What are Digital Payments and how do they work?

Even in the years before the Covid-19 pandemic, commerce had started to shift online, and it was only natural that payments would follow suit. Most of us regularly send or receive digital payments whether we understand it or not, and if your business is not able to accept them, you run the risk of becoming irrelevant in an age of constant digital transformation.

With most people now preferring to pay digitally, offering different types of digital payment for your customers is just one of the many ways you can remain competitive and offer a more flexible experience. It’s all about providing frictionless, scalable and future-proof solutions to meet and exceed consumer demand.

What is a digital payment?

Sometimes referred to as electronic payments, digital payments are financial transactions that do not involve the physical transfer of currency. Instead of paper, you’re trading 1s and 0s, and this is true whether you’re paying online via a mobile wallet or in person using your credit and debit card. Wire transfers are also a kind of digital payment that many people don’t realise is digital.

The benefits of digital payments were amplified by the stresses of the pandemic. Not only do these payments expand the range of people that can buy and sell, but they save costs through tighter efficiency, and allow for more transparent and secure online and offline trading, with greater control for the merchant and customer.

Digital payments also eliminate cash management, meaning a lower risk of theft, and provide a clear trail for accounting purposes. It’s a faster and more elegant system providing added convenience for the merchant and the customer alike.

How do digital payments work?

While it might seem  on the surface to happen in little more than a few clicks, there are several elements that make up a typical digital transaction.

The involved parties

A digital payments ecosystem has several intermediaries that need to work together to facilitate a successful transaction. The typical parties involved are a payer (consumer), the payee (merchant) and the payment network. This network will involve the payer’s bank (the issuer bank) and the payee’s bank (the acquirer bank).

Bank accounts

The customer must have an account with a financial institution with sufficient funds to make a successful transaction. The merchant must also have an account set up that is able to receive funds. The issuer bank debits an amount from the customer, and the payee bank credits that same amount on the receipt for the merchant.

Step-by-step payments

When a digital payment is made, either by a card being swiped or a button being clicked, payment information is sent via a payment gateway to the customer’s bank to not only ensure that they are who they say they are (via passwords, PIN codes and other security measures), but also that adequate funds are available to make the purchase. 

Payment rail

Once that has been verified, the request is either accepted or denied, and the payment is processed through a system commonly referred to as a ‘payment rail’. This is simply a platform that moves money from payer to payee.

To further clarify the process, however, let’s take you through a typical digital purchase.

Examples of digital payments

As an example of how digital payments work, we’ll assume somebody wishes to purchase an item of clothing from a high street retailer. They make that payment using a Point of Sale (PoS) machine, inserting their card, and entering their four-digit PIN number.

Several things must happen before the purchase is verified. First, the provider checks if the PIN is correct and then checks if there is a sufficient balance in the customer’s bank account. If there is sufficient balance, the money is debited from their account and credited to the retailer’s account. If a credit card was used, it’s the credit limit rather than the balance that’s checked.

If that same transaction happens online, meanwhile, then the payment request is sent through whichever payment gateway the retailer uses. It’s up to the gateway to check the balance or credit limit in the customer’s account.

Types of digital payment

There has been a major increase in the number of digital payment solutions over the last few years, which have made life easier for both merchants and customers.

Mobile wallets

If the customer uses a digital wallet system like Apple Pay on their smartphone or banking app, there is no need for a middle-person. These solutions are slowly becoming the preferred payment method for many younger consumers, as while there are fewer risks in digital payments, in general, mobile wallets are seen as being even more secure and flexible.

Contactless payments

For all purchases under $100, Australian cardholders can use near-field communication (NFC) technology to scan their cards and make instant payments at physical retail locations. It works in the same way as a traditional card transaction, only with a tap rather than a swipe. PIN codes are also not required. Note, however, that transaction fees might apply.

Digital wallet payments

Digital wallets are essentially a means of storing a digital duplicate of your physical credit and debit cards on your smart device. This works in a very similar manner to contactless payment, using NFC technology to process payments.

Peer-to-peer digital payments

Peer-to-peer (P2P) payments are made through payment gateway solutions such as PayPal. These solutions link the customer directly to the merchant’s bank account. This presents a particularly strong opportunity for small businesses, as they are typically less expensive to set up than more feature-rich payment gateways.

Paylinks

Paylinks are a means of allowing small business owners to charge customers via a unique link which then takes them to a secure payment portal where the digital payment is processed directly from the customer bank to the merchant bank. This is a convenient and affordable solution that is generally around 54% cheaper than online card transactions. GoCardless’s paylinks make it incredibly easy for businesses to get paid quickly and securely.

We can help

GoCardless is a global payments solution that helps you automate payment collection, cutting down on the amount of financial admin your team needs to deal with. Find out how GoCardless can help you with one-off or recurring payments.