How Online Payment Processing Works (8 Steps)

Lauren Fram
Lauren Fram  |  July 23, 2019

People love to shop online.It’s fast, it’s convenient, it’s easy, and sometimes it’s less expensive. But is it safe? Most of the time it is, but there are the occasional hiccups.

If you use a payment gateway, your data is likely pretty safe. But how do payment gateway software and other online payment processing methods work? How does your money get from point A to point B? How can you feel more secure when you spend money online or when your business receives money online?

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It’s magic, obviously. You just need to trust. Next question? (I’m kidding.)

How online payment processing really works

Online payment processing functions via a series of digital gateways. If a transaction meets the requirements of each individual gateway, it moves on to the next gateway. The last gateway is the merchant’s bank, where the money is deposited.

So let’s walk through it.

How online payment processing works step by step

Step 1: A purchase is made

If we think of the process used to make an online purchase as being like a secure building, making the purchase is the unsecured lobby. Anyone can walk in and roam around. Attempting to make a purchase is like presenting your credentials to the front desk: They’ll take your information and call upstairs to see if you can enter.

Step 2: Payment gateway encryption

You’ve decided you want to enter this particular building by making a purchase. You walk up to the front desk and provide them with your credit card information. The person at the front desk is the payment gateway: They will transfer your data to the decision-maker upstairs. They pick up the phone and relay your information using a secret code. Encrypting your data with this code prevents someone from overhearing your credit card information.

Step 3: Payment processor verification

The payment processor is on the other end of the phone. As the payment gateway relays your information, they verify that it is correct and that this is a valid transaction. It’s a bit like a very fast background check to make sure that this is your credit card information and that you are making a valid purchase.

The payment processor can be considered like an old-school switchboard. Once it determines that yours is a valid request, it transfers your information to the correct credit card company and bank.

Step 4: Credit card authorization

The credit card company and bank are the true decision-makers in this transaction. They hold the keys to your money, and in this metaphor, they decide whether you can enter the building. Once the payment processor relays your transaction request to the credit card company and bank, they decide whether to authorize the transaction. Typically, if there are no red flags from the payment gateway or the payment processor, they will quickly authorize the transaction. You’re in. 

However, if anything seems fishy, like the fact that you typically never make purchases over a certain amount or from a foreign country, the payment processor can reject the transaction and hang up the phone. You’ll have to either try again or leave the building.

Step 5: Funds transfer

After the processor tells the payment gateway that your purchase has been approved by your credit card and bank, you can enter the building. Now the money needs to get to the merchant. So while you’re in the elevator going on your merry way, the bank tells the payment processor that the funds are approved.

The payment processor, acting again as a switchboard, requests the transfer of funds from your bank to the vendor’s bank. Since the funds transfer has already been approved, the transfer is made and the vendor receives their payment.

Step 6: Transaction complete

In reality, this entire process takes only a few seconds. Once the transaction is approved, the e-commerce store can begin the process of fulfilling the order and you’ll hopefully have your purchase in hand in a few days.

Payment changes on the horizon

As streamlined and widespread as the process I just described is, it’s a bit old school these days. Credit cards are becoming almost passé, and there are more direct routes to transfer payments.

PayPal, for example, which can function as a normal payment gateway, also allows users to house funds on the platform itself. Users can both receive and send funds directly from the platform so no banks or credit card companies need to be involved. However, if a user wants to “cash out” and transfer their funds from PayPal to a bank, obviously a bank or other financial institutions become involved.

It’s also hard to ignore the influence of mobile payment platforms. Platforms like Venmo and Square Cash function similarly to PayPal, but are designed exclusively for mobile devices. The added social aspect of being able to directly pay and be paid by friends and contacts is facilitated by being installed on a phone. And more and more e-commerce platforms enable the use of mobile wallets, such as Google Pay and Apple Wallet, as people shop on their mobile devices more frequently.

One must also consider the influence of blockchain and cryptocurrencies, which claim to be far more secure and direct than other payment methods.

While it remains to be seen if credit cards and credit card processors will, in fact, become obsolete, for now you can feel secure in your knowledge of how online payment processing works and how your customers experience the online payment process. The smoother the transaction, the more likely customers are to return. While the payment gateway may be an invisible aspect of your business, it can have a huge impact and is worth finding the right product for your business and your customers.

To learn more about online payment processing, check out our guide on invoice processing and how payment departments are using it.

Lauren Fram
Author

Lauren Fram

Having lived on both the East and West Coasts, Lauren has settled in the happy medium of the Midwest. After nearly 13 years in Chicago, she has fully co-opted the Midwestern habit of saying "oop" when nearly bumping into things. In her free time she enjoys games of all sorts, and is particularly fond of board games and tabletop RPGs.