Payment gateways: What are they and how do they work?

Key takeaways

• A payment gateway is a technology that securely authorises and processes online payments by transferring payment information between a customer, merchant, and bank.

• Payment gateways are the first step of the payment processing workflow, acting as the  ‘customer-facing checkout’ where customers’ payment information is collected. They also perform several other key functions for businesses to accept payments efficiently and securely, like data encryption, payment authorisation, tokenization, fraud prevention, and data collection.

• With the Airwallex payment gateway, businesses of all sizes can accept payments from 180+ countries and regions and 160+ payment methods, while also saving money by eliminating unnecessary currency fees, and keeping themselves and their customers safe against fraud.

What is a payment gateway?

A payment gateway is a type of digital technology that allows you to accept and process online payments. Payment gateways facilitate the payment processing that takes place after a customer has made a transaction. They can take the form of physical Point of Sale (PoS) terminals in-store, however, the phrase ‘payment gateway’ is mostly used to refer to online payment gateways (as we’ll discuss in this article).

Payment gateways allow merchants to accept payments via credit or debit card, as well as other forms of electronic payments like Apple Pay and Google Pay. Buy Now, Pay Later (BNPL) services, such as Klarna, also act as payment gateways by facilitating transactions between merchants and consumers, offering flexible payment methods beyond the traditional.

Digital payments are going through an enormous surge in growth, with the total transaction value of digital payments expected to grow by almost 10% annually between 2024 and 2028, to a projected total amount of US$16.62tn by 2028. Growth-focused merchants should carefully consider the design and functionality of the payment gateways they choose to use to process these payments to ensure security of transactions.

How do payment gateways work?

Because payment gateways operate so quickly (usually in a matter of seconds) and we can’t see what’s happening behind the scenes, it can be easy to forget that there’s actually a whole sequence of digital events taking place to process a payment after a transaction.

As you can see, the payment gateway is just the first step in the payment processing workflow after a customer has made a payment online. Think of payment gateways as the ‘customer-facing checkout’ where customers’ payment information is collected.

Once this information has been collected by the payment gateway, it goes through a number of technical layers involving different parties, such as the payment processor, the merchant’s bank, the card network and the issuing bank. Here’s a quick summary of these steps.

1. Information sent to the acquiring bank: Once it’s collected the information, the payment gateway encrypts it before sending it to the acquiring bank (the merchant’s bank). The acquiring bank then acts as the merchant’s financial partner and steps in to help manage the flow of funds for the transaction.

2. The acquiring bank requests authorisation from the card network: The acquiring bank sends the payment request to the card network (such as Visa, Mastercard, or American Express), which then routes the request to the issuing bank (the customer’s bank). The issuing bank checks whether the customer has sufficient funds or credit to make the payment, and then sends the response back through the card network.

3. The payment is either approved or declined: If the payment is approved, the authorisation goes back to the acquiring bank, and it passes it on to the payment gateway, letting the merchant know they can complete the transaction. If the payment is declined, the payment gateway will let the customer know they need to try again with a different payment method.

4. Payment gateway fees are deducted: The payment gateway usually takes a small percentage of the transaction (around 2–3%), plus a fixed fee per transaction.

5. Funds are transferred: Once the transaction is approved, the funds are transferred from the customer’s bank account to the acquiring bank, and then to the merchant’s account. This transfer can take anywhere from a few hours to a couple of days, depending on the payment method and which financial institutions have been involved in the transaction.

6. Merchant receives payment: Finally, the merchant receives the payment, minus any fees.

What does a payment gateway do?

Payment gateways are the backbone of online payments, performing several key functions that enable you to accept payments from your customers efficiently and securely.

Connection with payment processor: Payment gateways act as the middle man between a business’s customer-facing checkout process and the payment processing provider.

Encryption: Payment gateways encrypt the data submitted by customers during the online checkout process before it is transmitted to other parties involved in the payment processing workflow. This prevents malicious parties from intercepting the information while it's being sent from one place to another, and ensures that standards such as Payment Card Industry (PCI) compliance are upheld.

Authorisation: Payment gateways forward this encrypted payment data to the merchant’s bank (the ‘acquirer’), and then send the information to the customer’s issuing bank or the payment processor. The gateway then verifies the transaction details, ensuring the customer has enough money to make the purchase and is using a valid payment method. The transaction is then approved or declined, and the payment gateway sends the response to the business.

Tokenization: Tokenization is another important method of securing payment transactions. When customer details are entered, payment gateways replace them with a string of meaningless symbols, known as a ‘token’. The gateway then securely stores and manages the token, allowing merchants to process future transactions without needing to store or handle sensitive card data.

Fraud prevention: Fraud-detection algorithms, address verification systems (AVS) and card verification value (CVV) checks are measures that can be put in place by payment gateways to help assess whether transactions are fraudulent before they are processed.

