How Does a Payment Gateway Work?

A payment gateway is a merchant technology provided by an e-commerce application service provider. It captures and conveys payment data from the customer to the merchant and then transfers the payment status (approved or declined) to the customer. A payment gateway does this by securely validating the customer's card details, ensuring the availability of the funds, and authorizing payment. It conceals sensitive credit card details, so information is transferred securely from the customer to the acquiring bank via the merchant.

Therefore, the payment gateway serves as the intermediary between the customer and the merchant, ensuring that you carry out transactions securely and promptly. A bank usually provides a payment gateway to its customers. However, specialized financial service providers also offer their own gateways.

Payment gateway software is ever-evolving to reflect modern consumer tastes and technical capacities. Previously, terminals would approve credit cards using magnetic strips, which would need paper signatures from the customer. With the development of chip technologies, signatures would be obsolete in favor of a personal identification number (PIN) inserted directly into the payment gateway. Nowadays, contactless purchases are also available, with various customers now utilizing their phones as payment devices instead of a plastic credit card.

Real World Example of Payment Gateway

Through bank partnerships, merchants can access payment gateway systems or select a payment gateway system themselves. Large banks like Bank of America (BAC) use advanced payment gateway systems for customers and their merchants acquiring bank services. Merchants can select various payment gateway software based on the compatibility with the merchant acquiring bank used for payment processing.

Another example of a payment gateway is Square (SQ), which focuses on flexible mobile payments for retail businesses. The Square Reader technology utilized by the company allows easy approval of payments by customers at ad-hoc locations such as conventions or farmer's markets or via roaming storefronts such as food trucks.

There are hundreds of third-party payment gateway options, but the most common ones are PayPal, Stripe, Amazon Pay, 2Checkout, Apple Pay, Square, and All these third-party payment gateways fall under different payment gateway types, and the option you go on to choose is mainly dependent on what you need from your payment gateway.

Types Of Payment Gateways

There are various payment gateway types to choose from, all depending on your business's size, needs and preferences, and budget. These are some of the most common:

  1. Hosted Payment Gateways (Redirects): Hosted payment gateways or redirects typically transfer customers to another site to process payment. It is easy to set up and is usually relied upon by various small businesses. PayPal is one example.
  2. Checkout on Site, Payment Offsite: Similar to the redirect option, this type offers simplicity but limited customization of the user experience. The processing/checkout occurs on the merchant's site, but you complete the final payment on the redirect site. A common example is Stripe.
  3. Customizable On-Site Payment Gateways: This type of payment gateway is for companies ready for more significant responsibilities. This means that you complete all payments and processing through your server.

The architecture of a payment gateway differs depending on if it is an in-store gateway or an online payment portal.

  • An online payment gateway requires application programming interfaces (API) to allow the website to communicate with the payment processing network.
  • In-store payment gateways utilize a POS terminal that electronically connects to the payment processing network.

History Of Payment Gateways

Payment gateways are essential to e-commerce. Adopting a secure way to transfer sensitive data aids impersonal commerce, a fundamental stamp in the payments realm. And merchants have Jeff Knowles, the father of payment gateways, to thank.

As far back as the project timeline goes, Jeff Knowles and his team began creating the earliest version of Authorize.Net (the first and one of the most popular payment gateways) in late 1996. It was made available to the public in April of 1997, exactly six months later. In the two years that followed, they introduced many updates and new versions and operated upon under a quick development standard—with only two or three software engineers writing codes.