The Ultimate Guide to Credit Card Tokenization for Small Businesses
As the credit card industry continues to expand, merchants are being impacted by credit card fraud at alarming rates. Credit card fraud was the second most frequent form of reported identity theft in 2020. In fact, it claimed the top spot in four of the past five years.
Most card fraud cases involved criminals who opened new credit card accounts. This likely occurred after the thief hacked into another person’s card data. To keep customers’ card data safe, an increasing number of merchants are using payment tokenization technology.
This article covers everything you need to know about credit card tokenization including how it works, the benefits it offers, and how you can implement it in your business.
Let’s get started.
What is credit card tokenization?
The term “credit card tokenization” is an increasingly widespread credit card fraud-prevention tactic. Tokenization replaces a customer’s credit card information with a series of algorithmically created letters and numbers (a token).
This digital token enables the completion of a payment processing transaction without exposing the customer’s credit card or bank account information. The merchant never sees any of this cardholder data.
Through tokenization, the actual card data and account number are securely stored in “tables” within the tokenization system. The practice is designed to prevent criminals from copying sensitive data onto a card that’s used for identity theft. The tokenization process works well for credit card transactions and e-commerce sales.
How does tokenization work?
As a merchant who regularly handles customer transactions, you may wonder: how does tokenization work?
- The tokenization process is a multi-step operation that begins with a token’s random generation through a non-reversible algorithm. This randomly created token is used to access a customer’s credit card data.
- Next, the tokenization system removes the card’s sensitive information and substitutes a single-use alphanumeric code. This code has no intrinsic value or link to the cardholder’s identity.
- The token transmits the customer’s credit card data to a secure “table” inside the tokenization system.
- Meanwhile, the token is used to complete the payment processing transaction. A new token must be generated for the next customer’s purchase.
Note that the merchant’s payment gateway is the only entity that can match the token with the customer’s credit card number. The merchant cannot access the token at any time.
Yes, it’s possible that clever hackers could intercept the token during the transaction. However, they cannot access the customer’s payment information.
Examples of credit card tokenization
Tokenization comes in many forms. For example, you might purchase a token for a car wash or a round of play at a casino slot machine. In both cases, the token has no value outside of the business that issues it.
Tokenization in the payments industry
The fast-growing payments industry uses tokenization technology in three important ways. Each tokenization application serves a different payment industry niche.
- Recurring payments or subscriptions. Let’s say a customer’s credit card number is kept on file for a monthly fitness center membership or online magazine subscription. The customer’s information is converted to a token, which is used to process the monthly payment. The actual credit card number is safely stored in a digital vault.
- E-commerce “frequent customer” checkouts. Customer purchases from e-commerce stores, along with online payments, utilize tokenization technology. Sometimes, the customer makes repeated payments to a specific e-commerce business. In both cases, tokenization keeps the customer card data safe while a token completes the transaction.
- NFC mobile wallets usage. A growing number of shoppers complete their checkout with NFC mobile wallets. When they use their Apple Pay or Android Pay app to finish the transaction, they are bringing tokenization into the mix.
Credit card tokenization: Comparisons
Credit card tokenization has some similarities to EMV technology and encryption technology. However, tokenization practices have significant differences when compared to these credit card fraud prevention methods.
What is EMV?
The development of EMV technology enables the generation of a one-time code to protect customer data during an in-store transaction. Essentially, EMV technology hides the cardholder data from cybercriminals who would use it for identity theft. The EMV microprocessor chip temporarily secures the data until the transaction has been completed.
Merchants who want to use EMV “chip and PIN” cards must have a certain type of payment processing hardware. The merchant will require a credit card terminal that processes cards containing microprocessor chips.
Because of improved processing technology, EMV cards can now be used on terminals offering near-field communication (or NFC). Here, the customer taps their card next to the terminal rather than “dipping” it as with a “chip and PIN” transaction.
Credit card tokenization vs EMV
However, credit card tokenization differs from both payment processing methods. Yes, tokenization uses the existing EMV technology. However, tokenization enables cardholder data protection during both in-person and online transactions.
With that said, it’s advisable to offer both EMV and payment tokenization capabilities. Through tokenization, the merchant can securely process recurring online transactions such as those using an on-file credit card or debit card. Issuing banks (or issuers) provide qualified customers with these cards.
What is encryption?
Encryption is a cryptographic method that turns sensitive credit card data into unreadable code. A complex encryption algorithm transforms each character into a completely different one.
The encoded information, along with a decryption key, is transmitted over a network. The recipient decodes the characters and processes the credit card transaction.
Unfortunately, an identity thief could also obtain the algorithm and decode the credit card information. In fact, this ambitious criminal can reverse-engineer all data encrypted by the same algorithm. In other words, the encrypted data can be returned to its original form.
The PCI Council, the originator of the PCI DSS Standard (or Payment Card Industry Data Security Standard) considers this “breakable data” very sensitive. Therefore, a merchant using encryption technology will find it rather costly to achieve PCI DSS compliance with this method.
Credit card tokenization vs encryption
Encryption and credit card tokenization are both effective security measures employed by current payment gateways. In contrast to encryption, however, tokenization’s irreversible nature means hackers cannot access the safely stored original data.
