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

What is a payment gateway?

A payment gateway is a technology platform that enables businesses to accept customer payments, both in-person and online. It facilitates the acceptance, processing, and management of these payments. While Point of Sale (PoS) terminals are a form of payment gateway used in physical stores, the term typically refers to online payment gateways. These gateways allow merchants to accept payments via credit or debit cards and often support other electronic payment methods like mobile wallets (e.g., Apple Pay).

Digital payments are experiencing a surge in growth, driven by the increasing convenience of payment apps and mobile wallets. This growth is particularly evident among younger demographics. The total value of digital transactions is projected to grow nearly 10% annually from 2024 to 2028, reaching an estimated $16.62 trillion by 2028. Given this trend, selecting the right payment gateway is crucial for merchants.

This article provides an in-depth look at payment gateways, covering how they function, the various types available, their advantages and disadvantages, and examples of providers. It also examines the payment gateway services offered by Airwallex, which is known for its cost-effective and user-friendly global transaction solutions.

One important point to note is that not all online payment gateways are the same. Businesses should seek a gateway that enhances conversion rates while maintaining security and minimizing chargebacks.

How do payment gateways work?

A payment gateway is the initial interface in the payment processing system, where customers input their payment information. Typically, the payment method is a card, but other methods, such as mobile wallets, can also be used.

Once the customer's information is entered into the payment gateway, it is sent to the payment processor. The information is then forwarded to financial institutions—banks and card networks, for example—who transfer funds from the customer’s account to the merchant’s.

After the information travels through the card network and issuing bank, a message is sent back through the payment gateway. The message informs the customer and merchant whether or not the transaction was successful. If the transaction is approved, the business is notified and proceeds to fulfill the order. If the transaction is declined, the customer may be prompted to try a different payment method.

Because of their role, credit card payment gateways have also been described as the “rails” that pass information between the merchant and issuing bank and back to the merchant.

What additional services do payment gateways provide?

There are a few other vital functions that a payment gateway performs:

Encryption: The payment gateway encrypts data submitted by customers during the online checkout process before it is transmitted to other entities. This prevents anyone from intercepting the information while it is being sent from one place to another and ensures that standards such as Payment Card Industry (PCI) compliance are upheld.

Tokenization: Tokenization is another essential method of securing payment transactions. When the customer details are entered, they are replaced by a string of meaningless symbols, known as a token. This token can then be stored for future transactions, while the details are held in a secure vault, to be unlocked by financial institutions to complete the transaction when needed.

Fraud prevention: Your payment gateway can implement fraud-detection algorithms, address verification systems (AVS), and card verification value (CVV) checks to help assess whether transactions are fraudulent before they are processed.

Data Collection: Payment gateways can also collect transaction data to help businesses tweak and improve their payments systems. For example, they can provide insights into the number of chargebacks and declined transactions.

What are the different types of payment gateways?

Different payment gateways offer different drawbacks and benefits, and each business must assess its transaction patterns and operational model to decide which works best for them. Merchants can then determine the amount of control and responsibility they want for their payment gateway. Payment gateways can be broadly divided into three main categories:

Self-hosted payment gateway

Also known as ‘on-site,’ this payment gateway is hosted on the business’s servers. The customer enters their payment details onto a page on the business’s website, which is transmitted to the payment service provider (PSP) to authorize the payment.

The benefits of self-hosted payment gateways include a seamless customer journey. Customers don’t have to click through to a separate checkout page that may look and feel different from the rest of the business’s website. Removing friction from the journey could contribute to a higher conversion rate and lower the chances of cart abandonment. There is also greater control over the design and flow of the checkout experience.

The drawback to self-hosted gateways is greater responsibility for PCI compliance, as customers’ payment information is stored on the business’s servers. More technical expertise and resources may be required to implement the gateway initially.

Redirect payment gateway

Also known as ‘hosted,’ a redirect payment gateway takes customers away from the merchant’s website to a page hosted on the payment service provider’s server to fill out their payment details.

This is simpler for the merchant, as the merchant will not need to worry about processing the payment, preventing fraud, keeping card details secure, and maintaining compliance with PCI and other standards. However, it adds an extra step for the customer, introducing friction to the user journey, and there is less control over the design of the hosted page.

