Chip Card: Definition, How It Works, Types, and Benefits

What Is a Chip Card?

A chip card is a standard-size plastic debit or credit card that contains an embedded microchip as well as a traditional magnetic stripe. The chip encrypts information to increase data security when making transactions at stores, terminals, or automated teller machines (ATMs). Chip cards also are known as smart cards, chip-and-PIN cards, chip-and-signature cards, and the Europay, Mastercard, Visa (EMV) card.

How Chip Cards Work

Plastic has been a go-to payment method for quite some time providing consumers with convenience and security over cash payments. Credit cards with revolving credit—like we have today—have been around since the 1950s, while debit cards have been on the market since the late-1960s. Account information such as the cardholder's credit limit, available balance, and transaction limits was stored in the magnetic stripe on the back.

Chip cards became a global standard for debit and credit transactions after the technology was introduced by Europay, Mastercard, and Visa. This is why it's also called an EMV card. Chip cards have a little silver or gold microchip embedded on the front of a debit or credit card. Just like the magnetic stripe, the chip contains information about the account(s) associated with the card. The technology was first used in Europe before becoming a standard around the world. The technology was officially adopted in the United States in October 2015.

In order to use the chip card, the cardholder inserts the card into a chip-enabled terminal such as an ATM or a point-of-sale (POS) terminal. The terminal submits the cardholder's information to the merchant or card provider's site. If the account balance supports the transaction, it is then approved. If not, the terminal rejects the transaction and it does not go through. Some terminals require the cardholder to enter a personal identification number (PIN) or a signature to complete the transaction.

Special Considerations

Despite the efforts of the global financial community to provide a uniform environment for financial transactions, not all card readers are chip-enabled. High costs, the availability of equipment and technology, along with other factors may prevent merchants from implementing chip-enabled technology. When a retailer or other service provider doesn't have a chip reading terminal, cardholders must swipe their cards using the magnetic stripe. Users may be required to enter their PINs or sign to authorize the transaction and complete the purchase.

Types of Chip Cards

In most cases, a cardholder is simply required to enter their chip card into a terminal in order to execute a transaction in the United States. But in other cases—including in other countries—consumers may be required to take additional steps in order to make a purchase or withdraw cash from the ATM using the following cards.

Chip-and-signature cards

A chip-and-signature card provides a little more security over the traditional magnetic stripe. Rather than using the stripe, the cardholder uses the chip to send data from the terminal to the financial institution. If the transaction is approved, the consumer must provide a signature in order to complete the transaction.

Chip-and-PIN cards

These cards offer the most security for consumers. They work in the same way as a regular chip card, but also require the use of a PIN to complete a transaction. A customer must enter their personal identification number in order to make a purchase or withdraw money from the ATM using their credit or debit card. PINs are commonly used for ATM withdrawals using debit and credit cards in the United States. Consumers in Canada and other countries are required to use their PINs regardless of how or where they use their cards—even if it's a credit card.

Benefits of Chip Cards

Chip card technology provides an additional layer of security when used at a chip-enabled terminal because the cards are more difficult to skim. This encryption security is in addition to the fraud prevention monitoring already offered by card providers. In most cases, purchases have coverage for fraudulent usage. This coverage limits a customer's liability in the event of theft. Embedded chips help merchants avoid card-present fraud, but other lines of protection must come from other methods to prevent card-not-present-fraud.

The chip makes transactions more secure by encrypting information when used at a chip-enabled terminal. Chip card technology is not yet a locator system so you can't find your card using a locator service if you lose it. In this case, you have to request a replacement card from your provider. Until engaged in a reader, the card cannot detect its location for security or advertising purposes. The chip is limited to supporting authentication of card data during purchases. Usually, this type of card is easily replaceable in the event of loss or damage.

Banks monitor the chip card's activity by location use, the purchase amount, and the merchant charging the account. If any deceptive activity is detected, the card provider will attempt to contact the customer. The bank issues a credit to the chip-card account after verification of fraudulent charges.