This means the PCI DSS requirements cannot be compromised, resulting in a less-expensive transaction. For both reasons, more organizations have begun to switch from encryption technology to tokenization technology.
Both card security measures can support merchants who process credit card transactions. Tokenization is a better option for businesses that process offline, card-on-file, or recurring payments. This especially applies to merchants with multiple locations or e-commerce stores handling online payments.
Encryption better serves in-person transactions in which the card data can be quickly encrypted when the customer passes it through the appropriate card terminal. Payment experts generally advise merchants to utilize both sets of payment fraud security solutions.
Benefits of payment tokenization
A security-minded payment processor likely includes payment tokenization in its credit card processing services. By doing so, this service provider offers its business customers four significant benefits.
1. Increases customer payment methods
By adding tokenization-based payment services, the merchant can provide customers with multiple ways to pay for items at checkout. At an in-store point of sale (or POS) station, a customer can seamlessly make credit card payments.
Frequently used cards include Visa, Mastercard, American Express, and Discover. Mobile wallets such as Apple Pay are also increasingly popular.
Payment tokenization also enables online payments for e-commerce merchandise sales. Payments for online services, such as bookkeeping or computer-aided design work, also use tokenization technology.
Finally, many customers prefer to make a smartphone-based mobile payment. Field-based service personnel, such as plumbers or mobile dog groomers, rely on their smartphones to conduct daily business transactions.
With a small mobile card reader, vendors can easily process customers’ payments. Tokenization is also a part of these transactions.
2. Enhances payment data security
Payment tokenization greatly increases the security of customers’ sensitive payment information. By sending this data outside of the payment processing network, and substituting a token, data breaches are less likely. Even if hackers somehow access the token, they cannot decipher it.
By utilizing a payment gateway affiliated with the merchant’s payment processor, it’s much easier to resolve any account inquiries. For example, Payment Depot is a highly rated payment processor that also maintains its own payment gateway. This streamlines all account-related customer service interactions.
3. Facilitates easier PCI compliance
Merchants who store sensitive customer data on their networks have difficulty staying PCI compliant. If data breaches occur, this lack of compliance can result in unwelcome fines.
Through tokenization, merchants can comply with the PCI DSS standard with minimal cost and very little liability risk. Because merchants are not storing credit card numbers or primary account number information locally, criminals effectively have nothing to steal.
4. Secures any form of information
US-based merchants typically use tokenization in their credit card processing operations. In some parts of the world, however, privacy laws dictate that merchants also tokenize other types of information. Examples include passwords, addresses, employee files, and patient records.
Tokenization technology can easily be adapted to these applications. Merchants with an international scope will find tokenization an easy, convenient way to meet other countries’ ever-changing privacy requirements.
Tokenization and PCI compliance
A merchant’s use of tokenization can decrease their scope of PCI compliance. As the PCI DSS states, tokenization use does not eliminate the need to maintain PCI compliance. However, tokenization can make it easier for a merchant to meet that standard.
Essentially, the merchant minimizes the system components for which the PCI standard applies. The customer’s credit card data is stored in a third-party digital card vault rather than being used in a payment transaction. As a result, the merchant’s credit card fraud risk is substantially reduced.
To meet the PCI DSS standard, the merchant must ensure that they are using an approved tokenization vendor. The merchant also must demonstrate that they utilize robust security controls. The goal is to protect their tokenization system’s operation.
Although tokenization is not a requirement for PCI compliance, it is regarded as a “best practice” within the payment processing industry.
Of course, a merchant can choose not to adopt this fraud prevention technology. However, they will find it much more difficult to meet the PCI compliance standard.
How to implement credit card tokenization
Implementing a credit card tokenization system or token service is surprisingly uncomplicated. To get started, a retail merchant should first obtain an NFC credit card reader.
Integrated payments apps often interact with these readers using an already-installed tokenization component. Because the tokenization is within the app itself, the merchant only needs to purchase a new NFC reader.
Beyond that, the merchant’s payment processor or payment gateway provider can offer additional guidance. Implementation of tokenization protocols is a simple four-step process.
1. The merchant converts legacy network data to tokenized alphanumeric characters. If a merchant does not store customer payment data after completing a payment authorization, this step is not necessary.
2. The merchant modifies their transaction data message to their payment processor. Specifically, the merchant should add tokenization instructions that meet their processor’s criteria.
3. Merchants are advised (but not required) to embed encryption technology to enhance transaction security. The cardholder’s information will be encrypted until the payment processor receives and decrypts it. The processor transmits the decrypted details through the network to confirm the authorization.
4. The merchant revises their internal business rules and protocols based on discussions with their tokenization provider. This step mostly applies to larger businesses that utilize cardholder information for other purposes.
As a guideline, startups and other security-focused businesses should consult with a third-party tokenization provider. These companies can offer multiple processor and payment gateway options. This enables the merchant to choose the best option for their business.
Moving forward with tokenization
Many small- and medium-sized businesses may want to incorporate tokenization into their payment processing operations. By choosing a payment processor like Payment Depot that uses tokenization, the business will have a more streamlined experience.
In addition, many businesses work with Payment Depot because of its membership-based pricing, wholesale rates, and no add-on fees. The company’s superb customer service has earned widespread acclaim throughout the payments industry.