What is a digital wallet and how does it work?

Convenient, secure, and easy to use, digital wallets have fast become a preferred payment method worldwide, accounting for nearly half of all global ecommerce sales.¹

What is a digital wallet?

A digital or e-wallet is a payment tool, usually in the form of an app, that facilitates purchases using a smartphone, smartwatch, or other digital device.

Digital wallets securely store financial data and can make transactions quick and simple. They remove the need to carry around physical cards or money.

How does a digital wallet work?

To make a purchase, a digital wallet communicates stored credit card or bank details to the vendor’s point of sale system, either through a magnetic signal or the device’s Bluetooth or Wi-Fi connection.

Unique tokens are used to create one-time transaction numbers for each purchase. They’re encrypted to protect the user’s data and then processed and communicated to the relevant credit card institutions and banks.

Digital wallets usually work through the following technologies:

• Quick response (QR) codes: QR codes are bar codes that can be linked and read through a smartphone camera. Some digital wallets also allow users to set up unique individual QR payment codes, which can be read by a vendor’s point-of-sale device or platform.
• Near field communication (NFC): NFC is where two smart devices connect closely through electromagnetic signalling (i.e., when tapping a smartphone to a merchant’s point-of-sale register).
• Magnetic secure transmission (MST): This is similar to the technology used by magnetic card readers when a credit or debit card is swiped through a point-of-sale device — only the encrypted magnetic field is generated by the smart device.

What else can a digital wallet be used for?

In addition to streamlining payments, digital wallets can be used to store:

• Loyalty cards
• Gift cards
• Membership cards (e.g., for fitness and leisure centres)
• Coupons
• Event tickets
• Plane tickets
• Boarding passes
• Hotel reservations
• Personal IDs

Examples of a digital wallet

Depending on the type of digital wallet, there are different formats and levels of access, including:

• Closed: A business offering goods or services may provide a closed wallet, which limits transactions to that particular business.
• Open: Open wallets are issued by banks or financial institutions and can be used to make purchases with any merchant that supports the technology — online, contactless in-store, or for cashback and at ATMs.
• Semi-closed: Semi-closed wallets allow you to make purchases with a select list of merchants and businesses that are uniquely affiliated or contracted with the particular wallet issuer.
• PayPal Digital Wallet: This digital wallet can store bank account debit and credit card information in one place for online payments, money transfers or QR code payments.

Potential benefits of a digital wallet

From quick payments and hassle-free transactions to keeping information organised and accessible, digital wallets can offer a range of benefits.

• Efficiency: Digital wallets store financial information for convenient access, allowing users to transact in real time without a physical wallet.
• Contactless: Make purchases without physically handling cash or credit cards.
• Safe and secure: Encrypted data and one-time payment tokens create secure transactions, so bank data, card numbers and ID details are not exposed. Many apps also utilise one-time PINs and two-factor authentication.

Potential cons of digital wallets

Though generally safe, it’s important to consider any draw backs. These could include:

• Universality: Depending on the access type of the wallet app, it may not be accepted at all locations.
• Connectivity: Digital wallets require a strong Bluetooth or Wi-Fi signal, functioning mobile data, and a well-charged device.
• Protection: Though unlikely, a user’s digital data can be vulnerable if the mobile device is stolen.

Learn about the PayPal digital wallet here.