Payment gateway API

Payment gateways can be integrated into a business’s website using APIs (application programming interfaces). This way, the design and user flow control can be maintained while data is securely and efficiently sent to the relevant financial institutions to complete the transaction.

Airwallex allows merchants to fully control their checkout experience without having to build a payment gateway solution from scratch. It implements an API in the back end to accept payments in an iOS or Android app using mobile SDKs (software development kits).

Is a payment gateway the same as a payment processor or payment provider?

This can be confusing because companies can bundle these services together. However, a payment gateway, processor and provider are all distinct entities within the ecosystem of electronic payment transactions. 

Payment gateway providers offer software that integrates with your site, collecting, encrypting and transmitting customer information. Payment processors receive this information and send it to financial institutions and card networks. ‘Payment provider’ is an umbrella term for someone who offers payment services.

Increasingly, payment providers are bundling together multiple services, which can mean cost savings for merchants. For example, Airwallex can act as a gateway, processor and acquirer. It also offers these services separately. On top of this functionality, payment gateway providers can provide other services to merchants, including customer support, invoicing, payment integration with accounting software, and detailed analytics that can be used to optimize business practices.

What type of businesses use payment gateways?

The types of businesses that use payment gateways to process their transactions can vary wildly. Here are a few examples of different kinds of companies and the way that they use gateways:

Independent store

Independent stores may use a payment gateway to process transactions for purchases made on their website securely. These stores are typically small businesses without tech resourcing, so they may use a redirect-gateway to keep things simple while ensuring they remain compliant. Many merchants use eCommerce platforms like WooCommerce and Shopify to sell their goods rather than building their own websites. These marketplaces provide merchants with a ready-made online store, and payment gateways can then be integrated into the backend of this store. 

Gimme Swag is a real-life example of an eCommerce store using a payment gateway. Gimme Swag crafts branded, one-of-a-kind toys, releasing them through limited edition drops that help content creators and gaming companies engage more with loyal fans. Gimme Swag uses Airwallex’s payment gateway. This allows the company to accept payments from customers in different regions and from other customers using various payment methods.

“Let’s say we continue to expand in Korea,” Daven says. “Or perhaps further markets in Latin America or Europe—where we already have a very strong presence, we can make things as easy and convenient as possible by conducting smooth local transactions and prioritizing their preferred currencies and payment methods. We’re letting our clients know that we hear and support them—and that’s critical to our business.”  - Daven Johnson, Founder and CEO at Gimme Swag

Online marketplace

An online marketplace could also use a payment gateway to facilitate transactions. It’s possible to embed a payment gateway into the platform that automatically splits funds to take any fees and bills from customer payments before the remaining amount reaches the merchant’s account.

Payment gateway providers that are acquirers may also allow merchants to hold money in multiple currencies, which can help them avoid paying transaction fees when receiving and sending money in foreign currencies. This eCommerce platform may use a white-labeled payments system, which allows the process to remain branded and integrated with the rest of the site without the business having to design a solution from scratch.

Subscription-based business

Subscription-based businesses may also use a payment gateway to manage recurring billing and subscription payments from their customers until they cancel or end the subscription. Payment gateways may help manage trials and invoices up to automated recurring billing. They may also help you manage plan upgrades, downgrades, and cancellations via an API. 

Payment gateways can use tokenization to securely hold customer payment information on file for repeat payments without any danger of breaches or interception by cyber criminals. Rather than holding the data and being responsible for keeping it safe, tokenization involves replacing that information with a ‘token’ (string of meaningless characters) that can be swapped back safely when the transaction occurs.

Top 4 benefits of using a payment gateway

• Convenience for your customers: With payment gateways, merchants can offer customers local payment options. This removes obstacles to conversion and contributes to customer loyalty, which can positively impact the business’s bottom line. 

• Enhanced security: Payment gateways offer robust security measures to ensure that customer information is always protected and the risk of fraudulent transactions stays as low as possible. These include encryption, which scrambles data to make it unreadable to anyone who intercepts it in transit, and fraud-detection algorithms, which look for patterns that indicate suspicious activity and prevent those transactions from being completed without additional authorization.

