Tokenization: Everything you need to know
August 7, 2023 · 15 min read
August 7, 2023 · 15 min read
Tokenization is a way for companies to protect sensitive data. Fundamentally, it allows companies to transform sensitive data into non-sensitive data. The nonsensitive data is called a ‘token’, hence the name.
The tokens are completely unrelated to the original data in terms of their values. However, there are still ways (such as the format) to link the tokens to the original data. This allows the company to continue business operations with a reduced risk of data leaks and breaches.
Here, we take a look at everything you need to know about payments tokenization. We discuss the benefits and drawbacks, the difference between tokenization and encryption, the types of tokens, and much more.
What is a token?
A token is a piece of data. The nature of this piece of data can vary wildly in terms of length and format. However, it will always replace other data. Using a small number of information retained from the original data, a token can effectively work as its replacement.
It is important to remember that a token has no value of its own. Without the original data, a token is basically meaningless. However, tokens are used in place of some of the most sensitive data worldwide, such as credit cards and identification numbers.
A great way to think about tokens is to imagine a hotel key card. When someone checks into a hotel, they usually get a keycard at reception once their identity has been authenticated and the reservation confirmed.
This keycard can then be used to access various areas in the hotel e.g. If you have special access to the VIP area or if you want to restrict children from the pool area but still allow them access to their rooms. This is much more convenient than having to carry identification papers or multiple keys at all times.
What are the benefits of tokenization?
Let’s move away from analogies and into the real world. Here are some of the major benefits of tokenization:
What are the drawbacks of tokenization?
No system is perfect. This rings true for tokenization as well. Here are the major drawbacks of tokenizing:
So far, we have talked about tokenization and its pros and cons. Once data has been tokenized, the issuer can then access the data through a process known as detokenization.
Here is how detokenization works:
The original tokenization system is the only one that can access the sensitive data. The sensitive data is safely stored with the security vendor.
Many times, a token will simply be used once. An example of this is two-factor authentication. These tokens are then deleted afterwards as they have no further use. It is important to remember that tokens have no value on their own. They are simply a representation of the original data.
Each company has a unique tokenization system. As such, the process of detokenization (accessing tokenized data) is unique for each company. This is exactly why tokenization is so secure.
Tokenization vs encryption
For those not too well-versed in the tech world, tokenization may seem like a concept that is quite similar to encryption. However, the two processes are fundamentally different.
Encryption is a method of changing the values of the data based on a precise cypher and encryption key. Users can then decipher the data as long as they have the key. Once something has been decrypted, it is back to its original state.
Problems with encryption
Because the data has been shuffled based on the cypher, the encryption key will reverse the exact same process. This can be a problem because anyone can access the data as long as they manage to access the encryption key. This can occur if a key holder is compromised. A hacker may also be able to access the key if it is written in a document.
Another problem with encryption is that many encryption systems can be brute-forced. This happens when a computer has enough time and power. It will try all the possible key combinations and eventually access the data. This is not practically possible for many advanced encryption systems. Many low-level systems can easily fall prey to brute-force attacks.
How tokenization differs
A token cannot be deciphered or reversed. In fact, there is no key or indicator that a person could use that will allow them to see the sensitive data behind the token.
Tokens can only be returned to their original form through access to additional data. This data is typically stored externally for safety reasons. As such, tokenization also tends to be a more cost-effective option.
This means that even if a data centre’s security is breached, the data obtained in a tokenized system will have no value for the hacker. The additional layer of security is precisely why tokenization has become more important in recent years.
There is no clear winner between tokenization and encryption. Whether to use tokenization or encryption depends on the company and the nature of its business. Many companies use them both. This is especially true for companies with a lot of highly-sensitive data.
Types of tokens
There are many different ways through which tokens can be classified. A lot of research companies out there classify tokens in their own way. As such, there is no true way of classifying tokens. One of the reasons for this is that most of the industry is not regulated.
Here is one way one could classify tokens:
1. Payment tokens
Payment tokens are used to purchase and sell items digitally. The main advantage of using payment tokens is that there is no need for an intermediary. These tokens are used to purchase goods and services on an external network.
