Contactless Payments: What They Are & How They Work

For decades, when a shopper wished to make a retail purchase via credit card, that meant swiping the magnetic strip on the back of the card. While the magnetic strip was a futuristic innovation in its time (it replaced carbon copy imprints of the card’s front panel), no one today regards it as cutting-edge payment technology.

Today’s merchants and customers have directed their focus toward other payment options—those that don’t even involve contact between the customer’spayment methodand the merchant’s terminal. Contactless payment methods rank among the most consumer-friendly options in today’s retail scene thanks to their convenience and security.

This has inspired many retailers—from conglomerates to small businesses—to accept such payments at their points of sale. As of early 2022, contactless payments account for20%of in-person credit and debit card payments in the United States. In other countries, the figure is even higher—in Australia they account for92%of card payments.

What is contactless payment?

A contactless payment is one that doesn’t require a customer to run a payment card through a machine. That method applies to cards with magnetic stripes or chip cards that one inserts into a payment terminal. Contactless payments simply require a customer to hover a card or a device next to the payment terminal. In some cases, a brief tap makes the transaction simpler, which has led to the expression “tap to pay.”

Contactless transactions can occur in two forms: using an implanted radio frequency identification (RFID) chip in a credit or debit card, or using a wireless radio in a mobile device like a smartphone or smartwatch. In both cases, the purchaser makes a “tap to pay” transaction.

How does contactless payment work?

Contactless payments transmit via cards and mobile devices, but they ultimately run through financial institutions, just like an old-fashioned credit or debit card payment. The exact mechanics vary depending on whether you make a card payment or a mobile wallet payment.

Card payments

The majority of tap-to-pay transactions involve physical credit or debit cards. These cards come with an embedded radio frequency identification (RFID) chip that can transmit all of your card information to a payment terminal. If your credit card company has issued you a new card within the past year, it more than likely contains such a chip.

When a customer pays with a wireless chip card, the interaction is as follows.

• The customer presents the card.The customer hovers the card over a point-of-sale terminal that accepts contactless payments. Only newer terminals offer this function.
• The wireless chip transmits card information.When the customer hovers their card close to the terminal or, more commonly, taps the card onto the terminal, the radio frequency identification (RFID) chip transmits all of the card information, just like a magnetic stripe would.

• The payment terminal contacts a bank.Now the payment terminal sends a payment request to the financial institution backing the card. This is typically a bank or a credit union. Just as with a normal credit card, the merchant will request the transfer of funds from the card issuer.

• Thecard issuertransmits an approval or a denial.If the purchase amount aligns with the purchaser’s bank balance or credit limit, the financial institution will allow the sale to go through. The payment terminal beeps to signal a successful transaction. Or, if the purchaser lacks the funds or credit to make the purchase, the bank will deny the transaction.

Mobile wallet payments

A mobile wallet payment occurs through the use of a mobile device like an iPhone or Android phone. It can also occur via a wearable device like an Apple Watch. These devices must run a payment app that enables mobile wallet purchases. Such apps include Apple Pay, Google Pay, and Samsung Pay. Here’s how the process works:

• The customer taps or hovers theirmobile device.This works just like the card model. The phone or wearable device communicates using a near-field communication (NFC) radio, which is a close cousin of RFID chips.
• In some cases, the customer must enable the payment app.Some mobile devices instantly default to certain payment apps, and you don’t even have to launch them to make a purchase. You just tap your device, and the purchase proceeds. In other cases, the customer must launch an app, or they must confirm the purchase with their thumbprint or Apple’s Face ID.

• The app links to a financial institution.Payment apps link back to financial institutions or credit cards that provide the actual funds for the transaction.

• The purchase is approved or denied.Once again, the underlying financial institution either approves or denies the customer’s purchase. This happens nearly instantaneously.

Advantages and disadvantages of contactless payments

Contactless payments provide clear benefits to both merchants and consumers. Advantages include:

• Security.Contactless payment systems offer greater security than cards that utilize a magnetic stripe. For decades, scammers besieged the credit card industry by skimming consumer information off of magnetic stripes. Tap-to-pay cards and mobile wallets use encrypted systems to transmit customer data, and this has successfully repelled most scammers.
• Convenience.Consumers don’t need to carry around a credit card to make contactless transactions. They can leave the house with only a smartphone, or even a wearable device like an Apple Watch, and get full use of their mobile wallet. Even when consumers do use a physical card, they enjoy the convenience of merely tapping a payment terminal or hovering their card just above it. This makes transactions even smoother than they’d be when scanning a magnetic stripe or inserting a chip card.

For all of their advantages, contactless payments do come with one primary limitation: a lack of universal adoption by merchants. While contactless-enabled terminals have become commonplace at major retailers, they appear more rarely at small businesses running on a tight budget. Thus, customers still need to carry cash or a traditional credit or debit card to ensure they can make transactions in every store.