The Complete Guide To Tokenized Payments: How Does Tokenization Work?
Digital currency and digital transactions are more important than ever to the modern global economy. Between concerns over the security of online transactions, increased privacy and security measures to protect sensitive cardholder data, and the many ramifications of the COVID-19 pandemic, it’s essential that merchants invest in systems such as tokenization to secure their customers’ financial information and safeguard their payments.
Ready to learn more about tokenization and how it can keep your business — and your customers — from falling prey to cybercrime and fraud? Read on to understand what a token is, how you can use tokenization to protect your credit card transactions, and more about the tokenization process.
Table of Contents
- What Is Credit Card Tokenization?
- How Does Tokenization Work?
- How Does Tokenizing Credit Cards Affect PCI Compliance?
- Benefits Of Credit Card Tokenization
- How To Implement A Credit Card Tokenization Service
- Frequently Asked Questions About Payment Tokenization
- Does My Business Need Credit Card Tokenization?
What Is Credit Card Tokenization?
Credit card tokenization involves the use of tokenization systems that replace credit card information with random letters and numbers. Instead of storing a customer’s unique credit card number, merchants can use tokenization to instead store a “token” that is worthless to both criminals and customers outside of a merchant’s system.
The same EMV technology that helps credit cards generate one-time codes for use for in-store purchases also makes tokenization possible. Credit card tokenization, though, also allows for card data protection both online as well as in-person.
Credit Card Tokenization VS Encryption
Credit card tokenization and credit card encryption are similar in that they both hide sensitive data from would-be interceptors. Both are security measures, and recently, standard features of modern payment gateways that happen to use two completely different processes to protect customer data during legitimate online transactions.
Merchants can use credit card tokenization to replace a customer’s actual card data with a token: a completely randomized (sometimes alphanumeric) number. With tokenization, merchants can safely obtain a token and pass it back to a “table” that holds actual credit card data without ever exposing a customer’s real payment card information. Encryption, on the other hand, encodes a customer’s credit card data together with a “key” that can decode it. Merchants can use credit card encryption to protect card information with an algorithm and transmit it over a network where it must be decrypted using the key.
Businesses should heavily consider investing in both tokenization and encryption to safeguard their customer transactions. Credit card tokenization makes the most sense for businesses that need to process offline and online recurring transactions and card-on-file payments, especially if they’re operating out of many locations or through an eCommerce store. Encryption is best used for in-person, card-ready transactions that can cipher a customer’s card number as soon as they swipe it through an encryption-compatible machine.
Credit Card Tokenization VS EMV
EMV, which simply stands for EuroPay, Mastercard, and Visa, differs from tokenization in that it directly relates to a customer’s physical credit card. EMV, like tokenization, protects customer data by “hiding” it during a transaction. And like encryption, EMV stores sensitive payment information right on its microprocessor chip, which encrypts the digital signature that’s used during a transaction.
EMV is exclusive to in-person “chip-and-pin” transactions, unlike credit card tokenization, and requires that merchants have a machine that can process payments from credit cards with microprocessor chips. “Chip-and-pin” transactions require that customers “dip” — not swipe — their cards into an EMV terminal to process their payment. More recently, though, EMV cards have also been using NFC (near-field communication) protocols to process and secure transactions, which requires that customers tap, rather than dip their card on a machine.
Merchants can offer customers a secure method to process card-ready transactions with EMV, provided they have a microprocessor-friendly machine. That said, you should offer tokenization as well as EMV in order to reliably secure online payments such as recurring, card-on-file transactions.
How Does Tokenization Work?
Credit card tokenization hides sensitive payment information using a randomized number called a token. Alphanumeric tokens allow for sensitive customer card information to safely pass from a merchant’s tokenization system to “tables” inside of the tokenization system. Tokenization stores actual credit card information in these tables rather than in tokens.
