What Is a Payment Gateway and How Does It Work? Types, Benefits, Examples

A payment gateway is an integral part of product development for many websites and apps. If you plan to receive and process online payments from customers through your site, then you need a payment portal that takes credit or debit card information and safely processes it to complete transactions. 

This technology bridges the gap between the financial institutions of businesses and their customers. This article explains what a payment gateway is, how it works, and how to integrate it into your website. 

• A payment gateway is a technology that acts as a secure intermediary between the parties involved in an electronic transaction, transmitting card data between them to accept online payments. 
• Under the hood, a payment gateway receives the customer’s credit card information on the merchant website and sends this to the payment network; it also receives authorization and payment confirmation and transmits it back to the customer. 
• A payment gateway can be hosted by the service provider, self-hosted directly on the merchant’s website, or hosted via APIs on the site. 
• Choosing a good payment gateway for your business secures transactions and improves overall customer experience. 

What Is a Payment Gateway?

A payment gateway is a technology platform responsible for authenticating and transmitting payment data between all the parties involved in an electronic transaction. It is similar to the point-of-sale terminals used for accepting payments in brick-and-mortar businesses. But in this case, the technology is integrated into a website or platform and acts as an intermediary between all the parties involved in the transaction. 

More than just a single piece of technology, a payment gateway is a combination of multiple technologies. It has an encryption system to securely transmit card details collected from the customer, a fraud detection system to validate transaction data, and an authorization mechanism to confirm payments. 

Although online payment gateways were originally designed to process and manage credit and debit card transactions, many gateways today can also process digital wallet payments and other new payment methods securely and efficiently.

How Do Payment Gateways Work?

When making payments on a website, customers only need to enter their payment information into the site and the transaction is processed in a few seconds or minutes. However, behind the scenes, a complicated series of steps takes place, managed almost entirely by the payment gateway. 

While customers may not need to know how this works, developers and businesses learning how to create a payment gateway need to understand what goes on in the background. Here’s a breakdown of how a payment gateway handles transactions.

1. Transaction initiation: The customer initiates the transaction by entering their payment information on a web page or portal connected to the payment gateway and hitting the payment button. This information may include the cardholder’s name, card number, expiration date, or card verification value code (CVV). 
2. Data encryption: Since credit card payment information is sensitive, the payment gateway encrypts it to protect cardholder data. The gateway also performs fraud checks to ensure the information is accurate. 
3. Transfer of data to the merchant bank: The payment gateway sends the encrypted data to the merchant’s payment processor (also known as the acquirer or acquiring bank) which is the financial institution managing the account of the business trying to accept payment. Here another layer of fraud check is completed before the data is passed off to the card issuer. 
4. Card issuers (such as Mastercard, Visa, American Express, and Discover) validate the data with the customer’s issuing bank and ensure there are enough funds on the card for the transaction. After this, the issuer sends a message to the acquirer to notify them of the transaction status (which can be either approved or declined). 
5. Status confirmation: The acquirer (acquiring bank) receives the status message and passes it back to the payment gateway. 
6. Complete translation: Finally, with the transaction complete, the payment gateway transmits the response back to the merchant’s website or app to notify the customer about the transaction status and initiate the next action based on the payment status. 

Types of Payment Gateways

There are four main payment gateway types that merchants can incorporate into their sites. Although they all perform the same function of collecting, encrypting, and transmitting data, they differ in terms of their integration and management. Here’s an outline of how each option works.

Hosted Payment Gateway 

A hosted gateway is a type of payment gateway hosted outside your website. Consequently, customers are redirected to an external page once they click “pay now” on your checkout page. With this type of payment gateway, the entire payment process from data collection to authorization is handled outside your website. 

The main benefit of this system is that data encryption, payment processing, fraud prevention, and other payment services are handled by the payment gateway and payment service provider. This reduces your burden as a merchant since you won’t have to build an infrastructure for this.

On the flip side, redirecting customers to an external site means you’ll lose control over the buyer journey (at least temporarily) at this crucial stage. Once redirected from your site customer experience from that point forward depends almost entirely on the quality of the payment gateway. 

