How does tokenization work in payments?

Tokenization is a buzzword these days in the payments and fintech industry thanks to the increased focus on online payment systems. In the simplest of terms, it secures sensitive credit card data by adding an extra security level.

What is Tokenization?

It is the process of securing sensitive information by converting it into an algorithmically generated value, called a token. It is best known for being able to prevent credit card fraud to a large extent. In the tokenization of credit card systems, the customer’s credit card number replaced by a set of randomly generated alphanumeric characters. This set is called a “token”. These tokens then passed on to the credit card processor using the internet and wireless networks, without ever revealing the actual card and account details.

For example, if there is a credit card number 4641-7768-9465-1120, it might get converted into a shorter token like H6r4%8juSq. This token then passed over the internet and it can only be matched by the merchant gateway.

Just as countries have started adopting chip-based credit and debit cards, replacing the magnetic ones, tokenization is critical to prevent fraudsters from accessing and replicating your bank details on another card. While chip-based cards protect against physical payment frauds, it can fight digital or online breaches.

How does it work for Credit Cards?

Step 1 – Transaction initiated by the cardholder where they enter their credit card data.

Step 2 – The credit card information converted into a token and then sent to the merchant acquiring bank.

Step 3 – Token transmitted to the credit card networks by the acquirer for authorization.

Step 4 – Upon authorization, the customer’s card data gets stored in the secured virtual vaults of the bank. Here the token matched to the customer account number.

Step 5 – Fund verification done by the bank and accordingly the transaction approved or declined.

Step 6 – Upon successful authorization, a unique token sent back to the merchant which used in future transactions as well.

Benefits of Tokenization

The most important advantage of this is that it keeps the account details of customers’ credit cards safe and out of the wrong hands. It can also secure any type of digital information, such as an address, employee files, patient records, and passwords. Also, tokenization reduce the overall PCI scope as no sensitive information stored in the payment environment which ensures that no information stored locally on your system.

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