Tokens don’t store any identifiable customer information, which means cybercriminals can’t maliciously use tokens even if they get their hands on them. In fact, tokens are literally worthless outside of a merchant’s tokenization system.
Tokenized Payments Transaction Flow
Tokens ensure a seamless, secure digital transaction process. Credit card tokenization makes it easy for merchants to protect customer accounts from fraud. It creates a frictionless, card-free experience that makes eCommerce purchases easier and more commonplace and allows for secure, in-app mobile transactions so people can purchase what they need, when they need it, on the go.
- Step one: Credit card tokenization transactions begin with the cardholder. The cardholder initiates the transaction either online, in-store, or in-app by providing their credit card information.
- Step two: The merchant passes a token on to the receiving bank and, depending on the commerce environment and payment service (eCommerce, in-store merchant, mobile app), does so as part of an authorization request.
- Step three: The party that’s acquiring the token initiates the routing process to transmit the token to the bank network for authorization.
- Step four: After authorization is complete, the token matches with the appropriate customer bank account while customer data remains secure in the tokenization system’s digital vaults.
- Step five: The party issuing the token accepts or declines the transaction of funds, returns the token, and transmits its notice of authorization back to the bank.
- Step six: Upon notice of successful token and payment authorization, a new token transmits back to the merchant for use in future transactions.
How Does Tokenizing Credit Cards Affect PCI Compliance?
As we discussed already, tokenization technology relies on the use of tokens in place of credit card numbers. Since merchants don’t need to store a customer’s actual credit card number in their tokenization system, both the merchant and their customer can rest easy. In other words, tokenization can permanently reduce a merchant’s scope of PCI DSS compliance.
PCI compliance, broadly speaking, is the process that merchants must follow to adhere to the security requirements set forth by the Payment Card Industry Data Security Standard (PCI-DSS). Formed in 2004 by the Payment Card Industry Security Standards Council (PCI SSC) composed of Mastercard, Visa, American Express, Discover, and JCB, PCI compliance institutes a common standard for security across the entire payment processing industry.
The requirements for PCI compliance as well as the means to enforce them are products entirely borne of private enterprise policing rather than federal government regulation. While the Federal Trade Commission (FTC) involves itself in cybersecurity as it relates to commerce, the PCI SSC is the main body that governs over PCI DSS requirements and works toward preventing data breaches and instances of credit card fraud that negatively impact the industry.
Think of tokenization and PCI compliance like this: a customer comes into a merchant’s store and uses their credit card at a register operating on a tokenization system. When the time comes for that customer to use the merchant’s card reader, though, their credit card number passes right on through the tokenization system and onto the bank for secure processing. All the merchant’s point-of-sale (POS) system does is store a token that the receiving bank can verify as related to the customer’s bank account number; the merchant’s system never stores the card number and continues to mitigate its scope of PCI compliance.
Benefits Of Credit Card Tokenization
By now, it’s hopefully apparent that data security can become easier to implement when merchants introduce tokenization systems. Consider the fact that approximately $24.2 billion was lost as of 2018 to cases of credit card fraud and it’s no wonder that tokenization is appealing to merchants who want to protect their customers’ sensitive data as well as their own.
Some of the biggest benefits that come with credit card tokenization include:
- Minimize your risk of data breaches with tokenization systems that don’t physically store sensitive customer information. Credit card tokenization desensitizes private customer card data with tokens and stores the actual account information in a secure and cloud-hosted digital vault.
- Reduce the work needed to maintain PCI-DSS compliance as a merchant by mitigating your scope. Credit card tokenization makes it so that merchants can create smaller data environments that need to adhere to privacy regulations. Since merchants don’t need to store actual card-specific information on their POS system, compliance with PCI-DSS becomes easier for them to establish and maintain with a system of credit card tokenization.
- Provide customers access to more than one payment method and expand your payment processing across your channels of transactions. For example, merchants can provide their customers with payment options to purchase products and services online, through a mobile app, or in person. Merchants who are interested in offering an intuitive and comprehensive set of payment options to build their base of customers should heavily consider adopting a system of credit card tokenization.
