Payment Processing: What it is and how it works

Online shopping continues to grow steadily: one in every five transactions took place digitally in 2023, and forecasts estimate that will become one in four by 2027. The global eCommerce market surpassed a total value of US$5.8 trillion in 2023.

This is good news for eCommerce merchants, marketplaces, software subscription businesses, and anyone else selling goods online. As online shopping becomes ever more popular, the technology on offer to provide secure, smart and seamless digital payments is evolving rapidly too.

The success of an online business will depend in part on understanding what payment processing solution is best for your operational strategy. This article will go in depth into all the knowledge you might need to make this decision.

What is payment processing?

Payment processing is what happens during an online purchase so that funds can be transferred from a customer’s account to a merchant’s account. After the customer has added the items they want to their digital cart, filled in their payment details, and clicked a button to complete the purchase, the payment is either processed or declined. Merchants partner with a payment processor to enable this to happen. Sometimes payment processing technology is offered in a bundle together with other services like acquiring.

In this article, we are focusing on digital payment processing. When items are bought in a store, payment processing is also involved in order to authorise payment information and ensure funds are transferred from the customer’s account to the merchant’s account. A point-of-sale (POS) system is used to capture card details.

Online, customers can pay in many different ways, including using cards and mobile wallets. Services such as Klarna, which allow customers to pay in instalments, can also be used in order to encourage sales from customers who may not be able to cover the cost of a purchase up front. Whichever payment method is used, payment processing is what ultimately ensures that the money is transferred and the transaction is completed.

What are the key elements of payment processing?

To explain how payment processing works, it’s helpful first to clarify some key terms:

Merchant: The business or individual selling goods or services.

Payment gateway: Technology that encrypts and transmits transaction information from the merchant's website to the payment processor.

Payment processor: A company that handles the transaction process, passing information between the merchant, customer’s bank and card network.

Issuing bank: The financial institution that issued the customer’s credit or debit card.

Acquiring bank: The financial institution that holds the merchant’s account and receives the transaction funds.

Card networks: Organisations such as Visa, MasterCard and American Express that facilitate the transaction process between banks and merchants.

How does payment processing work?

Because the payment process is not visible and can happen so quickly and seamlessly, it can be easy to forget that there is a buzz of digital activity happening ‘behind the scenes’ when a transaction is completed in order to process payments. Entities that may be based in different parts of the globe must communicate and share information. Here is a rough guide to what happens after a customer clicks ‘buy’ during an eCommerce transaction:

1. The customer provides their payment information. This can happen in different ways, for example by filling out online forms with card details or scanning their fingerprint to complete the purchase using a mobile wallet.

2. The payment gateway, which collects this information, forwards it to the payment processor. The payment processor sends an authorisation request to the card network, which routes it to the issuing bank. 

3. The issuing bank verifies the customer’s identity and checks whether the customer has enough available funds or credit to approve the transaction. It then sends a response back through the card network to the payment processor to approve or decline the payment.

4. If the transaction is approved, this message is forwarded from the payment processor back to the payment gateway, which informs the merchant. The customer receives a notification that the payment has been approved.

5. Funds are transferred from the issuing bank to the acquiring bank, minus any relevant transaction fees.

Popular payment methods for online transaction processing

Credit and debit cards

Payment cards are still the default online payment method. Credit cards allow customers to borrow funds while debit cards deduct money from the customer’s account. Online checkouts usually offer customers the option of saving their card information to streamline future purchases or regular subscriptions. 

Digital wallets

Digital wallets such as Apple Pay and Google Pay are rapidly rising in popularity. It’s been estimated that by 2027, ​​digital wallets will make up 49% of all global sales online and at POS (Points of Sale terminals in stores), accounting for more than $25 trillion in global transaction value, or 49% of all sales online and at POS combined.

A digital wallet is a mobile application that securely stores payment information, allowing people to pay for purchases from their devices without manually entering card details and billing information. This makes them a very quick and convenient method for paying both in-store and online.  

