In all probability, you’ve benefited from a modern payment technology, perhaps without even knowing it. If you’re launching an e-commerce business, you’ve heard about payment gateways and how they’re essential to your operations. Here’s how payment gateways work.

Payment Gateways in a Nutshell

Think of them as a bridge over which you’ll securely transfer information from a website server — or a physical store’s point-of-sale (POS) machine — to a payment processor. Gateways provide screening tools to enhance security. These include:

  • Address Verification System (AVS)
  • Delivery Address Verification
  • Card Verification Value (CVS)
  • Identity Morphing Detection
  • Geolocation
  • Computer Finger Printing Technology

In addition to fraud-prevention, payment gateways accomplish the following actions.

  • Payment Encryption: For payment data on your server to be securely transmitted to your bank, payment gateways encrypt all the information they send. This helps protect online transactions protected from cyber criminals.
  • Authorization: Payment gateways also act as a sleuth, confirming the validity of a transaction. In addition to transactions being securely sent to a merchant bank for processing, the gateway also sends the data to a card issuer, such as Visa, or MasterCard. Note: This is how credit card companies make a hefty sum on processing fees. The credit card’s issuing bank is also sent the transaction data, choosing either to approve or deny the transaction. In the latter case, a reason will be included such as “insufficient funds,” or “suspected fraud.” Holds or freezes on the credit card can also cause a transaction to be denied.
  • Finishing the Order: After getting authorization from the payment processor, the payment gateway is again responsible for interpreting and securely sending this information back to the server. This is where the payment page thanks your customer for your order.

In most cases, all of this happens in three seconds or less. You will then complete the transaction to change its status to an actual charge against the customer’s account.

Payment Gateways v. Payment Processors v. Merchant Accounts

Payment gateways communicate and make sense of the work financial institutions and payment processors perform. Meanwhile, payment processors handle the actual change of money in a transaction. They’re also used to settle a vendor’s authorizations.

Meanwhile, merchant accounts serve as temporary bank accounts. Money that’s been tendered but hasn’t arrived up in your actual bank account resides there until the deal is completely done. This process usually takes around two days. Merchant accounts can accept credit, debit, wire, ACH, and other payments.

Payment Gateways in E-Commerce

If you’re opening a new store and wondering how to handle payments, one of the first things you need to decide is whether your gateway will be integrated into your site or hosted on a third-party website. Of course, there’s also the third option if you want to host your site on a full-service e-commerce platform that offers everything from free website templates to full-service payment gateways.

Here are some pros and cons to each option:

Integrated Payment Gateway Advantages

  • Back-end API customization
  • Integration with shopping accounts
  • Integration with accounting software
  • Perceived as safer since customers stay on your site instead of being taken elsewhere

Integrated Payment Gateway Disadvantages

  • Burden of storing customer data
  • More customizable but requires developer assistance.

Hosted Payment Gateway Advantages

  • Third-party is responsible for PCI-compliance and data security
  • No developer help required; plug ‘n play solution

Hosted Payment Gateway Disadvantages

  • Can harm conversion rates/arouse suspicion when customers get redirected off store website
  • May not integrate well (or at all) with your existing tools and software

Now that you have an understanding of payment gateways and how they can work for your e-commerce store, check out a guide comparing the most popular options and also learn the specific things you should look for when comparing options.