• Supports efficiency and growth: Payment gateways automate transaction authorization and settlement, speeding up the process without compromising security. They can help businesses scale as transaction volumes increase, allowing merchants to cater to an international customer base with a wide range of currencies and accepted local payment methods.

• Gain insights from data: Many payment gateways provide reporting and analytics tools that allow you to gain valuable insights into customer behavior and transaction patterns. These insights can empower businesses to make data-informed decisions to optimize their strategies and maximize revenue.

Top 4 pain points when using a payment gateway

• High fees that eat into your margin: Transaction fees for processing payments can vary depending on payment method, transaction volume and geographical location. Additional fees may be incurred when customers dispute a transaction with their bank or credit card issuer, and a chargeback occurs, triggering a refund to the customer. These fees can eat into profit margins, particularly for businesses with high transaction volumes or low-value transactions. That’s why finding a payment gateway provider with a fee structure that works for your business is essential.

• Complex and lengthy integrations that consume team resources: Setting up a secure payment gateway to integrate with an eCommerce platform or website can be time-consuming and costly. In some cases this can require some technical expertise and coordination between different departments of the business. Ongoing maintenance and updates may be necessary to ensure that operations remain smooth and that evolving industry standards and regulations are always upheld. Talk to the customer service team at your potential payment gateway provider to find out the best and easiest option for your team.

• Keeping up to date with ever-changing security and compliance requirements: Payment gateways must meet industry standards and regulations, such as the Payment Card Industry Data Security Standard (PCI DSS), to protect sensitive financial information and prevent fraud. Every aspect of a business’s payment process must meet these standards, so ensure that you work with a payment provider that is up-to-date with evolving standards no matter where you or your customers are based.

• Lack of control of your checkout: A business’s checkout is crucial to its functioning. Integrating a payment gateway into your eCommerce site makes you vulnerable to any disruptions or service interruptions the gateway provider might experience. For this reason, it is imperative to choose a reliable provider with a strong reputation. Consider contacting other leaders in your industry for unbiased recommendations and testimonials.

Top 3 features of a reliable payment gateway

Multi-currency support

Online commerce now regularly takes place across borders, and it’s essential to create a frictionless experience for overseas and domestic customers. One way of doing this is using a payment gateway that automatically converts transactions into the customer’s preferred currency.

Combined providers, processors and acquirers specializing in international transactions like Airwallex can also allow merchants to hold money in multiple currencies. This can help avoid FX fees when accepting funds and paying suppliers in the same foreign currency.

Wide range of payment methods

A good and secure payment gateway should offer various payment methods. In addition to credit and debit cards from multiple networks, this could include mobile wallets like Apple Pay and Google Pay, which enable quick and seamless payments via mobile devices. Alternative payment options like Klarna, which allows customers to buy now and pay in installments later on (BNPL), opens up your customer base to include those who cannot or prefer not to pay for an item in a single transaction upfront.

It’s also important to remember that some popular payment methods in some regions may be unfamiliar to you due to your geographic location. For example, WeChat Pay and Alipay are widespread in China, and iDEAL is a preferred payment method in the Netherlands.

A recurring billing and subscription management capability

A payment gateway provider that facilitates automated billing for subscription-based services allows businesses to set up and manage recurring payments efficiently. This means that there is flexibility in the billing plans you can create for customers, with different options for pricing structures, billing frequencies and types of subscriptions. 

Subscription businesses also have specific security needs as they need to hold customer details on file. Ensure your payment gateway provider uses a robust security measure such as tokenization to protect this sensitive financial information.

How much does a payment gateway cost?

Price shouldn’t be the only consideration when choosing a payment gateway provider, but it is an important concern. Look into different fee structures and consider the type of transactions and the volume that you are likely to process. 

Costs can be broken down into various categories, such as:

• Setup fees

• Flat monthly or annual fees

• Transaction fees: a small percentage, flat amount or combination of the two for each transaction processed

• There may also be additional fees for administrative operations. For example, chargebacks may incur an extra cost to resolve.

If your transaction volume is relatively low, consider looking for a fee structure with lower monthly fees and lower set-up costs. Transaction fees will add up to a smaller amount than a high-volume company would be paying.