Self-Hosted Payment Gateway

As the name suggests, the self-hosted payment gateway gives you great control over the payment process because customers are not redirected from your site. Instead, your site has a portal built into it for collecting data, encrypting it, and transmitting it to the third-party payment gateway. 

With this type of payment gateway, the merchant has more control over the checkout experience since it all happens on-site. However, it’s more complicated to implement and manage since the merchant has to handle security and PCI compliance. It’ll also come at a higher upfront cost since in-house technical expertise is required.  

API-Hosted Payment Gateway

An API-hosted payment gateway is similar to a self-hosted gateway because data collection and management are handled directly on the merchant’s site. However, the data is handled using an application programming interface (API) provided by the payment gateway. 

The API is often quite flexible, allowing the merchant to design a tailored checkout experience on the site. This includes everything from designing the interface to deciding which payment methods to accept. Like the self-hosted gateway, the merchant is responsible for security and compliance on an API-hosted gateway. However, the API may include some built-in security features that the merchant will find helpful.  

Local Bank Integration Gateway

The local bank integration gateway is a type of payment gateway that routes the transaction details to a suitable local bank that handles the payment processing for the merchant. Like the hosted methods, the checkout experience depends on the connected local bank. 

This method is simple to set up and the merchant gets fewer responsibilities since everything is handled by the merchant. However, it may still require some level of technical expertise since you’ll have to integrate with the local bank’s APIs. Customers also get to make debit and credit card payments in their preferred local currency or payment method. This is particularly great for an eCommerce site or online store with an international customer base.

Payment Gateway vs Payment Processor

Although people sometimes mix both terms up, a payment gateway is different from a payment processor. The payment gateway is a technology that collects, encrypts, and transfers customer information between the parties involved in the electronic transaction. The gateway will also receive information about the transaction status and communicate this back to the app or website interface for customers. 

The payment processor on the other hand is a service that works behind the scenes to connect the customer’s bank to the merchant account in order to facilitate the actual movement of money between both accounts. 

Both parties play an essential role in the electronic payments settlement process. The payment gateway performs the function of collecting the customer’s credit card information while payment processors use that information to connect the bank accounts of the two parties involved in the transaction (customers and business bank account), debiting the customer’s bank account, while crediting the merchant. Payment processors typically have a direct relationship with the merchant or business since they’re in charge of managing the merchant account. 

Payment Gateway vs Payment Terminal

A payment terminal (also known as a point-of-sale (POS) terminal) is the more traditional method of accepting credit card payments in brick-and-mortar business locations. It is typically in the form of a physical device that collects customer data in person through chips on credit cards, debit cards, or contactless payment methods like NFC (near-field communication technology) on smartphones. 

A payment gateway does the same job but in an online environment such as eCommerce websites and other digital platforms. It serves as an intermediary between all the parties involved in an online transaction, collecting information from customers and transmitting it to the payment processor and banks that handle funds settlement.

A payment gateway is typically integrated into the merchant’s website using APIs and Plugins, and they transmit information over the Internet. The terminal connects to the payment processor via a phone line connection, mobile network provider, or internet connection. 

Payment Gateway Benefits

In the split seconds it takes to process an online transaction, the payment gateway provider performs several functions to make the transaction possible. The effectiveness of this transaction comes with several benefits for merchants. Some of the benefits of setting up a payment gateway include: 

• Better Customer Experience 
• Encourages Repeat Purchases
• Advanced Security 
• Operational Efficiency 
• Expand into New Markets
• Customizable Checkout Options

Better Customer Experience 

The payment gateway is an essential part of the framework that makes online debit and credit card transactions possible. It collects, verifies, and transfers customer details to the appropriate institutions for authorization, allowing merchants to receive debit and credit card payments from customers anytime and from anywhere. Some payment gateway providers also support alternative payment methods, which allows customers to select the most convenient payment method for them. 

Encourages Repeat Purchases

Simplifying the checkout process by integrating an online payment gateway into your site will encourage repeat purchases. Some payment gateways even allow customers to store their payment data securely or set up automatic periodic debit card payments or recurring payments with relative ease. 