How To Implement A Credit Card Tokenization Service
Now that you know about the basics and benefits that come with credit card tokenization, you may begin to wonder how you can implement a tokenization system of your own. If you’re worried that implementing credit card tokenization may be too complicated, you may be pleasantly surprised to discover that the reality is quite to the contrary.
The most straightforward way that retail businesses can start implementing their own tokenization system is by obtaining a near-field communication (NFC) credit card reader. “Pay” apps that integrate with NFC card readers already include tokenization as a built-in component and don’t require that merchants purchase any additional hardware aside from a new NFC reader.
Merchants can also begin their implementation process by connecting with their processor or gateway provider. These providers can often either put merchants in touch with their tokenization software partner or provide guidance themselves on the typical steps to take to implement credit card tokenization:
- The credit card tokenization implementation process is merchant-friendly and usually requires little to no new investments in hardware. To begin, discover any legacy data that resides on your network and convert that data to tokenized alphanumerics. This step isn’t necessary for merchants who don’t already store actual customer payment data after they complete their payment authorization.
- Credit card tokenization is relatively new to the world of payment processing and thus requires that merchants modify the message they send to their payment processor. This is the message that merchants send to a payment processor to deliver information on incoming transaction data. Merchants must modify this message to include tokenization instructions that their payment processor defines for them.
- Although this is another optional step, it’s highly advised that merchants embed encryption for additional layers of security. Merchants who provide credit card tokenization are often likely to offer encryption for increased security. Encryption routines function with a merchant’s POS system to encrypt cardholder information until the payment processor receives it. The payment processor decrypts this information and routes it back through the network to finalize the authorization.
- Finally, it’s time for merchants to modify internal business processes and rules according to a conversation they have with their tokenization provider. This step is mostly relevant to larger merchants that already use cardholder information for things aside from authorization transactions. Merchants who use post-authorization bank analysis, for example, likely need to modify their process of analysis to accommodate tokenization, so that they can continue to accurately determine the name of a bank and the type of card used during post-authorization analysis. It’s imperative that large merchants sit down with their tokenization provider to better understand which internal processes of theirs need to change and how tokenized alphanumerics can accommodate their business needs.
For startup businesses and other merchants that require as much security as possible when it comes to processing credit card payments, third-party services can also provide multiple choices of processor and gateway providers to implement tokenization. Keep in mind that the best third-party services provide as many choices for providers as possible; third-party solutions with only one or two choices often raise red flags and indicate that they use a long-term contract.
Additionally, merchants that use mobile POS systems likely already have access to their OWN NFC reader and usually can’t add third-party options to their system for tokenization without violating terms of service or voiding warranties. Generally speaking, it’s best for merchants to start by asking their processors for guidance on implementing tokenization and confirming whether they can purchase an NFC/EMV terminal for a reasonable price. Failing that, or in the event that a processor either increases their rates or asks that a merchant renew their contract, it’s best to make the switch to a new processor rather than purchase terminals from a third-party.
Frequently Asked Questions About Payment Tokenization
Does My Business Need Credit Card Tokenization?
Keep in mind that at this point, there are no hard and fast rules that apply to implementing tokenization. If you’re a merchant, the ball is in your court to make the best decision for your business needs. That said, tokenization can significantly reduce your liability when it comes to payment security.
Merchants don’t need to carry the burden of tokenization all by themselves. There are ways to use the expertise of other companies and hardware to get the job done. If your business just needs to improve its payment processing methods and doesn’t want to store sensitive payment cards or personal data in their POS system, then make sure to refer to the solutions in this article to more easily navigate credit card tokenization.
Interested in learning more about the methods merchants can use to securely accept customer payments without running the risk of losing or misrouting funds? Discover how merchants can protect cardholder information as well as their business’s data assets with mPOS apps that reduce the risk of data breaches and credit card fraud.