Payments 101: Understanding Tokenization Basics

The payment industry is ever-evolving, and tokenization is one of the major technologies that changed digital payment processing. While this topic tends to start and stop with data security, we believe it’s useful to think of tokenization as a security-driven aspect of user experience (UX).

On one hand, your customers will probably take some time to evaluate your brand, products, and digital storefront before they hit that checkout button. Everything must work perfectly or you risk losing the sale.

On the other hand, the brand loyalty and trust you spent years building can break with just one successful system hack or breach – taking years to rebuild. Security, therefore, must be a key component as well.

Heightened security measures rarely equal a good user experience – remember the last time you flew commercial? To help lessen friction at checkout, we gathered everything we know about tokenization to create a complete guide on how payment tokenization works. Keep reading to learn how it works, how it can benefit your business, and its importance in protecting sensitive payment data.

What is Tokenization, Generally?

Tokenization takes sensitive data like payment card details or social security numbers and replaces them with a unique, randomized token.* This token has no intrinsic value or meaning, rendering the original sensitive customer data unreadable by attackers or hackers. When optimally implemented, the token data will be essentially useless, even if it falls into the wrong hands.

Tokens are useful because they allow you, the merchant, to identify known payment methods once they’re in your system so that your customer’s payment information is ready when they make a purchase. Plus, you get to skip the security and compliance risks of storing their protected payment card data.

Tokens for One-Time Purchases

One-time purchases can also benefit from tokenization. Once your customer enters their payment, the token can act as a unique identifier that allows you to develop a more flexible payment user experience if your store offers customizations, add-ons, or ongoing interactions before finalizing transactions.

How is Network Tokenization Different?

Network tokenization is similar to non-network tokenization, but with additional security benefits offered by large card networks. For example, Visa®, Mastercard®, or American Express® will also generate cryptograms, a unique transaction id, for each card authorization that adds a layer of security between the card network and the payment gateway or processor.

Network tokenization is also a convenient feature for merchants because network tokens are persistent – even if a customer updates their specific card number or other payment details, their token stays the same. Your card network will maintain the payment information mapping on the backend, even if something changes.

With a network token, you will always have a card to run based on the persistent token – resulting in less cart abandonment/churn from inactive cards. Cha-ching!

Encryption vs. Tokenization

Tokenization and encryption are similar in that they are both a means to secure information, but that’s where the similarities end. Encryption converts data into an unreadable format using cryptographic algorithms; however, this encrypted data can be decrypted back into its original form using a decryption key or a substantial amount of computing power and time. In contrast, tokenization replaces sensitive data with tokens that hold no intrinsic meaning and cannot be reversed into the original, sensitive data.

The key difference between the two is the level of security they provide. Encryption protects data by rendering it unreadable, but the encrypted data can potentially be decrypted with the right key. On the other hand, tokenization ensures that sensitive data is never exposed or stored by eliminating any identifiable data or valuable connection between the token ID and your customer’s private payment information. If you want to offer your customers the highest level of protection, tokenization is the superior option.

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*Some implementations of tokenization may still include identifiable information such as the bank identification number (BIN) and the last four digits of a payment card. The most secure implementations of tokenization result in a completely unique and randomized token.

Why is Tokenization So Important?

Payment processing systems must, by law, maintain high levels of security around payment methods and payment card data. Let’s say you run an e-commerce business with recurring customers or recurring payments via subscription models or repeat services. In these cases, your ideal payment processing system would capture your customer’s payment method once and keep it on file for all future payments.

The last thing you want to do is force your customer to enter their payment details for every transaction. Repeatedly entering card information for the same website creates a poor user experience and leads to higher cart abandonment rates. The only exception is, of course, when they opt not to store their card info.

Tokenization sequesters sensitive customer payment data in a highly secure environment, often held by payment processors or card networks. This process allows you to accept payment methods from previous transactions using unique customer tokens without the burden of safeguarding customer payment information. The card networks or payment processors – depending on which kind of tokenization you use – assume the majority of the risk and significantly reduce your culpability in a data breach or compliance audit.

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PCI DSS and PCI “Zones”

Payment Card Industry (PCI) data security standards require payment processors and card networks to protect card data using either encryption or tokenization (among a shedload of other requirements).

Tokenization decreases the zone, or scope, of your PCI compliance. Some tokenization solutions can even eliminate your responsibility by ensuring that the token issuer, the payment processor or card network, is responsible for maintaining PCI compliance. This allows you to run your business freely outside PCI zones without exposing your business to additional risks.

From a business perspective, the ease that comes from tokenization is by far one of the largest benefits. If you were to manage and maintain sensitive data that falls under the PCI scope of compliance, you will spend a lot of hours and a lot of money (the lowest levels of compliance start out at about $125k) to do so.

Not to mention, the board of PCI releases multiple policy updates each year. Miss one, and you could find yourself in hot water, legally speaking. If you still plan to D.I.Y. (do it yourself) your PCI compliance, we recommend hiring a full-time PCI/security specialist.

Tokenization and UX

Most fintech experts will frame tokenization as an important aspect of data security and end the conversation there. While they aren’t wrong, we prefer to think of tokenization as a UX feature that happens to be about security.

Remember, security and convenience rarely exist in the same place. But with the power of tokenization, you can:

  • Interact with your customers’ known payment methods using their tokenized ID.
  • Safely store customer payment information and reduce the risks and costs of maintaining PCI compliance.
  • Have payment information readily available as soon as your customer clicks the “buy now” button.

In Summary: the Advantages of Tokenization

What do you get when your payment platform operates and integrates effectively with tokens?

  • Enhanced security: Tokenization replaces highly-sensitive payment data with tokens, reducing the risk of data breaches. The actual payment data is stored securely by payment networks/processors, limiting your liability as a merchant.
  • Simplified and lower cost PCI compliance: By tokenizing payment information, businesses can “remember” customer payment methods (remember, UX!) without the need to handle and secure the actual sensitive data. This helps reduce your scope of PCI compliance and data breach risks.
  • Streamlined customer experience: Tokenization allows businesses to recognize known customers and have their payment data ready at a moment’s notice, improving the overall customer experience and increasing convenience during the checkout process.

If you’re wrestling with tokenization or any other aspect of your payment processing solution, Clear Function is always here if you need a hand figuring it all out. Schedule a discovery call with us and let’s dig in.

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