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A digital wallet, also known as an electronic wallet or e-wallet, is a software app that allows an authorized user to conduct a financial transaction with a digital device. The widespread adoption of digital wallets has been driven by an increasing reliance on mobile technology for everyday activities.
COVID lockdowns and restrictions on in-person shopping also created a surge of interest in digital wallets. As online shopping and contactless payment systems became more desirable, it not only helped promote the general public’s acceptance of digital wallets like PayPal and Apple Pay – but it also inspired wallet platforms to improve storage capacity and build out features that support different use cases like P2P payments.
A digital wallet’s meaning is best understood by examining its role in the context of a physical wallet. Just as a physical wallet’s job is to protect someone’s cash, credit cards, and identification, a digital wallet’s job is to protect virtual representations of these items.
When someone sets up a digital wallet, the wallet app encrypts the user’s payment information and personally identifiable information (PII). Depending on the wallet, the encrypted information is either stored on the user’s device or in the cloud. (Wallets that store encrypted information in the cloud can be used across multiple devices.)
When the user conducts a transaction, the merchant is given a string of nonsense characters that represents the user’s real information. This process, which is known as tokenization, prevents the merchant from ever knowing the real payment details. This cybersecurity strategy minimizes the risk of digital wallet fraud and helps ensure that sensitive financial and personal information is kept secure.
Here are some of the other key technologies and strategies that support digital wallet transactions:
NFC technology allows two devices placed within a few centimeters of each other to communicate over radio waves. Smartphones and smartwatches use this technology for contactless transactions at compatible point-of-sale (PoS) terminals.
A secure element (SE) is a tamper-resistant chip that stores the user’s personal and financial information. It is isolated from the device’s main operating system (OS) and any potential malware that could compromise the device.
Digital wallets on mobile devices often use fingerprint scans or facial recognition technology to provide an additional authentication factor. This strategy ensures that only the authorized user can make payments from the device, even if the device is lost or stolen.
Digital wallet definitions and crypto wallet definitions have similarities because both types of wallets are used to store digital information securely. Their use cases, however, have traditionally been different.
Digital wallets are primarily used for making electronic transactions in traditional fiat currencies. They rely on internet access and are designed to be used on smartphones, smartwatches, tablets, and PCs.
In contrast, crypto wallets are designed to store, send, and receive cryptocurrencies such as Bitcoin or Ethereum. Unlike digital wallets, which are always software-based, crypto wallets can be hardware-based. Hardware-based wallets resemble USB drives and do not require internet connectivity.
It should be noted, however, that as cryptocurrencies go more mainstream, digital wallet providers are paying attention and responding by integrating features that support crypto purchases and sales. For example, PayPal allows users to buy, hold, and sell a selection of cryptocurrencies directly within its platform.
Digital wallets can be categorized by where they can be used, the source of their funding, and their need for centralized management.
Issued by companies to their customers for use exclusively within the company’s ecosystem. Funds in a closed wallet can only be used for transactions with the issuing company.
Allow users to conduct transactions at specified merchants and locations that have a contract with the wallet provider.
Provided by banks or financial institutions in partnership with credit card networks. This type of wallet can be used for a wide range of transactions, including withdrawing cash from ATMs.
Within these broad categories, digital wallets can also be categorized by how they are accessed.
Digital wallets can also be classified by their funding sources:
Require the user to “load” money into the wallet at the time of wallet acquisition. This type of wallet doesn’t have to be linked directly with a primary bank account or credit card unless the user wants to add funds to the prepaid balance.
Connected to the user’s debit card or a designated credit card. Transactions flow through the linked card.
Connected directly to the user’s bank account. This type of wallet provides a convenient way for users to manage wallet transactions directly from their bank account.
The “best” digital wallet is subjective, and choices can vary depending on device compatibility and geographic location. The following digital wallets are known for their ease of use, security features, and ability to streamline financial transactions.
Even though digital wallets have security features designed to protect personally identifiable information and financial data at rest and data in transit, it’s important to remember the human factor.
While digital wallets use encryption, tokenization, and SE chips, no system is completely immune to evolving cyber threats. Digital wallet safety also depends on security awareness and good security hygiene. This includes using secure, private Wi-Fi connections for financial transactions instead of public hotspots – and regularly updating digital wallet software.
Digital wallets can make digital financial transactions more convenient and eliminate the need for people to carry multiple physical cards and cash – but they also have their downside.
The table below lists some of the pros and cons of using digital wallets.
Digital wallets are safe and convenient. They give consumers who don’t want to risk sharing their credit card or bank account information with multiple merchants a way to conduct secure financial transactions through a single software app.
A digital wallet is a software-based system that securely stores users’ payment information to facilitate online financial transactions.
Determining the “best” digital wallet depends on several factors, including the wallet’s acceptance by local merchants.
Whether you need a digital wallet depends on your lifestyle, shopping habits, geographic location, and preferences regarding money management.
Yes, PayPal is considered a digital wallet.
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Margaret is an award-winning technical writer and teacher known for her ability to explain complex technical subjects to a non-technical business audience. Over the past twenty years, her IT definitions have been published by Que in an encyclopedia of technology terms and cited in articles by the New York Times, Time Magazine, USA Today, ZDNet, PC Magazine, and Discovery Magazine. She joined Techopedia in 2011. Margaret's idea of a fun day is helping IT and business professionals learn to speak each other’s highly specialized languages.
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