Payment Tokenization: How It Works and Why Businesses Need It

As the number of digital payments grow, security in payment processing is the need of the hour. It’s time to look towards advanced tech solutions for data breach protection.

In this environment, payment tokenization is quickly becoming a standard. According to Capgemini, the global tokenization market is expected to be valued at $ 9.82 billion by the year 2030. By replacing sensitive data with randomly generated tokens, this technology is able to protect customer data while offering plenty of other benefits.

In this guide, we’ll cover payment tokenization, end-to-end, and discuss how it can benefit your business operations. Let’s get started.

• Payment tokenization protects sensitive card and payment data. It replaces this data with a random token, reduces fraud risks, and maintains compliance with the PCI DSS.

• The TSP provides a unique token for the payment information. Card data is stored within a token vault. Merchants cannot access this

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• Tokenization is valuable for industries dealing with high-volume and sensitive data, including eCommerce, fintech, subscription services, travel, and hospitality.

Payment tokenization is a security process that replaces sensitive payment details, like the card number,  Primary Account Number (PAN), and account details with a random token. This ensures businesses never store actual card data, reducing the risk of fraud and complying with Payment Card Industry Data Security Standard (PCI DSS) rules.

Payment tokenization retains the stored information with the issuer, network, or payment processor. To get the payment information, the token is matched with the corresponding PAN in the token vault. The sensitive payment data is never revealed to the merchant, making payment tokenization a highly secure process.

Tokens generated in this process are also unique to the device the customer used to provide their details. This means that even tokens get stolen, they would not work on other devices, making them useless. 

When a customer enters card details, a Token Service Provider (TSP) generates a unique token. The real details are stored in a secure token vault, while the merchant keeps only the token. This allows safe repeat transactions without exposing card data.

Initiation

The process of payment tokenization is initiated when a customer begins a transaction. They provide their payment information to a business.

Token Generation

The business then routes the sensitive payment information to a tokenization service. The Token Service Provider (TSP) uses various algorithms and encryption techniques to generate the token and replace the payment information, securing the data.

Token Storage

Tokens are stored with the business, while the payment information is retained with the tokenization service.

Token Usage

The business sends the token to the tokenization service, which maps to the original payment information. The transaction is completed without revealing sensitive information.

For use cases like subscriptions, tokens can be stored and reused multiple times.

The tokenization process involves four common components: the PAN, a secure token vault, the issuer, and the token requestor (such as a merchant or payment gateway). Together, they create and manage payment tokens.

PAN

Using tokenization, the customer’s Primary Account Number (PAN) is replaced with a secure token. This is retained with the provider and is never accessible to the merchant.

Token vault

The key-value pairs of tokens and the information they replace are stored in PCI-compliant token vaults. The vaults themselves are highly secure.

Issuer

An issuer commonly refers to the card networks (Visa, Mastercard, RuPay) that offer or “issue” tokens.

Token requestor

Once tokens have been generated, token requestors, like merchants and card-holders, can request for the tokens. This request is sent to the card network, who issues the corresponding token.

There are three types of payment tokenization: network tokenization by card networks, gateway tokenization by payment processors, and device-based tokenization. Let’s discuss each of these.

Network tokenization

Network tokenization works by automatically updating a token with new payment information. There is no manual intervention needed. Network tokens are provided by payment networks (like Mastercard, American Express), and can be used across merchants, platforms, and payment service providers.

Gateway tokenization

Payment gateways provide gateway tokens. Gateway tokenization is frequently used for multiple transactions, like recurring billings.

Device-based tokenization

This tokenization generates tokens linked to smartphones, watches, and other types of devices. Payments must be made using that specific device in order to be authorized. This is often used in near field communication (NFC) payments, like Google Pay.

There are multiple advantages of payment tokenization: protection from data breaches, PCI compliance, and faster customer checkouts. Tokens securely store card details for subscriptions or repeat payments.

Fraud prevention

Using payment tokens effectively nullifies the risk of fraud for businesses. Tokens themselves hold no sensitive information, and cannot be used to trace back payment information. There is little risk even if the tokens themselves are compromised.

PCI compliance

Another benefit of payment tokenization is reduced compliance burden. Businesses that deal with payment information have to comply with PCI DSS. Tokens circumvent this compliance requirement by removing the merchant's access to payment information altogether.

Seamless checkout

Payments using a token are not just secure, but also efficient, as they do not require the furnishing of sensitive payment data again and again. Tokens can be used for billings, subscriptions, and other business financial operations, making the whole process frictionless.

eCommerce, fintech, subscription services, and travel all rely on tokenization for secure transactions. Tokens are able to protect customer data while enabling seamless payments. Industries with recurring, high-volume, or sensitive transactions can make the best use of payment tokenization.

eCommerce

The eCommerce industry uses tokenization for the privacy and security of financial data. Online transactions can be at higher risk for fraud, which tokenization helps manage.

