Payment Tokenization: How Does Tokenization Work

Payment processing is integral to the entire business operation. Over the last few years, businesses worldwide have lost over $33.4 billion due to financial fraud. With the increase in the number of fraud methods and cases, it’s becoming more and more important to secure funds and sensitive billing details from being stolen. 

In this post, you’ll discover fundamental aspects of tokenization, learn key value-adding benefits of payment tokenization, discover the actual payment processing flow when tokenization is involved, and review major payment tokenization examples. 

What is Tokenization?

Let’s learn definitions of the basic concepts involved in payment tokenization to gain complete insight into the technology. 

Tokenization is the process of converting sensitive data into non-sensitive tokens that can be used in place of the original data.

At the same time:

A payment token is a randomly generated set of letters and numbers intended to encrypt any bit of sensitive information.

So, with tokens, the sensitive data is encrypted and is of no use to fraudsters should they manage to hack in and steal it.

Important note: The main reason merchants use payment tokenization services is that they are not PCI DSS compliant, meaning they do not have the right to handle sensitive payment information directly.

As per PCI DSS regulation, without payment tokenization, businesses need a third party to secure and validate the transaction. It must be either a payment processor or a payment processor with a payment gateway pair. Often, payment processors and payment gateway providers also offer payment tokenization.

Offering payment tokenization requires obtaining PCI DSS certification, which allows a service provider to handle and store payment information securely. A separate service is set up to receive this information from customers and store it in a database. At the end of the day, instead of the actual payment information, which is of restricted access, a token is generated and given to the merchant.

For example, in online stores, customers provide their card numbers to a payment gateway like Liquepay, rather than directly to the merchant. Liquepay then returns a token to the customer, which the customer’s browser passes on to the merchant. The merchant then goes to Liquepay and requests to charge a specific amount to the token.

Let’s take a look at some business models that can benefit from payment tokenization already:

If you’re curious about tokenization, you’re probably also interested in learning more about blockchain and distributed ledger technology in fintech. 

Key Value-Adding Benefits of Payment Tokenization

Let’s find out what actually payment tokenization has to offer you as a C-level executive or a business owner. 

• Enhanced security: Tokenization minimizes the risk of data breaches by replacing sensitive payment details with non-sensitive tokens, making intercepted data useless to hackers.
• Reduced compliance burden: Businesses can ease their adherence to sector-specific regulations like PCI DSS by minimizing the management of confidential data, resulting in reduced expenses and simplified operations. 
• Seamless customer experience: Through tokenization, secure and effortless transaction methods, including “one-tap” purchases and repeated invoicing, are made possible without necessitating the constant re-entry of payment details by customers.
• Fraud reduction: Employing tokens can markedly lower the likelihood of fraudulent activities by restricting the availability of sensitive payment data and permitting the application of specific constraints on token usage.
• Data analytics and personalization: While protecting sensitive information, tokenization allows businesses to analyze customer purchasing behavior and preferences for targeted marketing and improved customer engagement.

As you can notice, all the detailed benefits can be translated into actual monetary value and result in higher revenue, cost-savings, stronger market position, etc. 

Payment Tokenization Providers

There is a range of payment tokenization vendors in the modern market. Let’s review some of the most popular options and find out what specific features they have to offer on top of the main payment tokenization service: 

#1 Braintree (a PayPal service)

Braintree is a payment platform that provides online and mobile payment processing solutions, with a focus on security and seamless integration.

Payment tokenization capabilities:

• Hosted fields
• Data encryption
• Multi-currency support
• Advanced fraud protection
• Secure payment vault

#2 Stripe

Stripe is a technology company that offers a suite of payment processing tools and APIs for businesses of all sizes, with a strong emphasis on ease of use and security.

Payment tokenization capabilities:

• Stripe.js and elements
• Strong Customer Authentication (SCA)
• Webhooks for event monitoring
• Mobile SDKs for iOS and Android
• PCI compliance assistance

#3 Adyen

Adyen is a global payment company that provides an end-to-end infrastructure connecting directly to Visa, Mastercard, and other payment methods, offering businesses a single platform for seamless payment processing.

Payment tokenization capabilities:

• Network Tokenization
• Point-to-Point Encryption (P2PE)
• Risk Management Tools
• In-app and Online Payments
• Unified Commerce Platform

#4 Worldpay (now part of FIS)

Worldpay is a payment processing solutions provider, delivering services that enable businesses to securely accept payments through various channels. The company specializes in facilitating transactions, offering robust security measures, and providing analytics to enhance payment efficiency.

Payment tokenization capabilities:

• Omni-Token
• FraudSight risk management
• Dynamic currency conversion
• Payment optimization tools
• Secure customer data storage

#5 Square

Square is a prominent player in the field of payment and financial services, delivering cutting-edge solutions specifically designed for small enterprises and solo entrepreneurs. The company’s emphasis is on streamlining payment processing, offering easy-to-use tools, and guaranteeing secure transactions, all aimed at empowering businesses of various scales.

