What is a digital wallet?

Close up of a male's hand paying bill with credit card contactless payment on smartphone in a cafe, scanning on a card machine
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Carrying a physical wallet everywhere you go can get old quickly. Technology has made it possible to ditch your bulky wallet in favor of a sleek digital option. 

A digital wallet provides a simple way to make payments without toting around all of your physical payment methods. 

But before you jump into a digital wallet, let’s explore exactly what this option entails.

What is a digital wallet?

A digital wallet goes by many names. You might hear the same technology referred to as an electronic wallet, e-wallet, or mobile wallet.

Regardless of the name, a digital payment wallet involves making financial transactions through an application that stores your payment information.

With the help of this technology assist, you can eliminate the need to carry around a physical wallet. 

How do digital wallets work?

The process of using a digital wallet starts by filling it up with payment information.

Depending on the digital wallet app, you can store payment details for your credit card, debit card, or bank account. When you are ready to pay for a purchase, the digital wallet will tap into that stored information to get started.

If it's using your mobile device, the digital wallet transmits payment information via QR codes, near field communication (NFC), or magnetic secure transmission (MST). You’ll need to get your device close to the point-of-sale terminal to process the payment.

If you aren’t making an in-person purchase, digital wallets can still come in handy. For example, you can easily send money to a friend to split the check. Or potentially withdraw cash from an ATM.

Beyond storing payment information, you can use your digital wallet to store a wide range of helpful details. Some wallets can store boarding passes, hotel reservations, gift cards, concert tickets, loyalty rewards, coupons, and more. In the iOS 16 Wallet app, iPhones will even be able to store digital ID cards and drivers licenses (provided the state issuing those identification cards is participating.)

Types of digital wallets

Not all digital wallets are created equal. It’s critical to understand the different types to find the best fit for your unique situation.

Digital wallets can fall into one of the following categories:

  • Closed wallet: A company that sells products or services to customers can offer closed wallets. The funds within a closed wallet can only be used within the company’s platform. For example, you may receive refunds or pay through a closed wallet.
  • Semi-closed wallet: Semi-closed wallets are compatible to work with a specific list of merchants. Typically, online and offline purchasing options are available. But the merchant will need to sign a contract with the wallet issuer to accept funds. 
  • Open wallet: Open wallets are issued by banks or in partnership with banks. In this case, customers can use the funds to make transactions at an approved list of merchants. Plus, they can withdraw funds from an ATM or transfer them to other users. 

When considering your digital wallet options, here are some of the popular options:

Of course, this isn’t an exhaustive list of digital wallets. But you likely recognize a few of the options available.

Are digital wallets safe?

Those new to digital wallets can’t help but wonder if this form of payment is safe. After all, the threat of hackers is real in our increasingly online world.

But the reality is that digital wallets are a secure way to store your financial information. In fact, using a digital wallet may be safer than carrying around your physical wallet. If someone steals your physical wallet, they’ll immediately have unfettered access to your cash, credit cards, and identity information.

Of course, people out there are still trying to get access to your payment information. But your digital wallet offers several lines of defense. If someone steals your phone, they’ll need to wade through several passwords and biometric checkpoints to use any payment information stored in your digital wallet. 

The information within your digital wallet is also encrypted, and that encryption puts up an extra roadblock for would-be hackers. A final measure of protection is "tokenization." Essentially, this involves creating one-time codes to share with merchants for payment instead of using your actual credit card number. 

The combination of security features makes digital wallets a good way to protect your payment information during a transaction.

Advantages and disadvantages of digital wallets

Every financial product comes with pros and cons. Here’s what you need to know about digital wallets before jumping in. 

Let’s start with the benefits of a digital wallet:

  • Convenience: You won’t have to deal with carrying around your physical wallet anymore. Since you already bring your phone everywhere, you’ll always have a payment method ready to go. 
  • Security: Encryption and passwords make it a challenge for thieves to access your information. Even if you lose your phone, would-be thieves will have a difficult time getting to the information stored in your digital wallet. Plus, you can’t lose your credit card if you don’t carry it with you. 
  • Variety of options: Digital wallets come in different styles for your payment preferences. You can work with a closed wallet for shopping at your favorite retailer or use an open wallet that offers more flexible payment opportunities. 
  • Commonly used: Many people use digital wallets. That makes it easy to send money back and forth when needed. For example, you can send a Venmo payment to a friend instead of bringing cash to split dinner. 

Now for the disadvantages of a digital wallet:

  • Easy to overspend: With a digital wallet, you can finalize a purchase with just a tap. Although you can still stick to a budget, the ease of payment can make it easy to overspend. 
  • Fees: Most digital wallets come with a suite of fees attached. You might find transaction fees or cash-out fees that really cut into your budget. 
  • May need multiple wallets: Not all digital wallets can perform the same functions. Depending on your spending needs, you may need to open up several wallets to accomplish all of your digital spending goals. 
  • Not accepted everywhere: Retailers have the choice to accept digital wallet payments. Many do, but some don’t. If you don’t carry a regular wallet, you might not have a backup payment method with you for a retailer that doesn’t accept digital payments.

Should you get a digital wallet?

A digital wallet is a convenient tool.

If you are tired of lugging around all of your credit cards, a digital wallet is a no-brainer. Another reason to spring for a digital wallet is when you want to add an extra layer of security to your payments. The string of security features will keep your payment information safe, even if you lose your phone.

But if you aren’t ready to leave your physical wallet at home, a digital wallet might be an unnecessary addition to your financial toolset. 

Sarah Sharkey
Personal finance writer

Sarah Sharkey is a personal finance writer who enjoys helping people make better financial decisions. She covers personal finance topics ranging from insurance and banking to mortgages and credit cards. Her real hope is that readers find valuable takeaways to improve their own financial situation in her work. You can find her writing on Business Insider, Money Under 30, Rocket Mortgage, Bankrate, and more. She lives in Florida with her husband and dogs. When she's not writing, she's outside exploring a new stretch of coastline. Connect with her on her blog Adventurous Adulting.