What is a digital wallet?

Nearly all modern smartphones and tablets come with digital wallet features nowadays. So what are they and how do they work?

a woman looks at her phone while making a transaction at the counter of a store where racks of clothing can be seen in the background.

Image source: Getty Images

You might have heard your relatives or friends talking about them, or maybe you've even used one without realising it. But what exactly are digital wallets?

Another way to pay

Perhaps you traditionally like paying for things with cash, a debit, or a credit card. These are common and relatively convenient ways to manage financial transactions in stores or online. But they also have serious drawbacks. Cash can be lost or stolen, while cards can be skimmed or hacked, putting your money and personal information at risk.

That's where digital wallets come in. A digital wallet is an app running on your smartphone or other mobile device that lets you make purchases online or in stores with just a few taps. 

A device you likely take everywhere is also a secure and convenient way to make payments without carrying physical cash or cards.

But digital wallets aren't just about convenience. They're also changing the way payments are made and processed. Digital wallets are part of a more significant trend toward cashless and contactless transactions, which could have substantial implications for the future of commerce.

From 'dial-a-coke' to the smartphone era

Digital wallets have been around for longer than you might think. Soft drink giant Coca-Cola (NYSE: KO) introduced the first one in 1997. Coke wanted to make it easier for customers to buy drinks from vending machines, so the company developed a system that allowed people to use their phones to make payments.

The first experiment involved two vending machines in Helsinki, Finland, where the local heroes at Nokia Corporation (NYSE: NOK) jump-started the mobile boom that would sweep the globe a few years later. With Dial-a-Coke, thirsty customers could buy a soda by texting a code to a unique number.

In the early 2000s, companies such as PayPal Holdings Inc (NASDAQ: PYPL) and Alphabet Inc (NASDAQ: GOOG) (NASDAQ: GOOGL), the parent company of Google, began offering digital wallet services, starting an unstoppable secular trend.

Nowadays, nearly all modern smartphones and tablets have digital wallet features such as near-field communication (NFC) for contactless payments and specialised security chips. You can make payments with just a few clicks or taps by linking bank accounts or credit cards to an online account. They are easy to use, protected by several layers of digital security, and most likely are preinstalled on your favourite mobile device.

Millions of people worldwide use digital wallets today for everything from buying groceries to sending money to friends and family. Transparency Market Research predicts that the global digital wallet market will continue to snowball in the coming years, reaching a value of more than $16 trillion by 2031.

As technology advances, we can expect digital wallets to become even more integrated into our daily lives. They can manage payment cards, loyalty club memberships, digital concert tickets, and other snippets of financial information. 

Some states even let you store your driver's license in a digital wallet. In the not-too-distant future, you might not need to carry physical wallets at all.

Embracing the cashless future with digital wallets

Digital wallets are more than just a convenient way to make payments. They're also helping to drive a fundamental shift in how we think about money and transactions.

For one thing, digital wallets are helping to make payments more secure. Using advanced encryption and authentication technologies, digital wallets can help protect your personal and financial information from fraud and theft.

The store never sees your credit card number since payments are processed through encrypted digital tokens instead. This can give users greater peace of mind when purchasing online or in stores.

But digital wallets are also part of a more significant trend toward cashless and contactless transactions. The COVID-19 pandemic accelerated the change as more people avoided touching cash or payment terminals in public spaces. 

Digital wallets allow users to make payments without having to physically touch anything, which can help reduce the spread of viral, bacterial, and fungal diseases.

Beyond traditional banking

Beyond these practical benefits, digital wallets also have the potential to democratise access to financial services. Traditional banking services can be difficult or expensive to access in many parts of the world. 

However, smartphones are pretty much everywhere. Digital wallets can offer a more affordable and accessible alternative to traditional banking services, allowing people to make payments and manage their money without needing a bank account.

This is especially important for people in developing countries, where many are underbanked or entirely unbanked. Digital wallets allow people to participate more fully in the global economy without relying on traditional financial institutions.

The power of this idea exponentially grows when combined with cryptocurrencies and decentralised finance apps. Moving money around without assistance from financial institutions is becoming easier all the time.

A digital wallet is not the same as a blockchain wallet, which specialises in managing your cryptocurrency accounts, but one app can undoubtedly provide both functions.

Digital wallets are a powerful tool, transforming our thoughts about money and financial transactions. Whether you're making a purchase at your favourite store or sending money to a friend across the world, digital wallets offer a convenient, secure, and accessible way to manage your finances.

Frequently Asked Questions

A digital wallet is an application that runs on your smartphone or other mobile device and allows you to purchase online or in-store without using cash or a physical credit card. The digital wallet stores your payment information, meaning you can carry out transactions easily with just a few taps.

Digital wallets began taking off in the early aughts when trailblazing tech companies like PayPal and Google began to offer them. Nowadays, they're ubiquitous, with nearly all smartphones, tablets, and other personal devices coming with their own preinstalled digital wallets, offering contactless payment options and extra security features to protect payment information.

Digital wallets are also incredibly easy to use. You simply create an account, link it to a bank account or credit card, and you're ready to start making purchases with just your phone.

Digital wallets are a safe and secure alternative to traditional forms of payment, like cash and credit cards. When you make a payment with a digital wallet, the store you purchase from never sees your credit card information, as everything is encrypted. This level of security provides users with added protection against fraud and theft. 

Digital wallets provide safety in other ways too. Their use took off during the COVID-19 pandemic when people were trying to cut down on physical contact to avoid the spread of the disease. This remains a concern for many people -- particularly those with underlying health conditions -- which is another reason to use digital wallets.

Digital wallets offer an alternative to traditional banking as many don't require a bank account to set up. You can send money to your digital wallet from many different sources and then store it there to make purchases later easily. This makes digital wallets particularly popular in developing countries, where traditional banking services are expensive and difficult for poorer populations to access. This helps people who would otherwise be shut out of the banking system access financial services and participate in the economy. 

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a 'top share' is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a 'top share' by personal opinion.

As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Alphabet and PayPal. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended the following options: short March 2024 $67.50 calls on PayPal. The Motley Fool Australia has recommended Alphabet and PayPal. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.