Buy Now Pay Later (BNPL)

BNPL payment methods allow customers to make a purchase and then either pay off the money owed at a later date or in a series of instalments. A small down payment is usually required, and subsequent payments can be automatically deducted from the user’s account or card. Klarna is an example of a popular BNPL provider.

The importance of security when processing payments

One of the most important aspects of processing payments is security. There are many ways the payment process can be tampered with. These include:

• Stealing a credit or debit card and using the information to make purchases.

• Targeting payment systems to steal sensitive customer data.

• Tricking individuals into sharing their payment information through fraudulent ‘phishing’ attacks and using this information to make purchases.

• Requesting a refund for fraudulent reasons, such as saying the item was not received.

As well as being aware of these risks, businesses must also ensure that they are compliant with industry regulations and standards or they may incur penalties. One important standard in this context is the Payment Card Industry Data Security Standard (PCI DSS), which is important for any business that handles payment card data. It requires that these businesses protect their customers by ensuring that their data remains secure and private. Working with the right payment provider and implementing secure payment processing technology can make it simpler to remain compliant when processing payments.

Key security technology for payment processing

There are various technologies that are used during the payment process to ensure that the transaction remains secure and any sensitive customer information held by the payment processor or merchant isn’t intercepted by fraudsters. Key security methods include:

• Encryption: Customer data is scrambled into a meaningless string of characters before it is sent from the payment gateway to the financial institutions that facilitate transactions. This ensures that no one else can access this sensitive information while it is in transit. You may have heard of the cryptographic protocols SSL (Secure Sockets Layer) and TLS (Transport Layer Security). These are tools for encrypting and securing internet communications that can be used during the payment process.

• Tokenisation: Similarly to encryption, tokenisation replaces sensitive card information with a unique identifier or token. The token can be stored on file for recurring payments, reducing the risk of a data breach. When the transaction takes place, a key is used so that the original cardholder information can be unlocked in order to complete the payment process.

• Biometric authentication: There are various authentication methods that can be used to ensure that the person making the payment is not using stolen card details. Multi-factor authentication – when two methods are used to ascertain the person’s identity, such as a one-time code and a password – helps reduce the risk of fraud. However, these methods introduce friction into the checkout process that can reduce conversion rates. Passwords can be forgotten, leading to time wasted in resetting them. The rise of mobile wallets has helped popularise biometric authentication, which is secure, quick and easy. A fingerprint scan or face scan can be completed with a single touch, and is difficult for criminals to replicate.

• Artificial intelligence and machine learning: AI and ML can be used by payment providers to track unusual patterns of transaction activity to assess the risk of fraud. Any suspicious activity could trigger an additional demand for authentication, for example. 

Additional challenges in payment processing

Chargebacks are an aspect of processing payments that can be challenging for merchants. They take place when a customer requests a reversal of the payment. The cardholder’s issuing bank investigates the dispute and reverses the transaction if validated. Sometimes chargebacks happen legitimately due to stolen cards, merchant errors and customer dissatisfaction. Other times, customers try to reverse the transaction illegitimately while retaining the item they bought.

Frequent chargebacks can be problematic for merchants. Not only do they lose the sale, they can incur higher processing costs from payment processors. Reliable payment processors can help lower the rate of chargebacks using fraud prevention measures such as 3D Secure (3DS), which add an extra layer of security. Transactions can also be monitored for unusual patterns or high-risk indicators. Another service that payment processors can provide is alerting merchants of potential disputes before they become chargeback, to help reduce the frequency of chargebacks.

Why does a business need a payment processing solution?

