What Is a Digital Wallet and How Do They Work?

Woman at a restaurant making a contactless payment with her cell phone stock photo
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A digital wallet is a cashless payment system that stores your payment information and allows you to make transactions through your devices, without swiping a debit or credit card.

These systems are also called e-wallets, electronic wallets or mobile wallets and are typically are used right in the palm of your handheld mobile device, though they can also be stored on your laptop or desktop computer.

How Does a Digital Wallet Work?

Unlike the wallet you carry in your purse or pocket, this digital version holds your credit card information without needing the physical card itself. The mobile app on your phone securely stores information about your payment methods and other items you might keep in your physical wallet. Besides your bank and credit and debit card information, you may also store your ID, loyalty cards, coupons, event tickets or airplane tickets you’ve purchased.

To process payment for products or services at a point of sale, the system instantly withdraws the purchase amount from the bank account or the debit or credit card designated as your default choice when setting up your account.

With modern technology and conveniences, it has never been easier to spend your money. You can even leave the house without your wallet or purse and still be able to go into many stores and purchase items with just the touch of your phone

How You Can Use a Digital Wallet

Perhaps the most common use is to pay for purchases you make online, in-store or in-app. Other systems for digital wallets include keeping cash or cryptocurrency — or, in the case of a cryptocurrency wallet, buying, storing and trading bitcoin and other cryptos. You can also transfer money to family and friends and withdraw cash from ATMs.

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Because different digital wallets have different purposes, you might use more than one.

Good To Know

Digital wallets aren’t only alternative for contactless payments in stores and online payments that don’t require entering a credit card number. Virtual credit card numbers are created on the fly when you check out. And contactless credit and debit cards let you pay at the register by holding your card near the credit card reader or tapping the reader with your card.

How Do You Set Up a Digital Wallet?

You can create a digital wallet by downloading the app and installing it on your phone or wearable device. Then follow the prompts to add the cards you’ll use for payments.

Most smartphones already have a digital wallet version built into the phone, so all you have to do is link your preferred credit card, debit card or bank account information to it to get shopping.

Types of Digital Wallets

The three main types of digital wallets are closed, semi-closed and open.

  • Closed: Closed wallets, like Amazon Pay and Walmart Pay, are for use only with a particular store or website.
  • Semi-closed: Semi-closed wallets like Apple Pay and Google Pay let you shop online and offline with a select group of merchants that accept that particular wallet.
  • Open: Open wallets let you make payments with just about any merchant, as well as transferring money between other users of the same app and performing banking tasks like ATM withdrawals
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What Are the Best Digital Wallet Companies?

Many phones and devices come already equipped with a digital wallet, but if you’re not interested in using the pre-downloaded version, you can opt for a different one. The following are examples of where you can find user-friendly wallets:

  • Apple Pay: Lets Apple users make purchases and send and receive cash. About half of U.S. retail establishments accept Apple Pay.
  • Google Pay: Is compatible with many popular retailers, as well Airbnb, DoorDash and other services. Supports a limited number of debit cards, but you can link to your PayPal account. You’ll need a separate app — Google Pay Send — for person-to-person cash transfers.
  • Samsung Pay: Can be used for nearly any merchant, because it works with credit card readers.
  • PayPal: Is used most often for person-to-person payments but is also widely accepted by online merchants. Instant Transfer from a linked debit card incurs a fee.
  • Venmo: Is mostly for person-to-person payments between people who have the wallet installed on their devices, but a small number of retailers — mostly online — accept it, as well.

What Companies Accept Digital Wallets?

Digital wallets are widely accepted, and you’ll know a store merchant accepts your digital wallet if you see its logo or the contactless symbol — which looks like a Wi-Fi symbol turned on its side — at the register. Tap the digital wallet app on your mobile device, and select the account or card you want to use to purchase your items.

Are Digital Wallets Safe To Use?

Digital wallets are safer than many people think, because the merchant doesn’t ever see the credit card or bank account number. Instead, the system generates a unique, random transaction number for purchases.

Your account information is encrypted and available only to people with a password. Many smart devices come with biometric authentication that you can enable for your digital wallet, so it needs your fingerprint or facial recognition to open the app. Furthermore, users can lock their digital wallets remotely if they suspect someone has accessed their bank accounts.

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Final Take To GO 

Before using a digital wallet, you should take precautions to protect the information you have stored electronically. Take advantage of your smartphone’s built-in safeguards like biometric access from the lock screen. The phone will ask for your fingerprint or scan your face before opening, which helps prevent fraudulent activity. 

FAQ

Here are the answers to some common questions about digital wallets.
  • What is the best digital wallet?
    • There are many popular digital wallets to choose from, including Apple Pay, Google Pay, Samsung Pay, PayPal and Venmo.
  • Is PayPal considered a digital wallet?
    • Though technically, PayPal is considered to be a peer-to-peer payment app, it stores your credit card, debit card or bank account information and is accepted by many vendors and merchants, so it can also double as a digital wallet.
  • What does a digital wallet do?
    • A digital wallet stores your payment information – like your credit card, debit card or bank account – so that you can use it to pay for purchases instead of using your physical card. Some digital wallets also enable person to person payments, so you can easily send money to friends and family.

Alicia Bodine and Daria Uhlig contributed to the reporting for this article.

Our in-house research team and on-site financial experts work together to create content that’s accurate, impartial, and up to date. We fact-check every single statistic, quote and fact using trusted primary resources to make sure the information we provide is correct. You can learn more about GOBankingRates’ processes and standards in our editorial policy.

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