Advanced Security 

Payment gateways employ a variety of checks and security measures to secure the payment process. Once the credit card information or any other payment details are imputed, the gateway verifies to ensure the purchase is being made by the cardholder, preventing fraud and unauthorized online transactions. Then the data is encrypted in line with PCI DSS standards to protect the data from hackers. Fraud detection mechanisms on the gateway also protect merchants from malicious activities.  

Operational Efficiency 

Payment gateways allow merchants to process card payments online without human intervention. It automates payments, which is one of the most important parts of the sales process, giving merchants the freedom to focus on other aspects of running their business such as customer service, marketing, and so on. 

Expand into New Markets

For businesses looking to enter into new markets, integrating payment gateways into their website is essential. Many of the best payment gateways today support multiple currencies and can be used to process both local and international payments. This allows merchants to make their products and services available to a global market without borders. 

Customizable Checkout Options

This is particularly true for self-hosted and API-hosted payment gateways. These systems allow merchants to customize their shopping cart and payment page to their preferences in order to deliver a tailored experience to their customers. 

Best Examples of Payment Gateways

To choose the best mobile payment gateways to integrate on your site, you must be familiar with the different options available. Some of the most popular gateways to consider include: 

• Stripe: One of the most popular payment gateways in the world known for its robust and developer-friendly API that can be customized with a wide range of features. 
• PayPal: arguably the oldest digital payments platform, PayPal is renowned for its high security, and its simple checkout system. It has a large user base since it is one of the most commonly adopted payment gateways especially for eCommerce businesses. 
• Authorize.Net: Authorize.Net is a reliable and secure payment gateway, often favored by small businesses. The company is a subsidiary of Visa, one of the biggest card issuers in the world. 
• Braintree: Braintree is a PayPal subsidiary famous for its flexible payment solutions for mobile and web payment processing. 
• Amazon Pay: Amazon’s official payment gateway. However, it can also be integrated into other popular e-commerce platforms as well.

Payment Gateways Costs

Many payment gateways don’t charge an upfront cost to integrate the gateway into your website or eCommerce store. Consequently, the setup cost is usually low, especially for API-hosted or hosted payment gateways. However, self-hosted gateways tend to cost more since they have more technical requirements. 

In addition to the setup cost, payment gateways also charge transaction fees and may collect a flat monthly fee as well. These costs vary from one platform to the other. For instance, the transaction fee on PayPal is about 3.49% and $0.49 per transaction while Stripe charges 2.9%, plus $0.30 per transaction. 

Other fees merchants may have to pay include: 

• Fraud management fee 
• A fee for tokenizing card details (if recurring payments or one-click payments are enabled)
• Monthly fees
• Customer authentication (SCA) / 3DS2 

Payment Gateways Integrations

How your site will be integrated with a payment gateway depends on the type of gateway you have chosen. The process for integrating each payment gateway type is highlighted below: 

• Hosted Gateway
• Self-hosted Gateway
• API-hosted Payment Gateway

Hosted Gateway

A hosted gateway is the simplest to integrate since it does not require any major infrastructure on your end. In most cases, the gateway provider simply gives you an HTML code to be added to your website’s code or a link to be added to an existing button. This will take the customer to the gateway’s checkout page to complete the transaction. 

Self-hosted Gateway

For a self-hosted gateway, you may have to download and install the gateway software onto your web server. This may involve following specific installation instructions provided by the provider. You’ll also have to build the system for handling the checkout, data capture, and encryption on your site. For sites hosted on a third-party e-commerce platform like Shopify or WooCommerce, installing a gateway is as simple as installing an extension or plugin on the platform.

API-hosted Payment Gateway

The API-hosted payment gateway is set up using API keys provided by the gateway provider. Once the key is authenticated, you can set up the payment functions and customize it for your website. You’ll also be responsible for setting up the front end for the payment page and tailoring it to your unique needs. 

Payment Gateway Solutions from CrustLab

Payment gateways simplify the process of receiving payments online for your business. In setting up your website or app, you must partner with a company that can handle the payment gateway integration process efficiently. CrustLab is a partner you can trust for this and many more important aspects of your software development process. Our web and mobile software development experts will guide you through all the steps of integrating payment gateway solutions for your iGaming site from selecting the most suitable payment gateway type to setting it up to meet your business needs. Contact us today to get started.