Shopify and other eCommerce platforms often offer their own payment processing solutions, but it can be beneficial for merchants to partner with a third-party payment processor whether they have created their own online shop or are selling through a marketplace. These providers can create additional benefits for merchants, optimise the checkout experience and help boost conversions, and the software can be integrated seamlessly with the pre-existing eCommerce store. Here are some of the benefits payment processors can provide: 

Multiple payment methods: If merchants are catering to an international customer base, a diversity of payment methods is crucial to boost conversions. This means thinking beyond the usual options, like the most globally popular card networks, mobile wallets and BMPL options. There are payment methods that are popular in certain countries and regions such as WeChat Pay and Alipay, which are huge in China, and iDEAL, which is the leading non-card payment method in the Netherlands.

Advanced security: As mentioned above, advanced payment processing solutions use encryption, tokenisation and secure communication protocols such as SSL/TLS to protect customers’ payment information from cyber threats​. They also help businesses comply with standards such as PCI DSS, which imposes measures to protect cardholder data.

Operational insights: It’s possible for payment processing solutions to provide merchants with details and analysis of their transaction data. This can help them understand customer behaviour and optimise sales.

Risk management: Payment processors can help manage chargebacks, protecting businesses from fraudulent claims and reducing losses. In-built fraud-detection systems can monitor transactions in real time so that any suspicious activity is flagged and investigated before fraud can take place.

Streamlined record keeping: As well as ensuring that businesses remain compliant with local and international financial regulations, modern payment processors such as Airwallex can seamlessly sync with accounting software. This streamlines financial reporting and auditing.  

Top 3 features to look for in a payment processing solution

Global reach

As well as offering a wide range of payment methods, a good payment processor will allow customers in a variety of regions to see prices displayed in their home currency, and to buy items using that currency. Internationally focused payment processors like Airwallex enable merchants to accept payments from all over the world, including payments using less popular currencies and in countries that are not well connected in terms of financial infrastructure. Merchants should also ask if it supports digital wallets such as Apple Pay and BNPL methods as embracing these can offer strategic advantages for businesses. 

Security and compliance

Security and fraud prevention are critical when it comes to financial transactions in order to protect both companies and customers. A good payment processing solution will have advanced security measures to deal with evolving threats. Look out for solutions that have 3DS protocols in place, offer pre-chargeback programs, and employ machine-learning powered checkout optimisation that can enhance payment acceptance rates.

Cost savings

Different payment processors offer different fee structures. Often there’s a monthly or yearly subscription fee as well as additional charges for each transaction that can either be a flat rate, a percentage of the transaction amount, or a combination of these. When considering fees, remember that there can be “hidden” costs that aren’t immediately clear up front. Chargebacks can incur additional fees, for example, and currency conversions can come with steep mark-ups. For merchants with a high proportion of international transactions, consider using a payment processor that specialises in cross-border payments.

The wrong payment solution can lead to a negative checkout experience for overseas merchants, costly conversion fees, increased risk of fraud. Learn more about the key features to look for in a payment processor here.

3 examples of payment processors

Airwallex

Airwallex is a modern fintech company that specialises in global transactions. Stand-out offerings include low FX fees, multi-currency business accounts, in-built expense management and integration with accounting software. Rates for both domestic and cross-border transactions are cost-effective, and a wide range of international payment methods are offered to customers.

Paypal

Paypal is a popular legacy solution that is easy to use and accepted all over the world. The solution is great for small businesses with low transaction volumes who want to set up quickly with a trusted name. However fees can be complex, especially with international business transactions. The platform charges a high fee for converting currencies and this can significantly impact businesses that deal in multiple currencies.

Stripe 

Stripe is a flexible payment provider with a wide range of tools and plugins and it offers payment analytics that are easy to use. It is also one of the most popular PCI-compliant payment gateways in the world. However, its processing rates are not the most cost-effective, and fees for converting currencies are high. Reviewers have also suggested that developer support is required to make the most out of Stripe.

Why choose Airwallex payment processing services?

Airwallex helps customers all over the world pay as though they were in the same country as the merchants they are buying from. One-time and recurring payments can be collected in customers’ preferred currencies and local payment methods. 

