What is a payment gateway and how does it work?

With online payments now a part of everyday life for a huge number of people, the efficient and secure transfer of payments is vital. This is why a payment gateway is important.

So, what is a payment gateway? Put simply, a payment gateway acts as a virtual connection between buyers, sellers, and their banks.

In this article, we’ll provide a little more information about what a payment gateway is, how it works, and how you can use it for your business.

Payment gateway definition

First things first: if you want to take online payments, then you’ll need a payment gateway.

A payment gateway is a form of software that facilitates the movement of funds between a buyer and seller during an online transaction. It acts as an intermediary between both parties, as well as between any financial institutions, usually banks, that are involved.

When a customer makes a purchase online, whether on a website, app or social media platform, the payment gateway encrypts sensitive information, such as credit card details, and then validates the transaction. Once validated, the gateway securely transfers the funds.

How do payment gateways work?

Payment gateways play a vital role in online retail. If you are starting an online shop, then you will almost certainly need one.

Fortunately, the majority of the best ecommerce website builders include gateways as a part of their standard package.

Transaction begins
Information encryption
Authorisation and verification
Transaction completion
Settlement

Take a look at the sections below to find out more about the processes involved when you use a payment gateway, or click any of the options in the list above to skip ahead.

1. Transaction begins

The first step happens when a customer begins a transaction.
Once they have selected the products or services they want, they will usually proceed to a checkout page where they’ll begin the actual purchase step.

2. Information encryption

Once the customer has initiated their purchase, the payment gateway will encrypt their sensitive information. This information includes debit or credit card details, banking information as well as personal information.
This data is encrypted to protect it from unauthorised access during the transaction process, making it unreadable to anyone else.

3. Authorisation and verification

Once the encrypted data is securely transferred to the payment gateway, it is forwarded to the relevant financial institution, typically the customer’s bank.
At this stage, the customer’s bank will validate the transaction details, confirming information is correct and checking that funds are available to complete the transaction. They will also perform additional security checks to ensure the transaction is legitimate.
Once the financial institution has confirmed that everything is correct, they will send a confirmation response back to the payment gateway, indicating that the transaction is either approved or declined.

Authorisation and verification will usually take a few moments to complete.

4. Transaction completion

If the transaction has passed the various checks mentioned above and has been approved, the payment gateway will notify the customer and merchant, allowing the purchase to continue.
If the transaction is declined, the customer will be informed, and the transaction will be cancelled. Typically, at this stage the customer will be offered asked to use an alternative form of payment.

5. Settlement

Once a transaction has been confirmed and completed, the payment gateway will securely transfer the funds from the customer to the seller.
The settlement process may take a few business days to complete, though can sometimes be done in as little as a few minutes.

Best payment gateway providers

How you work with a payment gateway provider will depend on several factors, including on how you build your website. If you use an ecommerce website builder, for example, then you may find that the platform you use provides easy ways to link up with reputable gateways.

If you take another route to get online though, or if you want to be in charge of which brand provides your payment services, it’s worth considering some of the different options available.

Provider	Transaction fee	TrustPilot score	Find out more
Revolut Business	1% + £0.20	4.2	Visit Revolut
Square	1.4% + £0.25	4	Visit Square
Stripe	1.5% + £0.20	2.6	Visit Stripe

As you can see from the small number of providers above, there are differences to be aware of when it comes to choosing a payment gateway provider for your business.

The two most important considerations though when you start your search are:

The cost of transaction: how much will you spend each time someone transacts on your website?
Are you accessible: it might seem smart to choose a cheaper provider, but if that provider means fewer customers can pay on your site, it may do more damage than good.

How much does a payment gateway cost?

You can see a few cost examples in the table above. Broadly though, what you’ll need to factor into your costing includes:

Set-up fee: does the payment gateway charge for integration with your website or business? Do you need to pay for any equipment? This is more likely to be the case if you’re signing up for both an online payment gateway as well as a real-life point of sale system.
Transaction fee: how much will you be charged for each transaction? Typically, the transaction fee will include a percentage of the sale, plus a standard fee. What sort of fee you’ll be happy with therefore depends on the cost of items you are selling, as well as the volume of items you expect to sell.

Payment gateway vs payment processor

Though they can be easily confused, there are key differences to bear in mind between a payment gateway and payment processor.

A payment processor is the entity – usually a business – that is responsible for handling and completing transactions.
Payment processors work behind the scenes to direct payment information that is received by a payment gateway – e.g. a customer’s credit card information – to the appropriate financial organisation: Visa, Mastercard or other banks in this case.
Payment processors manage the movement of funds between buyer and seller, through the relevant bank accounts.

