Credit Card Tokenization Explained: Everything You Need to Know

Handling customers’ sensitive data is a nerve-wracking experience for any business, especially if you’re a company that relies on recurring payments. As a merchant, it’s your responsibility to keep sensitive payment data safe and secure. However, deciding which data protection method is most effective can be confusing and difficult to navigate.

In this article, we’re going to define payment tokenization and why it’s become a popular method for businesses to protect digital payment information.

We’re going to cover:

  • How credit card tokenization works
  • Examples of how tokenization can be used by businesses
  • Payment tokenization vs encryption
  • How small and medium-sized businesses can benefit from credit card tokenization

What is credit card Tokenization?

To define credit card tokenization, we first need to understand what it means to “tokenize” something.

A token refers to an item that represents something else, such as using plastic chips at a casino in place of real money. Tokens don’t have value in and of themselves, but because they can be exchanged for different goods or services.

Similar to how EMV protects in-person credit card transactions at the point of sale, payment tokenization is a security protocol that protects sensitive data when consumers are purchasing with an online merchant or making online payments.

Instead of sensitive customer data being transferred openly between networks, it is tokenized by replacing credit card information and cardholder data with randomly generated strings of numbers. This means that cardholder data and card details are never exposed during the payment process, which protects them against data breaches.

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How Does Credit Card Tokenization Work?

So how does credit card tokenization work? Payment or credit card tokenization works by replacing a cardholder’s Primary Account Number (PAN) with a one-time unique identifier. These randomly generated tokens, also known as tokenized data, are a stand-in for sensitive data that communicates where the payment request is being sent from. When you tokenize credit card data you actually replace the sensitive data, this ensures that sensitive credit card information can be authorized for speedy payment processing by the card networks.

Here is a run-down of what a real-time tokenized credit card transaction might look like:

Step 1: The customer makes an online purchase by providing their debit or credit card data at checkout.

Step 2: This card data is tokenized via a token service provider and sent to the acquiring bank—i.e. the merchant’s bank—replacing the actual payment processor data. The tokenized credit card data is created from randomly generated data.

Step 3: The acquirer uses this token to request authorization from the relevant credit card networks i.e. Visa or American Express.

Step 4:  The customer’s actual payment data is held by their bank within a secure token vault. Once the token is supplied by the credit card issuer and is matched to the account number, the bank will verify the transaction.

Step 5: Once the payment is successful, the payment token will be returned to the merchant. Future transactions made by the same customer will use a different token sequence.

Examples of Tokenized Sensitive Credit Card Data

Where can we see tokenization in action? Consider the following.

Tokenization in eCommerce. Tokenization opens the door to more personalized payment experiences by enabling customers to save their payment preferences for future purchases. Because tokenized card information is saved to their account, no sensitive data can be stolen or lost in event of a data breach.

Moreover, because every merchant will use a different token when keeping a customer’s credit card information on file, there’s no chance of a widespread leak of this sensitive information that would require them to cancel their card completely. This also helps prevent credit card fraud.

When sensitive credit card data is saved to a mobile wallet, the credit card number is replaced with a token which is sent to the issuing bank. These tokens are replacing sensitive data, allowing consumers to have their actual payment data safely stored. This means that no card details are jeopardized if a smartphone is lost and stolen, as real payment data isn’t held by the device.

In-app payment tokenization. A wide variety of retailers, including Amazon and Best Buy, have launched their very own in-app stores for customers who want to shop on the go. With 10% of all retail sales in the United States expected to be generated via mobile commerce by 2025, swift credit card processing is essential to increase customer satisfaction.

If a mobile device is storing tokenized payment information, such as via mobile wallets, shopping apps can integrate with this directly to avoid consumers needing to input credit card data, and ensuring that their original form of payment is safely stored.

Credit Card Tokenization vs. Encryption

Tokenization technology can appear very similar to encryption in articles about data protection. However, there are some distinct differences between the two.

Encryption Vs Credit Card Tokenization Explained

Unlike tokenization, encryption uses encryption keys to protect cardholder data for upcoming credit card transactions. Instead of swapping sensitive information for a meaningless placeholder (the token) the real payment data is encoded using an algorithm. With the right key or decryption solution, the encrypted data and credit card number can be returned to its original form. Unlike encryption, the randomly generated token is not reversible and is a safer way to store sensitive data.

The more sophisticated the algorithm, the more difficult encryption is to crack. But even the strongest encryption can never be entirely foolproof; if credit card information is being stored on a network, such as for a recurring payment, this provides ample time for malicious actors to allow information to be decoded and sensitive data captured. This is why the Payment Card Industry Data Security Standard (PCI DSS) considers encryption to be insecure when used on its own.

