the number of large and/or failed transactions allowed. 

The gateway you choose must also be compliant with PCI DSS, a set of security standards to ensure businesses accepting, processing, and storing credit card information maintain a secure environment. PCI DSS applies to every merchant that accepts, transfers, or stores cardholder data.

Types of payment gateway services

When you begin your search to find a payment gateway, one of the most important decisions you’ll need to make is whether to use a traditional or modern gateway.

Traditional payment gateways

Traditional payment gateways take a little bit longer to set up because you need to first register for a merchant account yourself. This requires you to undergo a review process and enter a contract with a bank. To ensure you’re making the right decision, you’ll need to do your homework to compare merchant account providers and make sure to understand all the fees that come with having a merchant account.

Digital payment gateways

Digital payment gateways are usually a better and more efficient option. Unlike traditional gateways, digital or modern payment gateways are much more convenient and faster to set up. They don’t require you to register for a merchant account but often charge higher fees for each transaction.

Difference between payment gateway vs. payment processor

A gateway and payment processor are two vital components for accepting online payments that each carry out distinct functions. A payment gateway is a front-end software application that captures and sends credit card data to a payment processor and communicates approvals or rejections to merchants and their customers. 

On the other hand, a payment processor executes transactions by transmitting the card data received from the gateway between the merchant, issuing bank, and the acquiring bank.

The key difference between the two is that a processor moves money and facilitates transactions, whereas a gateway is a tool that communicates the approval or decline of transactions between you, the merchant, and your customers. Today, much of the confusion arises because many companies perform both of these services. That said,  most companies provide either payment gateway or payment processor services only.

What’s the difference between a merchant account and gateway?

A gateway and merchant account serve two different functions. As you already know by now, a payment gateway is a front-end software application that captures and sends credit card data to a payment processor and communicates approvals or rejections. 

A merchant account is a bank account for businesses that want to accept electronic payments - including credit cards, debit cards, and other types of transactions. A merchant account is linked with a business’ acquiring bank and acts as a middleman or holding account for payments before they are deposited into your standard bank account. 

What are the benefits of payment gateways?

Payment gateways provide you with a fully automated way to accept online payments, which is an essential thing for every merchant. With a payment gateway, your business can:

  • Accept multiple payment methods 
  • Provide faster payment processing
  • Facilitate recurring payments
  • Deliver a seamless payment experience for your customers
  • Take control of your checkout experience and collect valuable customer data to optimize revenue
  • Provide secure transactions and comply with security standards like PCI DSS
  • Increase online sales and grow your business into new markets

Are payment gateway services really secure?

With data breaches and fraud on the rise, merchants are right to be worried about security. The good news is that payment industry standards have tightened in recent years, and most reputable gateways offer a host of security protections, including:

PCI compliance

The Payment Card Industry Data Security Standard (PCI DSS) is a set of security standards designed to ensure merchants that accept, process, and store credit card information maintain a secure environment. Today, using a PCI DSS compliant gateway is not only a necessity to remain compliant but also one of the best ways to keep your business and customers safe from cybercriminals.

Encryption models

Data encryption is an important part of managing payments online and is used by payment gateways to protect payments. After a customer enters their payment details, their data is scrambled into an unreadable format. By doing so, the possibility of a cybercriminal accessing this customer data during transmission from the gateway to the acquiring bank is significantly reduced.

Secure Socket Layer (SSL)

Today, most payment gateways use an SSL protocol to allow for the safe transfer of private data between a web server and a browser. By using this security protocol, gateways add another layer of security that protects the transfer of data between different parties. 

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FAQs

How much does a payment gateway cost?

It really depends on the provider. In general, you can expect three types of fees when you use a payment gateway, including a setup fee, a monthly gateway fee, and a processing fee for each transaction.

What is a payment gateway with example?

A payment gateway is a front-end software application on a merchant’s website that captures and sends credit card data to a payment processor and communicates approvals or rejections to you, the merchant, and your customers. Pay.com is simple to set up and offers some of the most advanced features for merchants.

Do online payment gateways process international payments?

Yes, there are many online payment gateways that process international payments. Make sure to always understand things like conversion fees, processing fees, and processing times which can considerably impact your customers’ experience and your bottom line.

How do I choose a payment gateway?

Choosing the right payment gateway is one of the most important decisions you'll make for your business. When deciding which one to use, you should first establish whether you require a hosted or self-hosted gateway. You should then look at several factors, including payment processing fees and policies, features and functionalities (especially security-related), compliance, customization capabilities, payment methods available, and level of support.

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