How does a card reader work and how does it process payments?

In our tech-driven world, it is becoming increasingly clear that an ever-growing number of consumers are opting for using less cash while making purchases using their cards. This means merchants need to be prepared to offer this type of payment method using card reader technology. 

However, because there are Chip&PIN, magnetic stripe, contactless payments, and payments with digital wallets made with a mobile device, it becomes crucial for a merchant to understand how to operate with such card terminals.

In this blog post, we answer the question, “How does a card reader work?” We ultimately aim to help you understand how card readers work as sophisticated pieces of technology in today’s business landscape. 

How card readers work in 5 steps – a general overview

If you’ve ever accepted card payments with a card reader before, you’ll know that the card transaction is approved almost instantly, in just a few seconds. It’s a rather logical process that involves communication between several actors.

So, how do card readers work? First, these electronic devices, which require an internet connection, read the information from the customer’s card. They can do this via the card’s chip (EMV chip cards), the magnetic stripe, or by tapping a contactless credit and debit card to make a payment on the card reading device. But what is the communication process that takes place behind the scenes?

Let’s break the process down into 5 simple steps.

Step 1. Payment authentication

The customer presents their card so that the card reader can “read” the sensitive banking information and transaction data contained in the physical card itself. Alternatively, customers can make payments via QR codes or through digital wallets. 

Step 2. Payment verification 

The merchant’s processing provider or bank receives the request and contacts the customer’s card issuer or provider to verify the card and proceed to authorisation. This step involves important secure processes to ensure the safety of the customer’s credit or debit card.

Step 3. Payment authorisation

The customer’s card issuer will check that the cardholder’s details are correct and whether there are sufficient funds in the cardholder’s account and then either approve or decline the transaction.

Step 4. Payment confirmation

If the card issuer approves the operation, they send a response to the card processor, which then sends it back to the card reader. The reader then transmits information that the transaction has been approved. This process is called payment confirmation.

Step 5. Payment completion

The funds are withdrawn from the customer’s or cardholder’s account and are then transferred into the merchant’s account once sales data has been processed.
The usual industry standard for fund settlement into the merchant’s account is 2-3 days, although some providers, like myPOS, settle funds instantly, thus eliminating liquidity challenges and more.

Credit card processing explained

Another payment method that can be performed is via a credit card. Card readers process payments made through these cards in the same five steps outlined above.

The credit card readers work by securely communicating with the customer’s issuer bank and the merchant’s provider. hen ensuring that funds are securely transferred into the merchant’s business bank account or merchant account using NFC technology or near-field communication.

How do contactless readers work?

The cardholder taps or hovers their contactless card to make contactless payments on or just above the card reader. Contactless payments function on short-range wireless technology, which sends information to the card payment machine.

You can find this wireless technology in the card through a microchip incorporated in it. It is also known as RFID (radio frequency identification), and it is not limited to security tags, smartwatches, security fobs, mobile wallets through a smart device, discussed in more detail below, and others.

How do Chip&PIN card readers work?

The ‘chip’ installed in debit and credit cards is approximately the size of a pinhead. Small as it may be, it stores a record of the customer’s four-digit PIN number. When a customer inserts their card into the chip card reader, the chip is read and the payment details and transaction are verified when the customer enters their matching PIN either onto the keypad or on the device’s touchscreen.

Chip-and-PIN card readers were introduced on the market over a decade ago, replacing the more traditional sign-and-swipe method—the magnetic stripe readers or magnetic stripe reading, which was more prone to fraudulent transactions. 

How do Apple Pay and Google Pay readers work?

Digital wallets or mobile wallets such as Apple Pay, Samsung Pay and Google Pay are apps that use Near-Field Communication (NFC), similar to the RFID technology that is used to process mobile wallet payments.

NFC payments use encrypted data with multiple layers of security to ensure fraud prevention and better security of a customer’s account details, while minimising credit card fraud.

As a starting point, app users need to add their credit and debit cards to their virtual wallets. Then, through a process of “tokenisation“, the card details are exchanged with a “token” to mirror the real, existing card details. It’s also possible to secure transactions through an encryption key.

The purpose of tokenisation is increased safety and security in the event of a lost or stolen device or lost or stolen card data. You can make payments with these mobile wallets either in-store or online. 

Conclusion

Credit card readers are sophisticated pieces of technology that “read” card information or information from mobile wallets, chip cards, contactless cards, or magstripe cards and then communicate this information to the relevant parties.

The way in which this communication process works is practically the same whether you’re paying by debit or credit card, Chip&PIN, contactless, or through a mobile wallet – with a few differences, of course.

This communication process is almost instantaneous – it takes just a few seconds for the cardholder and payment information to be transferred from the cardholder’s bank to the merchant’s acquiring bank or payment services provider.

That, in a nutshell, answers the question of “how does a card reader work?” The simplicity, ease, and convenience offered by credit and debit card readers make them a brilliant choice for merchants who wish to accept card or digital payments.