That’s why businesses of all sizes, from eCommerce marketplaces to online stores, are using Airwallex to expand their international customer base, eliminate unnecessary currency fees and protect against fraud.

With Airwallex, it’s possible to:

• Accept payments from 180+ countries and regions and 160+ payment methods.

• Settle like-for-like in 12+ currencies directly into an Airwallex Global Account. Avoid double conversions and hedge against currency fluctuations.  

• Enjoy competitive FX rates — just 0.5 to 1% above the interbank exchange rate.

• Choose from flexible integration options, ranging from a simple plug-and-play solution to a fully customisable checkout.

• Reduce chargebacks and improve payment acceptance rates with our pre-chargeback program and smart retry logic.  

• Protect against fraud with our 3DS fraud engine.

• Enjoy the benefits of Airwallex’s full product suite, including Global Accounts, a multi-currency digital wallet and Borderless Cards.

• Streamline bookkeeping with end-to-end expense management

• Sync with your accounting software for easy reconciliation, including Xero, QuickBooks, NetSuite and more.

• Integrate Airwallex with Shopify, Magento and WooCommerce and save on FX.

FAQs

1. How long does a payment process take?

The amount of time it takes to process payments depends on several factors, including the payment processor used, the payment method used and the financial institutions involved. Here is a breakdown of typical time frames for various payment processes:

Credit and debit card payments

The authorisation process is almost instantaneous, and after this the transaction is batched and sent for settlement. The transfer of funds typically takes one to three business days.

Mobile wallet payments

The authorisation and settlement process is similar to that of card payment. It usually takes one to three days for merchants to receive their funds.

Buy Now, Pay Later (BNPL) services 

These services allow flexible payment options for customers while merchants are paid upfront, minus the fee that the BNPL provider charges for their service. The exact time it takes for the payment process to be completed may vary depending on the BNPL provider, but typically merchants receive funds in one to three business days.

ACH (Automated Clearing House) Payments

These are often used for direct deposits, bill payments and other types of electronic funds transfer. Usually they take a day or two to process, however same-day ACH settlement is becoming more common.

Wire transfer

This is a method of sending money from account to account through the SWIFT network. Domestic wire transfers are generally complete within a few hours, but international wire transfers can take up to five days, depending on the banks and countries involved.

2. Does my business need a payment process solution?

Yes, eCommerce businesses need payment processors to ensure that funds are securely and seamlessly transferred to their account from their customers’ accounts. Online storefronts offered by eCommerce marketplaces like Shopify do come with built-in payment processing solutions, but they also have the flexibility to integrate with third-party payment processors. Partnering with a separate payment processor can come with benefits such as enhanced customer experience, built-in fraud detection, competitive rates, lower FX fees, a greater level of customisation, a wider range of payment methods and data analytics that provide insights into customer behaviour.

3. What to look for in a payment process provider

Different payment providers will work best for different businesses. However, there are several factors that it will be important to consider. These include:

• Security and compliance: Look for PCI DSS compliance, encryption and tokenisation, and advanced fraud detection and prevention tools. 

• Fees and pricing: As well as considering subscription fees, transaction fees and setup fees, check for additional costs such as chargeback fees and high FX rates for international payments.

• Accepted payment methods: Ensure that the processor accepts all major credit and debit cards, including those that are popular in other regions of the world. Look for additional options like BNPL services and digital wallets. Again, on top of familiar digital wallets like Apple Pay, think about those that may be typically used in other locations such as China and Europe.

• Integration and compatibility: Make sure the payment process provider integrates seamlessly with your eCommerce platform.

• Scalability: You need a processor that can scale with your business as it grows. Does the provider being considered offer advanced features that you might need in the future? Can it handle large transaction volumes? Does it offer a wide variety of global payment methods and low FX fees to help you expand internationally?

• Reporting and analytics: Look for comprehensive reporting tools that will give you information about customer behaviour so you can optimise sales.

• User experience: The payment process should be smooth and simple for customers to reduce the possibility of cart abandonment.