The main difference between a payment gateway and payment processor is in their role in the payment process. While the payment gateway focuses on transmitting data securely from a customer to the seller, the processor is responsible for the movement of funds between the seller and their bank or merchant account.

Payment gateway vs payment terminal

You may also have heard about payment terminals, and you may need one if you run a business that includes real-life – not online – transactions.

A payment terminal is also known as a point-of-sale (POS terminal), or card reader. It is a physical device used to process card payments.
Payment terminals are normally located at the checkout in any shop, restaurant or other business. They allow customers to insert their card, swipe or tap to pay.
Payment terminals communicate with payment networks – in a similar way to payment gateways – to authorise and process payments in real-time.

The main difference between a payment gateway and payment terminal is in where they are used. Whereas a payment gateway is accessed online, through websites or through an app, a payment terminal can only be used in person.

You can think of them as broadly a similar tool, but with different use cases. Many businesses that operate both online and in person will use both gateways and terminals to complete transactions with customers.

Payment gateway benefits

Payment gateways offer a range of benefits to both customers and merchants. In the sections below, we’ll provide a little more information about them.

Security
Convenience
Reach
Trust
Efficiency

Security

Payment gateways employ robust security measures, including encryption protocols, that protect sensitive customer information.
This reduces the risk of fraud and unauthorised access.
Paying online can also reduce the risk of human error – if cash is lost or stolen – meaning that you can feel safe in the knowledge that money is out of your hands.

Convenience

By offering multiple payment methods, such as credit cards, debit cards, digital wallets and even cryptocurrency, payment gateways can improve the convenience and flexibility of online transactions.
Whereas in a real-life store an owner may only have one terminal to accept payments – potentially limiting the alternatives a customer can use – a website owner can make use of multiple payment gateways if they like to provide several options for transacting.

Reach

Payment gateways can support a range of currencies and can enable businesses to take international payments. This means that, for an online business, a payment gateway can unlock a much wider audience.

Trust

Integration with a reliable and reputable payment gateway can help to establish trust with your customers. Using a payment gateway assures visitors to your site that their financial information will be secure, and that their transactions will be processed efficiently.

Efficiency

Payment gateways automate the transaction process, reducing the need for manual intervention. Using a gateway means that merchants can focus on the other aspects of their business.

What is a payment gateway? Final thoughts

Payment gateways are the backbone of modern ecommerce, facilitating seamless and secure transactions.

By encrypting data and securing the transfer of funds between buyers and sellers, gateways have improved the way that people conduct business online.

Bryn Glover

Bryn is the founder and editor of WebsiteJumpStart. He has worked in the digital field for over a decade and was editor for Startups.co.uk - the UK's leading small business website - and for NerdWallet UK before launching WebsiteJumpStart to help people and businesses get online with ease.

Weebly review 2024: Ecommerce web builder features & benefits

Weebly is a well-known and popular ecommerce website builder that offers a full suite of online retail functionality to users and businesses. Owned by Square, a software provider offering tools to help businesses operate effectively, Weebly is a website builder that offers ecommerce functionality for a reasonable cost. Even if

September 13, 2023 No Comments

Shopify review 2024: Ecommerce website builder tested

Shopify is a leading ecommerce website builder that provides end-to-end online retail functionality to users and businesses. Shopify offers a range of high-quality ecommerce tools, along with professional templates for you to choose from. While it is one of the more expensive ecommerce builders we’ve compared, the range of functions

September 1, 2023 No Comments

What is an online payment? How it works and how it helps

If you’re starting an ecommerce store or using a website to shop, you might ask the question, what is an online payment? Whether you’re purchasing a product, paying bills or transferring money to a friend, online payments can offer a convenient and quick option. But there are various factors to

August 17, 2023 No Comments

How to use Weebly to build a website: Step-by-step guide

Weebly is a popular website builder that offers ecommerce functionality, along with the tools you need to create a functional, attractive site quickly and easily. With a user-friendly platform and a range of easy-to-use functions and features, Weebly is a great way to get online. Offering a range of ecommerce

August 15, 2023 No Comments

How to use BigCommerce: 9 steps to get started

BigCommerse is a robust and feature-rich ecommerce website builder that can empower businesses of all sizes to establish and scale an online presence. One of the best-known platforms on the market for those looking to build an online store, BigCommerce offers a range of competitively priced plans. Each plan offers