Payment Gateways vs Payment Processors – What is the Difference?

The numbers don't lie: cashless payments are the way of the future in business. In 2020, the global transaction value of digital payments was $5.2 trillion. With accelerating growth, this figure is expected to more than double by 2026. Convenience, changing customer habits, and COVID-related health concerns are all factors contributing to this increase.

This leaves business owners with no choice but to provide digital payment options to customers if they want to maximise their revenues in the future. When looking for payment solutions, you will come across two terms: payment processors and online payment gateways.

While the terms gateway and processor may sound similar, they are not interchangeable. While both are essential for online payments, their roles are vastly different. This blog post provides an overview of payment gateways and processors and explains how they differ.

The Basic Anatomy of a Cashless/Online Transaction

To understand these two services, we must first understand the fundamentals of an online transaction. Every eCommerce payment has four parties on the surface. The first two are self-evident:

• the customer
• the merchant
• payment from the customer is coordinated by the issuing bank. It will typically collaborate with a card company such as VISA/MasterCard to link a credit/debit card to the customer's bank account
• accepting payment into the merchant's bank account is coordinated by the acquiring bank

In a typical online transaction, these four entities interact as follows:

• At the merchant's website, the customer initiates an online payment.
• After secure authentication, payment is processed.
• The funds are debited from the customer's bank account by the issuing bank (when they pay their bill, the "credit" is extended by the processor in the meantime).
• The funds are accepted by the acquiring bank and deposited in the merchant bank account.

These steps are not possible without data transmission between the four entities. This is where payment processors and payment gateways come into play. Let us first understand their separate roles:

The Role of a Payment Processor

A payment processor is the entity in charge of transferring funds from the customer account to the merchant account. This type of company has existed since the inception of remote payments. Payment processors' original role was in offline transactions such as credit card payments.

They continue to play this role in brick-and-mortar businesses, despite the advent of the internet and electronic payments. Payment processors are the companies that provide merchant shops with credit card terminals or other Point of Sale (PoS) devices.

A PoS terminal's purpose is to ensure that the transaction is being conducted with an authentic credit card presented by the card's/legitimate account's owner. In these cases, authentication is based on a combination of an EMV chip embedded in the credit/debit card and customer approval.

After receiving customer authentication, the payment processor will send the payment information to the issuing bank. At this point, one of two things can happen: if the bank approves the transaction, the processor sends the transaction details to the acquiring bank and communicates the transaction's success to the customer at the PoS terminal.

If the bank rejects the transaction for any reason, such as a lack of credit balance or funds, the payment processor will notify the customer via the PoS terminal. The payment processor serves as the messenger in this offline system, while the PoS serves as the security/gatekeeper.

The Role of a Payment Gateway

In an online transaction, a payment processor also serves as a "messenger." However, there is no secure PoS device to act as the authenticator in an online setting. This is where a payment gatekeeper enters the picture.

After online payments and debit cards became commonplace in the 1990s, the need for an electronic "gatekeeper" for transactions arose. A payment gateway functions similarly to a virtual PoS terminal, authenticating a customer's digital payment request.

Instead of inserting a physical card into a physical terminal, the customer must enter credit card information, a security code, and the billing address into the payment gateway's virtual terminal as proof of authenticity. If the credentials are correct, the payment information will be forwarded to the payment processor.

Payment Gateways also provide merchants with fraud screening tools that can be customised, such as address verification (AVS) and newer velocity and IP-based tools. Using these tools, a merchant can hold specific transactions for review or choose to have them declined, even if the payment processor has approved them, providing an additional level of fraud protection.

The transaction then proceeds in the same manner as an offline, in-person card transaction, with the payment processor securely transmitting the transaction data to the two banks. When the fund transfer is completed successfully, the processor sends the details to the customer via the gateway.

Secure authentication is a major focus for payment gateways due to the massive increase in cybersecurity threats. Payment service providers must implement more robust mechanisms, such as two-factor authentication, in order to comply with new regulations such as the SCA and PSD2. This blog post delves into SCA/PSD2 and provides an overview of how it improves data security.

Understanding the Choice between Payment Processors Payment Gateways

The best online payment gateway is essentially a software or technological platform that establishes a secure, encrypted link between a merchant's online website or hosted payments software and major credit card processing companies.

While some gateways are available as standalone platforms, many modern gateways are available as part of a larger payment processor's integrated service.

To ensure maximum coverage of cards, payment methods, currencies, and foreign markets, large corporations may choose to use multiple processors and onsite gateways. A single integrated payment service is frequently the most cost-effective option for smaller merchants.

Each alternative has some significant drawbacks. Using multiple gateways and processors incurs additional fees and other costs. Having your own gateway platform gives you more control, but it necessitates more maintenance. A more affordable all-in-one platform provides limited coverage and less data control.