Data collection: Payment gateways can also collect data on transactions that can help you streamline and optimise your payment systems. For example, they can provide insights on the number of chargebacks and declined transactions, allowing you to make informed strategic decisions about how to address these issues.

Payment processor vs payment gateway: what’s the difference?

The difference between a payment processor and a payment gateway can be a little confusing, as companies will often sell these two services together as a bundle. However, the payment processor and the payment gateway are actually two entirely distinct entities in the digital payments ecosystem.

Payment gateway providers offer the software that integrates with websites, collecting, encrypting and transmitting customer payment information. Payment processors, on the other hand, receive the payment information and then send it on to financial institutions and card networks. And, finally, the term ‘payment provider’ is used as an umbrella term for a business that offers these and other types of payment services.

Examples of payment gateway providers

• Airwallex: Provides a payment gateway, payment processor and business accounts all-in-one platform. Airwallex supports businesses to operate in multiple markets and currencies, and offers a variety of flexible integration options, ranging from Payment Links and simple plug-and-play solutions, to a fully customisable checkout.

• PayPal: A traditional payment gateway provider known for its wide acceptance, offering payment solutions for both personal and business needs.

• Adyen: Provides a payments platform to accept payments with a strong focus on mobile payments and direct credit card acceptance.

• Braintree: A subsidiary of PayPal, Braintree offers a payment gateway, supporting mobile and web payments and providing tools like fraud detection and data encryption.

• Revolut: Offers a digital banking service that includes a payment gateway. May be more suited to the needs of micro-SMEs and startups.

Payment gateway fees

Payment gateway fees cover the payment processor provider’s costs for the technology and measures needed to securely handle, verify, and process sensitive financial data. Payment gateway fees can be broken down into various categories like transaction fees, monthly or annual access and maintenance fees, one-time setup fees, chargeback fees and more.

• Transaction fees: This fee is usually charged as a percentage of each sale plus a fixed amount per transaction. Rates vary by payment gateway provider and payment method (credit card, debit card, etc.).

• Monthly or annual access and maintenance fees: Some payment gateways charge a monthly fee for access to their platform, and to cover features like customer support and reporting tools.

• Setup fees: Many payment gateways charge a one-time setup fee to integrate their services with your website or payment system. 

• Chargeback fees: If a customer disputes a transaction and initiates a chargeback (a reverse of their transaction), the merchant may incur a chargeback fee. This compensates the payment gateway for the administration involved in managing the chargeback process.

• Refund fees: Some payment gateways charge a fee when they need to process refunds, to cover the cost of the resources needed to reverse the transaction.

• International transaction fees: For cross-border payments, some payment gateways will charge additional (and often high) fees for currency conversion, international transactions, and handling different payment methods. These can potentially include both a percentage of the total transaction amount and a fixed charge per transaction.

While price shouldn’t be the only factor when choosing a payment gateway provider, it’s important to look at the different fee structures on offer and the types of fees being charges, to make an informed decision about which one will best suit your business.

Understanding the ins and outs of payment gateways

Now you understand more about what a payment gateway is and its importance when it comes to efficient and secure payment processing, you may be considering upgrading the payment gateway system you’re using.

Putting serious thought into the payment gateway you’re using can bring a whole host of benefits to your business, including better security, an improved bottom line, more seamless global selling, and better acceptance rates.

The payment gateway provider for businesses focused on global growth

As the payment gateway provider purpose-built for businesses of all sizes with ambitions of global growth, Airwallex stands out for its competitive pricing, seamless integrations, detailed reporting insights and truly international reach, letting customers pay how they’d like to with 160+ local payment methods, in 130+ currencies and 180+ countries.

In fact, Airwallex is more than just a payment gateway. The Airwallex platform helps thousands of businesses simplify financial operations and scale their organisations, by offering an end-to-end platform on which merchants can collect, hold, manage and spend their funds.

Other FAQs

Which is the best payment gateway?

Different payment gateways will appeal to different businesses. Cost is an obvious factor, as well as ease of use, security, customisation, scalability, global reach and customer support. For global transactions, Airwallex stands out due to its transparent pricing, low FX rates and wide range of local payment methods. In terms of popularity, PayPal remains widely used worldwide and provides a reliable, user-friendly interface, although its fees can be higher than alternatives.

Do I need a payment gateway?

Yes, eCommerce merchants typically need a payment gateway to facilitate online transactions and securely process payments from their customers. A payment gateway serves as the intermediary between the merchant's online store and the financial institutions that process the transaction. If you have an account with a platform like Shopify, a payment gateway may be provided as part of the overall eCommerce package. However, it may be possible to upgrade to a payment gateway that is more compatible with your specific business by integrating a separate payment gateway with your store.