3 examples of payment gateway providers

While some companies offer payment gateways alone, many providers offer a merchant account and a gateway. This can simplify operations rather than setting up a merchant account separately. Here are some reliable options:

Airwallex

Airwallex is a top choice for growing or global companies looking for competitive FX rates and multi-currency business accounts. It is compatible with software platforms like Xero and Shopify and is a cost-effective way of processing cross-border payments and currency conversions. The software integrates effortlessly with many other eCommerce and accounting platforms, and in-built expense management is offered for no additional fee.

PayPal

PayPal’s fees and currency conversion rates tend to be higher than those of competitors, and there is limited customization available for checkout pages. However, it is a widely known solution with a simple payment process and extensive integration with almost all eCommerce platforms. It is well-optimized for mobile, with flexible payment options, including PayPal Credit.

Shopify

For entrepreneurs who already use Shopify as their online storefront, Shopify is a simple option as only one account is required for all their transactions and eCommerce needs. The interface is user-friendly for merchants and customers, and security measures are advanced. Scalable pricing plans cater to businesses of all sizes, from startups to enterprise-level organizations, allowing merchants to grow their online presence and sales over time. Like PayPal, the convenience and perks of Shopify as a payment gateway come with relatively high fees; there is limited customization, and some merchants have reported challenges in accessing responsive customer support for technical issues.

Why choose Airwallex as a payment gateway provider?

As a payment gateway provider, Airwallex stands out for its competitive pricing, seamless integration with tools like Shopify and WooCommerce, detailed reporting analytics and global reach. 

In addition, Airwallex's services go well beyond gateways. Airwallex helps thousands of businesses simplify their financial operations and grow internationally by providing an end-to-end platform where merchants can collect, hold, manage, and spend their funds.

Some of the benefits of partnering with Airwallex for your payment solution needs include:

Scalability

Businesses of all shapes and sizes use Airwallex to reach new global customers, eliminate unnecessary currency fees, and protect against fraud. This includes eCommerce stores, subscription businesses and online marketplaces.

Local payment methods

Pricing in local currencies and letting customers pay with their preferred payment methods can maximize conversions. Airwallex accepts payments via 160+ payment methods in 180+ currencies and 180+ countries. In addition to the major card networks—such as Visa, Mastercard, and American Express—there are a range of regional payment methods available, such as GoPay, GrabPay, E.SUN, WeChat Pay, and Ali Pay.

Like-for-like settlement

Businesses can collect and settle funds in the same currency without the hassle of setting up multiple entities or paying hidden conversion fees. Airwallex allows merchants to collect and store funds in a multi-currency wallet, eliminating unnecessary conversion fees.

Reduce chargebacks

With Airwallex as your payment gateway provider, suspicious transactions can be automatically identified with built-in fraud detection and dispute management. This means that fraudulent transaction attempts can be declined, and chargeback frequency can be reduced.

Improved acceptance rates

Airwallex’s machine learning-powered 3D Secure (3DS) optimization engine improves transaction acceptance rates by assigning smart merchant category codes (MCC), automatically retrying, optimizing ISO messages, and more. At the same time, compliance with regulations is maximized: the best strategy is automatically chosen based on transaction risk, applicable regulatory exemptions, and policies. Each merchant’s risk appetite can be customized based on their business model.

Saved payment details

Customers can save their details to drive repeat sales. Thanks to network tokenization, security remains high, and customer details remain secure and private. Tokenization can also improve card acceptance rates and reduce processing costs.

Flexible integration options

You can integrate an Airwallex payment gateway into your online store, no matter the size of your team or level of technical expertise. Simple plug-and-play integrations are available for popular platforms like Shopify and WooCommerce. It’s also possible to get an Airwallex-hosted page, allowing Airwallex to take care of the payments journey. If you want more control over the checkout experience, you can build directly via Airwallex’s API or accept payments in your iOS or Android app using Airwallex’s mobile SDKs.

Frequently asked questions:

• Which is the best payment gateway?

Different payment gateways will appeal to other businesses. Cost is an obvious factor, but other factors include ease of use, security, customization, 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 customer payments. A payment gateway is 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.