Fintech

For fintech companies, payment tokenization has been both a motivator of payment innovation, and a tool to safeguard sensitive data.

Subscription services

Industries and services that offer subscriptions require recurring billing. In turn, it means recurring access to financial data. Using payment card tokenization to handle data makes this process more secure.

Travel & hospitality

Travel and hospitality industries can also use tokenization when making payments. These are sectors that particularly need to protect sensitive card data for the customers.

Encryption scrambles financial data and can be decrypted with a key. Tokenization, however, replaces card data with random tokens. These tokens have no obvious link to the original data. This makes tokenization a stronger security method for protecting customer card details in payments and storage.

Let’s look at a side-by-side comparison to understand both.

There are some common challenges of implementing payment tokenization. There can be difficulties in integration, the costs that come with it, and managing token lifecycle events. Businesses must work with payment partners to ensure that these challenges can be overcome. Let’s look at each in detail.

System compatibility

The payment card tokenization solution you use must be compatible with existing payment processing networks, such as payment gateways, databases, and more. All systems in your tech stack need to be able to handle tokenized data.

Cost

Tokenization is more expensive to implement than simple card transactions. These costs have to be borne by the merchants.

Token lifecycle management

Token lifecycle management is another operational problem. Every token has a life span, with activation, deletion, and renewal. The management of these states, especially for a very large number of tokens, can become quite complex.

There are a couple of approaches that can make the transition to, and the experience with, payment tokenization frictionless. Choosing the right provider, integrating, selecting the appropriate tokenization rules, and conducting thorough testing and monitoring are a few key steps.

• Choose a reputed payment tokenization provider. These are likely to have stronger security measures and PCI DSS compliance in place. 

• Integrate the tokenization solution with your payment gateways and merchant accounts.

• Craft tokenization rules around which data elements you need to protect.

• Test and validate each step of the tokenization process.

• Remember to monitor the tokenization solution to check if it is working as expected.

Payment tokenization supports compliance with PCI DSS, GDPR, and RBI guidelines. In India, the RBI has mandated that merchants cannot store raw card details. The PCI and GDPR compliance standards similarly protect private customer data. Let’s discuss each of these regulatory standards.

PCI DSS

The Payment Card Industry Data Security Standard (PCI DSS) is a standard for protecting sensitive card data. Tokenization can simplify compliance with this standard by reducing the number of parties with access to card data and the number of components to which PCI DSS rules apply. 

GDPR

The General Data Protection Regulation (GDPR) is established in the EU. It protects personal data. Tokenization helps in meeting this objective, by hiding sensitive payment data, adding an extra layer of security, and protecting against fraud.

RBI Guidelines

The Reserve Bank of India (RBI) has its own set of guidelines with respect to customer data privacy and tokenization. Because merchants are no longer allowed to store card information, all three parties (the card issuer, the merchant, and the customer) must follow tokenization to protect the data. Under these guidelines, card issuers provide tokenization, at no extra cost, with a management portal. Multiple cards can be tokenized at once.

Future innovations include tokenization in real-time payments, blockchain-backed systems, and global interoperability. These advancements will soon contribute to the central role that tokenization will play in digital payments. 

Let’s look at each of these trends in detail.

Tokenization in real-time payments

The security of tokenization is soon expected to merge with the speed of real-time payment systems. Payment providers are in the process of providing instant transactions that are still secure, and compliant with the PCI DSS.

Blockchain-backed tokenization

Blockchain, another technological advancement, is a secure and decentralized repository of transactions. Integrations with payment tokenization can add another layer of security to transactions. Another benefit is enhancing payment accuracy using “automated smart contract” systems.

Global interoperability

As businesses grow at an international level, global interoperability in tokenization is soon to become standard. Issuing and managing tokens across borders is a trend to look out for.

Modern payments need to be secure. End-users and businesses need multiple layers of security architecture in their payment platform to build trust. With so many options on the market, how do you pick a secure and versatile payment partner?

Xflow is a cross-border payment solution built for managing secure international transactions. Xflow offers fast, no-limit fund transfers at a transparent pricing point. Xflow provides transfer at live FX rates, at the highest standards of security, certified by the SOF2 and ISO 27001 certifications – all of this, with a short onboarding process and a user-friendly interface.

Related reading

1. B2B payments: Everything you need to know

2. SEPA Payments: Understanding and Processing Schemes

3. Detailed guide on International Payment Platforms in India