What is Payment Tokenization and how does it work?

In this article we will discuss how your business can fight cybercrime and privacy breaches with the help of tokenization technology.

What is Payment Tokenization?

In the simplest terms, the word “tokenize” means to substitute something or to turn it into something else. 

Tokenization isn’t a new concept by any means. Think about the times when you go to a casino and purchase tokens to play slot machines. You basically exchange money for plastic coins that have no value outside of the casino.

It’s the same in the world of online payments. Credit card tokens are created to protect customers’ sensitive data (like credit card number, address, account number, etc.) by replacing it with a series of algorithmically generated numbers and letters.

By employing credit card tokenization, merchants can move data between networks without actually exposing customers’ sensitive information.

How does credit card tokenization work?

Credit card tokenization substitutes sensitive customer data with a one-time alphanumeric ID that has no value or connection to the account’s owner.

This randomly generated token is used to access, pass, transmit and retrieve customer’s credit card information safely.

Tokens don’t contain any sensitive consumer data. They rather act like maps explaining where the customer’s bank is storing this sensitive data within their own systems.

Tokens are generated through mathematical algorithms and they can’t be reversed.

The tokens can only be opened after the transaction is complete. Outside of your system, these tokens have no meaning and no value. So even if hackers somehow encounter your customer’s data while it’s being processed, they will not be able to use it.

Here is how the tokenized credit card transaction works:

Cardholder initiates transaction and enters their sensitive credit card data
Step 1

Cardholder initiates transaction and enters their sensitive credit card data.

Credit card information goes to the merchant acquiring bank in the form of a token
Step 2

Credit card information goes to the merchant acquiring bank in the form of a token.

Acquirer transmits the token to the credit card networks for authorization
Step 3

Acquirer transmits the token to the credit card networks for authorization.

Once authorized, the customer's data is being stored in the bank's secured virtual vaults and the token gets matched to the customer's account number
Step 4

Once authorized, the customer's data is being stored in the bank's secured virtual vaults and the token gets matched to the customer's account number.

The bank verifies funds and allows/declines the transaction
Step 5

The bank verifies funds and allows/declines the transaction.

If the authorization is successful, a unique token is then returned to the merchant for current and future transactions
Step 6

If the authorization is successful, a unique token is then returned to the merchant for current and future transactions.

Because the entire tokenized credit card payment process is happening behind the scenes, customers don’t actually need to do anything differently.

What are the benefits of credit card tokenization?

It goes without saying: credit card tokenization boosts payment security immensely. Tokenization is a sure way to protect your customers’ payment information from both outside digital hackers and potential internal problems.

Randomly generated tokens are only readable by the payment processor – they can’t be monetized even if they’ve been exposed. Thus, when a token is passing through the systems, anonymous thieves and hackers have fewer opportunities to commit a cybercrime.

Many businesses that collect and store sensitive data on their networks often find it very hard to comply with PCI DSS standards. If the data breach happens, the lack of PCI compliance can result in fines by the PCI Council.

Tokenization makes it possible for merchants to comply with PCI DSS with minimal liabilities and security expenses.

By removing customers’ card information from your network, you minimize the risks of data breach. Therefore, you don’t have to invest as much money and resources on data protection – it’s been done for you by credit card tokenization.

Other sensitive business data like passwords, addresses, secret files and customer accounts can also be protected using the tokenization technology.

Tokenization vs. Encryption

While both excellent tools for combating credit card fraud, tokenization and encryption are often confused with one another. So what is the difference between tokenization and encryption?

Encryption is a form of cryptography that protects sensitive data by turning it into unreadable code. Each number, letter and space on a card is being disguised by a different one that is chosen by a system based on a sophisticated encryption algorithm. This encoded information should be decrypted at the end using the key or the password.

The biggest difference between tokenization and encryption is that encryption is reversible. Encrypted information can be returned to its original form at any point – as long as you know the algorithm behind it.

Because encrypted data is “breakable,”  PCI Council still views it as sensitive. Thus, meeting compliance obligations with encryption is much more expensive than doing so with tokenization.

Encryption is one of the strongest card data protection methods for transactions where the card is physically present. And yet, tokenization provides much better protection when it comes to payments where the card is not present.

To better secure sensitive data in transit and to comply with PCI DSS requirements, specialists recommend having both encryption and tokenization working together.