This is where using a tokenization system gives merchants a strong PCI DSS approved security advantage when processing payments online. It’s far easier to achieve PCI DSS compliance using tokenization because digital payment data is never available during the transaction. Because tokenized data is completely randomized and contains no real data, there’s no risk of sensitive card data being lost or stolen—even in the case of a data leak.

Why Businesses Should Invest in Tokenization

Here are some of the reasons to implement card number payment tokenization in your business.

Ensuring your business is PCI compliant. Making sure your business follows PCI compliance is essential to reduce liability and avoid fines in the event of a data breach. Using tokenization minimizes the risk of data hacks because real payment data isn’t stored on your server, making it possible to achieve PCI compliance without costly security systems. There is a reason that tokenization is the preferred digital safeguard in the payments industry and PCI DSS requirements are more easily achieved with payment tokenization technology.

Protect a wide variety of payment solutions. Today’s consumers have a wide range of payment methods available to them, and they expect merchants to offer them flexibility and choice. Tokenization enables merchants to offer a high level of cardholder data protection across a variety of payment technologies and via the customer’s preferred method of payment, including digital wallet credit cards, Apple Pay, Google Pay, Android Pay, Buy Now, Pay Later, and even cryptocurrency. This means that businesses that want to diversify their payment options don’t have to worry about subscribing to additional payment protection systems.

Enable one-click payments and safe recurring billing. Allowing customers to store their payment details on your website via a shopping account or recurring billing plan helps to streamline the shopping experience and make payments easier and faster for returning customers. With credit card tokenization, keeping your customer’s digital payments on file is much more secure way to store customer credit cards.

Enhancing the customer experience. When customers trust that you’ll keep their data safe and secure, they’re much more likely to enjoy their shopping experience and return to shop with you in the future. Token service providers typically run an open API that integrates directly with your chosen payment system, making it easy to offer a wide variety of payment services.

Bringing It All Together

Payment tokenization makes it easy for small and medium-sized businesses to protect their customer’s sensitive credit card data without investing in expensive security systems.

Because actual payment data isn’t being stored on any of your networks, this minimizes liability in the event of a data leak and ensures that your customer’s credit card details and payment data is secure.

Tokenization also offers merchants much more flexibility in how they accept payments, as one-click transactions and recurring payments present far less risk when sensitive credit card data is tokenized. This helps to create more streamlined, convenient shopping journeys for your customers that enhance the shopping experience.

At Stax, we equip merchants with the best security features to ensure that transactions are always secure—and this includes tokenization.

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FAQs about Credit Card Tokenization

Q: What is credit card tokenization?

Credit card tokenization is a security protocol that protects sensitive data during online transactions. It works by replacing a cardholder’s Primary Account Number (PAN) with a unique, randomly generated identifier, referred to as a token. Hence, cardholder data is never exposed during the payment process.

Q: How does credit card tokenization work?

In a tokenized credit card transaction, a customer’s credit card data is tokenized by a service provider. This tokenized data is sent to the merchant’s bank, replacing actual payment processor data. The acquirer then uses this token to request authorization from the relevant credit card networks. The customer’s actual payment data rests securely within a token vault in their bank. Upon a successful payment, the payment token is returned to the merchant, and future transactions utilize a different token sequence.

Q: What are some examples of credit card tokenization use cases?

Tokenization is widely used in eCommerce, enabling more personalized payment experiences by allowing customers to save their secure tokenized payment preferences for future purchases. It’s also used in mobile wallets, where a credit card number is replaced with a token sent to the issuing bank. In-app payment tokenization is seen in several retailers’ in-app stores, enhancing the shopping experience.

Q: What is the difference between credit card tokenization and encryption?

While both are data protection methods, encryption uses keys to protect cardholder data and encodes real payment data using an algorithm. This encoded data can be decoded using the right decryption solution. In contrast, tokenization replaces sensitive information with a meaningless placeholder (the token) that cannot be reverted back.

Q: How can businesses benefit from credit card tokenization?

Tokenization helps businesses achieve PCI DSS compliance, protecting a wide range of payment technologies, like digital wallets, Apple Pay, Google Pay, etc. It enables one-click payments and safe recurring billing, thereby enhancing customer experience. Moreover, it allows businesses to protect sensitive credit card data without significant investments in security systems, reducing liability in the event of a data leak.

Q: Does credit card tokenization safeguard against data breaches?

Yes, with tokenization, sensitive payment data isn’t stored openly on the network, minimizing the risk of it being lost, stolen, or exploited during a data breach.

Q: Is tokenization a PCI DSS approved security measure?

Yes, the Payment Card Industry Data Security Standard (PCI DSS) approves tokenization as a security measure. Indeed, achieving PCI-DSS compliance is far easier with tokenization as digital payment data is never exposed during transactions.