How Chip and PIN Credit Cards Works

Every credit card holder in America knows the "swipe and sign" checkout ritual. Line up the magnetic stripe, swipe the card, press "OK" for the amount to be charged, and then sign your illegible scrawl on the screen. The swipe and sign system is so common in U.S. that American travelers are often shocked to learn that almost no other country still does it this way. The new international standard for credit card security is called "chip and PIN," and its coming to American wallets in 2015.

With chip and PIN cards, the credit card data is stored on a tiny computer chip — not a magnetic stripe — and customers punch in a four-digit PIN (personal identification number) instead of signing the screen.

Chip and PIN credit cards made headlines in the U.S. in December 2013 when hackers stole credit and debit card information from 40 million Target customers, and the names and e-mail addresses of 70 million more [source: Harris]. The craft store Michaels and retailer Neiman Marcus were also victims of massive data breaches. Security experts believe hackers remotely installed malware on the companies checkout machines that stole credit card data each time a customer swiped a card .

In the wake of the data breach, Target pledged to switch its store-branded credit and debit cards to the new chip and PIN technology.. Visa and Mastercard have announced similar plans to switch from magnetic stripes to chip and PIN by October 2015.

What will the credit card switch mean for the average American consumer? Are chip and PIN cards really more secure than magnetic stripes? And what if you want a chip and PIN card now? Do American stores even accept them?

Chip and PIN credit cards represent a significant technological upgrade to the traditional magnetic stripe credit cards. Instead of embedding credit card numbers and card holder information in a magnetic stripe, all data is contained within a tiny computer chip built into the card.

Chip and PIN technology has been around since 1984, when French banks began testing chip-based cards. In 1996, the worlds leading credit card companies collaborated to create a new, more secure standard based on the French technology In the industry, chip and PIN cards are called EMV cards, an acronym standing for Europay, MasterCard and Visa, the three credit card companies that developed the first international technological specifications for chip and PIN cards .

The computer chip inside a chip and PIN card functions like a small computer. Not only can the chip store data, but its also a data processor. One of the reasons why chip and PIN cards are so secure is that the chip uses cryptography to protect secure data when communicating with a card reader.The chip itself has no power source, but it leaps into action when it comes in contact with a checkout terminal.

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The most common way to use a chip and PIN card is to insert the end of the card into a slot on a card reader. Depending on the type of terminal, you will then either enter a four-digit PIN or sign a printed receipt. There are also so-called "contactless" checkout terminals where you simply hold the card near the reader to activate the chip. The same chip technology is being used in mobile phones to enable on-the-go mobile payments.

One of the benefits of chip and PIN technology is that the card reader does not have to be connected to a phone or Internet line to process the charge. With magnetic stripe cards, the card reader must "talk" with the credit card company before authorizing the charge. (In the old days, cashiers would call in the charge over the phone.) In places with slow telephony networks, chip and PIN terminals can work offline, processing the charge using the chip alone and then authorizing the charges in bulk at the end of the day .

The Target data breach during the 2013 holiday shopping season was the largest incident of credit card theft and fraud in the history of retail. The hackers — who were never caught — got their hands on the personal data of millions of Target customers . It served as a wake-up call to corporate America about the costs of credit card fraud, both to their bottom line and their reputation.

American consumers account for a quarter of credit card purchases worldwide, but are the victims of 50 percent of the worlds credit card fraud .. The rate in the U.S. has doubled since the early 2000s as chip and PIN cards spread across Europe .

As the Target hackers demonstrated, data encoded in old-school magnetic-stripe technology is relatively easy to steal. Magnetic-stripe credit cards are also much easier to counterfeit than chip and PIN varieties. And magnetic-stripe cards offer almost no protection against the most basic kind of identity theft: stealing someones wallet or purse. Since magnetic stripe cards require no PIN, a thief can simply scrawl a bogus signature — does your "digital" signature look anything like your real one? — and walk away.

The biggest reason chip and PIN cards are more secure than magnetic stripe cards is because they require a four-digit PIN for authorization. Thats the easiest way to know that the cardholder is the real owner of the card. Also, since all data and communications are protected by cryptography, that makes chip and PIN cards infinitely more difficult to hack.

However, neither magnetic stripe nor chip and PIN cards offer much protection against fraudulent online purchases. In fact, in the U.K., while in-store credit card fraud has declined greatly, fraud from credit card use over the phone or Internet has exploded .

In Western Europe, more than 80 percent of all credit cards feature chip and PIN technology, and 99.9 percent of card readers are equipped to read them. In Canada and Latin America, the adoption rate of chip and PIN cards is about 54 percent. The U.S. has resisted the switch, making American consumers and their credit cards the "low-hanging fruit" for hackers. But for how much longer?

In the U.S. market, expect to see a lot of so-called "chip and signature" cards. These hybrid cards include the new chip technology, but still require a signature — not a PIN — to authorize the charge. Chip-and-signature cards are seen as a "half-step" that offer better security, but are still not universally accepted abroad.