Payment tokenization features offered:

• Square payment form
• In-app payments SDK
• End-to-end encryption
• Square secure
• PCI compliance

The listed providers offer different features and pricing models, so businesses should evaluate their specific needs and requirements when choosing a payment tokenization provider.

How Does Payment Tokenization Work

In essence, payment tokenization in transactions works by replacing sensitive billing information, like the name of the credit card holder and credit card number, CVV, and expiration date, with a randomly generated set of numbers and letters. 

The mentioned is just the basic principle. Now, let’s discover what exactly the payment processing flow with tokenization looks like and how randomly generated tokens work. 

#1 Transaction initiation and data collection. A cardholder initiates and permits the payment by providing sensitive credit card data. 

#2 Tokenization generation, storage and usage. Depending on how the business’s payment system is configured, the sensitive data may be sent to a secure tokenization service, which is often supplied by a payment processor or a third-party tokenization provider. If the company uses tokenization-enabled payment hardware or software, such as Stripe Terminal, tokenization occurs automatically as part of the payment processing procedure.

This tokenization step includes several substeps: 

1. Token generation. A combination of algorithms and encryption methods are used to generate a unique token that represents the original payment data. This token is typically a random string of characters or numbers with no inherent value or meaning outside the specific payment system.
2. Token storage. The token is saved in the company’s system and replaces the sensitive payment information. The original payment data is safely preserved in the tokenization service’s secure vault, which is intended to prevent illegal access and data breaches.
3. Token usage. When the firm wants to complete the transaction, it sends the token to the payment processor or tokenization provider. The service then maps the token back to the original payment data, allowing the transaction to be completed without disclosing sensitive information to the company or another third party.

Pro tip. For recurring purchases, such as subscriptions or saved customer profiles, the same token may be used several times without gathering sensitive payment information again. This streamlines the payment procedure while still ensuring security.

You may be additionally interested in learning the difference between a payment processor and a payment gateway to complement your understanding of transaction processing flow. 

#3 Transmission of the token by an acquirer to the credit card network. Then, the token is passed to the Visa or Master Card network, pretty much as a conventional set of sensitive payment information required for the transaction to be authorized and processed. 

#4 Matching of the token with the customer’s account number. Once authorized, the customer’s data is stored in a bank’s virtual vault, and the token gets matched with the customer’s account number. 

#5 Verification of funds. Upon the verification of funds required to process the transaction, the bank either allows or declines the transaction.

#6 Return of the token to the merchant. After successful verification, the token is returned to the merchant for current and future transactions, while the bank transfers the funds from the payer to the acquirer’s bank account. 

It’s worth noting that customers do not have to do anything differently because the entire tokenized credit card payment procedure takes place behind the scenes. The process is similar to conventional payment processing but with tokens used as a secure transfer of sensitive cardholder data.

Payment Tokenization Examples

Let’s get to know the major  examples of tokenization, or simply types of payment tokenization you can consider requesting from tokenization vendors and using in your payment processing flow: 

• Card-on-file

In this method, a bank card or primary account number (PAN) is transformed into a unique token for secure storage in a merchant’s or processor’s environment. This method is ideal for recurring payments and subscription billing, enhancing payment security and convenience.

• One-click payments

Utilizing open banking, merchants and payment processors exchange tokens generated when a consumer links their bank account to the merchant’s account. This facilitates seamless identification in the payment processor’s system, streamlining transactions for returning customers in e-commerce.

• E-commerce checkout

During online checkout, sensitive payment information is replaced with a token, ensuring a secure and streamlined payment process. This tokenization reduces the risk of data breaches and ensures compliance with PCI DSS standards for e-commerce platforms.

• Mobile payments

A single payment card is converted into multiple independent tokens for different devices, enabling secure transactions through NFC mobile wallets like Apple Pay or Android Pay. This approach ensures flexibility and security in mobile payments. This is useful in Tap to Pay payments. 

*Learn more about Tap to Pay contactless payments in another our blog post. *

• Point-of-Sale (POS) systems

In physical retail environments, POS systems use tokenization to convert card data into secure tokens at the time of transaction. This protects customer information and reduces the risk of having a data breach or another fraud in in-store purchases.

Guide your choosing based on your business model and needs. For example, if you own offline stores, then POS and mobile payments can be of use to you, while as a provider of online services per subscription model, you are most likely to stick with the card-on-file tokenization option. 

Final Take

Payment tokenization is a crucial technology that enhances security and streamlines payment processing. By converting sensitive information into non-sensitive tokens, it protects against fraud and simplifies transactions. As digital payments evolve, adopting tokenization is essential for businesses to maintain security and efficiency in their payment operations.

Establishing a seamless payment processing flow with the involvement of tokenization requires vast expertise and experience. The right call for many businesses is to request assistance from a fintech development service provider. Consider DashDevs, a development firm with more than 12 years of experience, as your primary choice. 

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