How Credit Card Machines Work
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The Credit Card Machine Reads the Card
The magnetic stripe on the rear of a credit card contains thousands of tiny magnets that encode vital information about the credit card account. By assigning magnets oriented upward a value of "1" and magnets oriented downward a value of "0," vital information such as the card number and expiration date are digitally encoded in a way that can be interpreted by the magnetic stripe reader on a credit card terminal.
The Credit Card Machine Sends the Transaction to the Network
Once the credit card account information has been read by the machine (or manually entered using a keypad), it is combined with other transaction information, such as the transaction amount and merchant identification. These data are modulated into sound that can be
transferred across the telephone network and sent to a local credit card network node.
The Credit Card Machine Waits for a Response
Once the data is sent, it is processed by the credit card network and a response is returned to the credit card terminal. The terminal demodulates the incoming sounds into usable data and deciphers the response. If the transaction is approved, a message is displayed on the credit card machine's screen, a receipt is printed and the transaction is retained as part of the current credit card "batch." If the transaction is declined, a message is displayed on the machine's screen, the transaction is canceled and the merchant asks for an alternate form of payment. If some other response is received, the message is displayed on the screen, and no further action is taken.Source: ehow.com