What are payment gateways and how do they work?

If you’ve ever made a purchase, chances are you’ve used a payment gateway. Whether you were aware of it or not, your simple online shopping transaction was likely processed and secured using payment gateway software through a third-party provider. As the name suggests, payment gateways are like bridges between merchants and customers. When a customer makes an online purchase, information is exchanged between their bank accounts and your merchant account. The payment gateway software communicates back and forth between sellers, buyers and financial institutions, eventually determining whether to accept or decline the transaction.

This virtual payment process occurs in seconds and is now one of the most common methods of accepting payments in the retail industry. Virtual payment gateways work in tandem with payment processors, which transmit the data gathered by payment gateways between businesses and customers. Payment gateways are typically protected by layers of encryption, ensuring that payments are legitimate before they ever reach the acquirer, which in many cases are banking institutions. This process verifies that personal customer data, like credit card details and addresses, are kept safe and protected from fraud.

And if you’re a business owner with an online shop, a payment gateway is an essential tool that helps you accept and authenticate customer purchases. Yet not all payment gateway providers are created equal. When looking for a solution that’ll work for your virtual business, it’s important to consider crucial aspects of a good payment gateway, like PCI compliance, encryption and comprehensive customer support.

As we know, payment gateway solutions are far more complex than they may seem from the outside. These solutions can become even more complicated depending on what service you use and how you organize your virtual store. 

So how many kinds of these gateways exist? There are generally three types:

1. Local, platform-based gateways

These gateways are typically hosted on the merchant’s own server. Typically, this option is best for large businesses with a high volume of daily purchases. With a local gateway, a business owner is completely responsible for processing customer payments. This can be costly to implement and maintain, but gives you the most control over your payment system.

2. Offsite payment gateways

Online payments systems like PayPal and Stripe are good examples of this kind of gateway. When a customer makes a purchase, they are redirected to a payment form on a third-party server. In these cases, the payment system handles all of the payment processing, ensuring PCI compliance and an easy checkout for your customer.

3. On-site payment gateways

On-site payment gateways are similar to off-site options, but this time, the customer completes the checkout on your website. The payment processing is completed on the back end, using a third party server that completes the payment. In this case, you have the benefit of keeping the checkout process local, without redirecting your customers to another website to make a purchase. You still get the benefits of a secure payments system while controlling the checkout process for your buyers.

All of these payment gateway types have a few things in common. Whether you decide to host your virtual payment terminal on your own server or use a third-party host, payment gateways are just a part of the payment processing operation.

Imagine you’re buying a sweater from your favorite online shop. You select your item, type in your credit card details and authenticate your identity with your address, location or other information. Once you initiate the purchase, your credit card information passes through the payment gateway, which pushes the data to either the merchant bank or other acquirer. The payment gateway then determines the card network, such as Visa or MasterCard and sends the information to your issuing bank.

Your bank then approves your sweater purchase, and sends that information back through the credit card network through the payment gateway and to the merchant account. If everything goes well, the payment processing terminal confirms your purchase and your sweater will be on the way.

If that seems like a lot of steps to you, you’re not alone. In fact, it’s pretty common for business owners to use several types of software and payment solutions in order to protect and accept their purchases. Depending on your payment solution, your payment terminal, gateway, processor, and merchant account could be brought together by a few different third-party companies. So how do you choose which payment solutions are right for your business?

Related: Payment Gateway vs Payment Processor: Everything you need to know

Finding a payment solutions provider that works best for your business can be difficult, and payment gateways are only one aspect of an intricate process. Still, there are several solutions that can make it easier for you to manage your online business.

We know that there are several providers for every step of the payment process, but there are also providers that offer end-to-end payment solutions. End-to-end payment solutions provide support for the entire payment processing structure, while also following PCI compliance standards and adhering to strict encryption guidelines. With these solutions, you’ll receive the payment gateway, processing service, merchant account and often a physical payment device in one package.

When searching for end-to-end payment providers, you’ll have to consider cost, ease-of-use and the services or products that you will be selling. Because these providers offer seamless payment processing, you'll have to do some extensive research to make sure you’re happy with each of the services individually. If you do choose an end-to-end option, you’ll be saving time and money by consolidating your operating expenses into a monthly fee. You’ll also have a built-in customer support system through your chosen company.

If you decide to choose a more customized option instead, you’ll have to dig a little deeper. Like the end-to-end solution, you’ll have to determine what prices are reasonable for your online business. When looking for a payment gateway or a merchant account provider, you’ll likely find that the specifications are complex. That’s because there are several financial institutions and third-party organizations involved in even the most simple transaction. This can add up to a steep fee for processing customer transactions, so studying up on which combo is most cost-effective for your business size is a great first step.

You may also have to consider merchant account options. A merchant account is set up through a banking institution, either directly or through a payment processing service. If you’ve already been taking payments using an existing merchant account, then you’ll want to research which payment processor works best with your existing account. Otherwise, you may want to find a solution that includes a fully integrated merchant account designed to work specifically with your payment gateway.

Finally, you’ll have to ask which payment processor provides the best security and compliance options. Before a customer’s payment is processed, their sensitive information is encrypted using a security protocol. This is meant to protect both your customers and your business from fraud and cyber attacks. Choosing a provider with robust encryption is crucial to maintaining your customer’s confidence—and protecting your merchant account.

When researching the strength of your payment gateway provider’s encryption software, make sure that PCI compliance is at the center of their security standards. PCI, or the Payment Card Industry Data Security Standard, is a list of requirements for companies that process and accept credit card payments. Your business will need to follow these guidelines in order to legitimately perform business using a virtual payment terminal. And remember, PCI compliance rules apply to all steps of the payment process, so you’ll need to be thorough before choosing a provider.

Online transactions show no signs of stopping anytime soon—and neither does the software that supports those transactions. When a customer makes a purchase, they trust you to process their payment quickly, securely and without hassle. Finding the right payment gateway is key to delivering memorable customer service, as well as protecting the reputation of your business.

Since there are many options available, you can find an online payment processing system that works best for your needs, while fitting it into your monthly budget. With just a bit of research, some know-how and careful decision-making, you can make your online store experience seamless for everyone involved.