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

Key takeaways

• A payment gateway is a technology that securely authorizes 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 authorization, 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. They can also save money by eliminating unnecessary currency fees and keeping themselves and their customers safe from fraud.

What is a payment gateway?

A payment gateway is a technology platform that enables businesses to accept customer payments, both in-person and online. Payment gateways facilitate the payment processing that takes place after a customer has made a transaction. While Point of Sale (PoS) terminals are a 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 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?

Because payment gateways operate so quickly (usually in seconds) and we can’t see what’s happening behind the scenes, it can be easy to forget that ‌ a whole sequence of digital events takes 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. Payment gateways are considered ‘customer-facing checkout’ where customers’ payment information is collected.

Once the payment gateway collects this information, it passes through several 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 the information is collected, 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 authorization 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 authorization goes back to the acquiring bank, which 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 must try using a different payment method again.

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 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 customer payments efficiently and securely.

Connection with payment processor: Payment gateways are the middle person 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.

Authorization: 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 purchase and uses a valid payment method. The transaction is approved or declined, and the payment gateway responds to the business.

Tokenization: Tokenization is another vital 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 storing or handling sensitive card data.

Fraud prevention: Payment gateways 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 that can help you streamline and optimize 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 addressing 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 often sell these services together as a bundle. However, the payment processor and the payment gateway are‌ two distinct entities in the digital payments ecosystem.

Payment gateway providers offer ‌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 to financial institutions and card networks.

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: This all-in-one platform provides a payment gateway, payment processor, and business accounts. It supports businesses operating in multiple markets and currencies. It offers a variety of flexible integration options, ranging from Payment Links and simple plug-and-play solutions to a fully customizable checkout.

• PayPal: A traditional payment gateway provider known for its wide acceptance, offering payment solutions for 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 that supports mobile and web payments and provides 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 handle, verify, and process sensitive financial data securely. Payment gateway fees can be categorized into 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 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 necessary 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 include 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 consider the different fee structures on offer and the types of fees charged to decide which one will best suit your business.

Understanding the ins and outs of payment gateways

Now that you know more about what a payment gateway is and its importance in efficient and secure payment processing, you may consider upgrading your payment gateway system.

The payment gateway you’re using can bring many 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.

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

Frequently asked questions about payment gateways

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's more compatible with your specific business by integrating a separate payment gateway with your store.