The industry of payment tokens is quite murky. They are not classified as securities. In fact, there is no regulation in most countries that classifies these tokens in any way. On top of that, they do not guarantee access to anything once they exchange hands. Great examples of payment tokens include most cryptocurrencies, such as Bitcoin and Ethereum.
Payment tokens are also sometimes known as currency tokens.
2. Utility tokens
Utility tokens are different from payment tokens. They represent something on the blockchain but are not used as a currency. Here, the token does provide its holder with a product or service. The issuer of the token decides this.
For example, a token may allow the holder to receive programming credits at the issuer. Or, the holder may be able to access certain services at a discount.
One thing to remember is that utility tokens can instantly lose their value. They are not considered an investment and are largely unregulated across the world. Examples include Golem and Brickblock.
3. Security tokens
As the name suggests, these tokens are akin to securities. These tokens are also sometimes known as asset tokens. Certain regulations around security tokens vary according to the country.
For the most part, security tokens promise a positive return. Many people consider them to behave similarly to bonds and other credit-based instruments. In many cases, security tokens are used to tokenize financial instruments such as bonds. Currencies and real-estate security tokens are also common.
Those based on real-world assets are usually known as asset-backed tokens, and others are known as equity tokens.
4. DeFi tokens
DeFi tokens are used, as the name suggests, for decentralised finance. These are used to power apps and services that can be used to transact on the apps.
For the most part, DeFi tokens are built on the Ethereum blockchain. These tokens can be used to engage in banking and investing. This can be done for both traditional assets that have been tokenized and for blockchain-related assets.
5. Non-fungible tokens
Non-fungible tokens are certificates that represent digital ownership of something. It could be something as simple as a screenshot of a meme or a painting by an artist.
NFTs became extremely popular for a short amount of time, skyrocketing in value before they came crashing down. While they are considered a fad by many, they still might be of some value when it comes to art.
Payment Card Industry Data Security Standards (PCI DSS)
The PCI DSS is one of the key reasons why tokenization is important. Being compliant with PCI DSS regulations is quintessential for any merchant that wants to be able to accept card payments at their business.
The main reason the PCI DSS exists is to make sure that the customer data is protected. Perhaps the most important regulation is that credit card numbers cannot be stored by the merchant after the transaction. This includes the merchant’s database and the POS terminals.
How tokenization helps with PCI DSS
Prior to tokenization becoming popular, encryption was the most popular method for compliance. However, we have already seen the pros and cons of that method. The major issue here is that the cost can be quite high. Encryption requires data systems that need to be able to handle the calculations required for advanced encryption.
This is even more of an issue for smaller merchants with low budgets. A smaller merchant may need to go through a massive upgrade in order to encrypt their data.
Tokenization is a viable alternative. With tokenization, only the last four digits of the card are stored on the merchant’s systems. The actual data of the cardholder is stored at a secure location by a third-party. This third-party is also responsible for issuing the tokens.
The token is created by changing the card numbers to random values. This token can then be used for a specific transaction with the merchant.
In the fast-paced world of technology and data security, tokenization stands out as a vital tool for safeguarding sensitive information. It offers a cost-effective, secure, and adaptable way for companies to protect data such as credit card numbers and identification information, reducing the risk of breaches and leaks. From the hotel key card analogy to the practical real-world applications in various industries, tokenization's unique attributes distinguish it from encryption, offering an additional layer of security.
However, the journey towards embracing tokenization is not without its challenges. The lack of clear regulations, potential vulnerabilities, complexities in IT structure, and other drawbacks make the decision-making process nuanced and context-specific.
Tokenization is poised to become an increasingly important part of the digital security landscape, providing opportunities for efficiency in the financial sector and facilitating compliance with essential standards like PCI DSS. As businesses grapple with the evolving threats of the digital world, understanding tokenization, its applications, its distinctions from encryption, and the array of tokens available becomes essential. Companies considering tokenization should weigh its many benefits against its potential drawbacks and consult with experts to craft a strategy that suits their unique needs and objectives.
In the end, tokenization is more than just a buzzword; it's a tangible solution with the potential to reshape how we think about data security and privacy in the increasingly interconnected global economy. Its strategic implementation may well become a standard practice, transcending industries and shaping the future of secure data management. Whether a business decides to utilize tokenization, encryption, or a combination of both, what's clear is that the quest for security in our digital age remains a complex and ever-evolving challenge.