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What Is Tokenization? An Overview on Payment

By Brian Nibley · December 22, 2021 · 5 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

What Is Tokenization? An Overview on Payment

Tokenization refers to the process of encrypting sensitive information by replacing the details with random strings of characters. These random character strings are generated by algorithms and are referred to as tokens.

Tokens can be used as a more secure method of data transfer, such as a customer’s credit card or bank account information. Rather than the raw data being exposed, the same information in tokenized format can be passed through a payment gateway instead.

Keep in mind we’re not talking about a crypto token or cryptocurrency here.

What is tokenization and what purpose does it serve? Some security methods, like the computer chips in credit cards, are designed to stop hackers from replicating banking details onto another card. The main goal of safeguarding data through tokenization, however, is to prevent online data breaches.

How Does Tokenization Work?

With regard to payment processing, tokenization requires a credit card or account number to be substituted with a token. The token itself isn’t connected to any person or account.

The 16-digit primary account number (PAN) of a customer gets replaced with a custom-made string of random numbers, letters, and special characters. This process eliminates any connection between customer data and a transaction.

Payment tokenization safely stores bank account numbers or credit card numbers in a virtual vault. This allows for the safe transmission of data through wireless networks. Organizations need a payment gateway to effectively make use of tokenization.

Payment gateways are services offered by e-commerce applications that double as tokenization service providers. They allow for direct payments or the processing of credit card payments. This kind of gateway can store credit card numbers in a safe manner and generate the random tokens needed for payment tokenization.

Tokenization vs Encryption

How is tokenization different from encryption? Both methods involve protecting information from prying eyes, but how they go about doing this is quite different.

While encryption uses a “key” to protect data, tokenization uses a “token.” One method makes data opaque, with the intention of revealing it later through use of a special decryption key. The other method uses random data to represent real data.

Encryption

Encryption can be reversed. Data that has been encrypted is intended to be decrypted at some point and restored to its initial state. How strong the encryption will be depends on the complexity of the algorithm used to encrypt the data.

All encryption can theoretically be broken. The stronger the encryption algorithm, the more difficult it will be to break. But given sufficient computing power, an attacker can overcome just about anything. Encryption serves to obfuscate data but doesn’t protect it completely. When something is encrypted, it becomes more difficult to access — but not impossible.

Tokenization

Tokenized data can’t be reversed. Tokenization involves substituting sensitive data with random data, so there’s nothing to decrypt. A token simply holds the place of other data and has no real value.

The real data can remain in a different location such as an offsite platform. The original data doesn’t have to be kept inside an online computer network at all. If the tokens are compromised, an attacker has gained nothing. Tokens are useless to criminals.

Benefits

Tokenization

Encryption

Reversible X
Refunds, chargebacks, subscriptions X
Low-cost per transaction X
Centrally controlled X
Established security X
PAN data displayed X

What Are Some Examples of Tokenization?

When a credit card transaction is processed, the primary account number (PAN) gets substituted with a token. For example, 1234-2323-3434-5454 might be replaced with 6^fjk8Nm$zqGa.

A merchant can then use this token ID to retain customer records, like connecting the 6^fjk8Nm$zqGa token to Bob Smith. The token then gets sent to the payment processor who de-tokenizes the identification and confirms the transaction. 6^fjk8Nm$zqGa turns into 1234-2323-3434-5454 again.

Only the payment processor can read the token, making it useless for outside parties. The token can only be used with one merchant.

Here are some more specific examples of using tokenization payment.

Apple and Android Pay

With payment apps like Apple Pay or Android Pay, you first take a picture of your credit card and upload it to your phone. Then the payment processor (either Apple for Apple Pay or Google for Android Pay) sends the details to the bank who issued the credit card, which then tokenizes the card’s details. The token is then sent to Apple or Google before being programmed into the phone. This way, the number stored in the payment app can’t be of any use to attackers.

Tokenization Within Apps

Some apps allow for direct in-app purchases on a mobile device. If the phone has a token, such apps won’t have access to any raw credit card information. Not only does this kind of tokenization of payment prevent data from being useful to criminals, but it also makes payments easier. A tokenized account can be linked to your stored payment and shipping information, making the process quicker the next time around.

Tokenization in eCommerce

Tokenization helps protect consumers when they shop online, too. For example, when someone buys a product from a retail website, the retailer tokenizes the card information and keeps it on file. The data is safe even if it were to be hacked. If an attacker gains access to the system, all they will be able to see is random strings of characters.

Tokenization ensures these types of transactions can happen in a way that most benefits customers in terms of both safety and speed.

Benefits of Tokenization

Merchants and their customers benefit from tokenization in many ways, notably additional security, reduced costs, and a better user experience.

Additional Security

Today, cybersecurity often functions from a perspective of assuming that breaches are likely to occur. Because of how tokenization works, even if hackers access tokenized data, they probably still won’t be able to use it. The data would have to be decrypted first to be of any use. In this way, tokenization minimizes the risk of a data breach being harmful to a merchant or its customers.

Reduced Costs

Merchants can save on some of the costs that come with payment card industry (PCI) regulatory compliance by working with the right tokenized service providers. Protecting a company’s reputation by securing customer data can also prevent losses down the road, should something go wrong.

Better User Experience

Tokenization allows customers to store their credit cards in mobile wallets or at checkout for online payments. Cards can then be charged again without having to expose the original information. Merchants can provide a smoother customer experience this way because tokens can be used as payment for recurring subscriptions and one-click payments.

The Takeaway

Tokenization works by replacing real information with random characters called tokens. The tokens can then be used to process payments. There are a number of advantages to tokenization, especially over encryption — notably, while encryptions are made to be deciphered, tokenization is not.

There’s a lot to know when it comes to securing your transactions, finances, and investments. With a SoFi Invest® brokerage account, you can build your portfolio by securely trading your choice of stocks, exchange-traded funds (ETFs), and Initial Public Offerings (IPOs).

Find out how to get started with SoFi Invest.

Photo credit: iStock/paulaphoto


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