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By Nihara Gooneratne · Yesterday
Digital wallets: Redefining the way we pay
Smartphones are undoubtedly an integral part of our lives and we use them for far more than just communication. Having already made cameras, calculators, and diaries somewhat obsolete, smartphones are now letting people leave their physical wallets at home. Digital wallets are more or less substitutes for physical ones, allowing users to store all their debit/credit cards, loyalty cards, gift cards, and much more.
In this insight, we will explore how digital wallets work, their benefits and use cases as well as the key companies operating in the space. We will exclude other types of wallets such as crypto or IoT wallets.
What are digital wallets?
Digital wallets (also known as mobile wallets or virtual wallets) are online payment tools that allow people to carry out various payments and transactions via an app. They are commonly used along with mobile payment systems, allowing customers to make payments with their smartphones. Digital wallets aim to address the hassle of carrying physical wallets, allowing people to store digitized versions of credit cards, debit cards, and items such as loyalty cards, coupons, and transit tickets, in one centralized location.
While some digital wallets offer the full suite of features, others focus on specific areas such as in-store payments, online payments, or P2P transactions. Although digital wallets don’t typically allow users to store funds directly within the app, a few, such as Venmo, also allow users to store funds in a cash account that can be linked to a bank account or credit card.
What can a digital wallet do?
Source: Created by Uzabase based on various sources
Digital wallets can be split into three broad categories, largely depending on the type of transactions they facilitate and where they can be used:
Open wallets: These enable users to utilize their wallets for various transactions at virtually any merchant that accepts digital wallet payments. It imposes no restrictions on where digital wallets can be used. Some digital wallets also permit ATM withdrawals. These wallets are typically developed by banks or in partnership with them.
Semi-closed wallets: These are among the most common digital wallets, enabling users to carry out transactions at a selected list of merchants and locations. Merchants may need to set up predefined agreements with digital wallet issuers to accept payments from the wallet.
Closed wallets: These are typically developed by merchants themselves, and allow customers to use their wallets to make payments at their own stores. Users are unable to use these wallets for transactions outside the issuing merchant.
How do digital wallets work?
A common misconception is that digital wallets may lack safety and security. On the contrary, digital wallets are far more secure than carrying physical cards, as they are heavily encrypted and tokenized. This means actual card details and account numbers are not stored within the digital wallet.
Instead of storing card numbers within the app, all card data is encrypted and assigned a unique virtual number, ensuring that card details are not shared with anyone, even merchants. Encrypted data is then replaced with a non-sensitive digital equivalent known as a token. These tokens are randomly generated each time a user makes a payment and only the merchant’s payment gateway can match this token with the card to accept payment. If a token is stolen, the card issuer issues another token in place of the stolen one and disallows payments with the stolen token.
Steps involved in digital wallet transactions
Source: Created by Uzabase based on various sources
Since digital wallets store all payment details within the app, they eliminate the need to manually enter details each time an online transaction is made. These card details are then authorized via biometrics (such as facial recognition or fingerprint) or PINs. Some digital wallets also have additional security protocols like two-factor authentication with one-time PINs to ensure maximum security.
When making payments at brick-and-mortar stores, users need to go a step further and hold their phone (or paired watch) close enough to card readers upon authorizing the payment. Information is then transmitted using near-field communications (NFC) technology, enabling customers to pay for transactions in a completely contactless manner. The NFC makes use of a QR code, key, or another method of personal identification to process the payment.
Digital wallet payment process
Source: Created by Uzabase based on various sources
What has enabled digital wallets and what is driving demand?
Advancements such as high smartphone penetration have undoubtedly played a key role in enabling the development of digital wallets. In addition to this, industry-specific enablers, such as open banking (a banking practice that allows third-party providers [TPPs] to access customer data stored in banks and non-bank financial institutions), have also contributed to establishing the infrastructure needed for digital wallets to function successfully. This enables digital wallets to leverage financial data from multiple sources and provide users with a centralized place to store all their financial data from multiple institutions. Additionally, the development of biometric facilities to authorize payments has also played a key role in establishing digital wallets and ensuring the data is stored safely and securely.
On the demand front, factors such as the need for speedy and convenient payment options have greatly sparked interest in digital wallets, as they enable seamless and hassle-free checkouts, both online and offline. Here are a few key factors fueling demand for digital wallets:
Faster checkout leads to more checkouts: Digital wallets promote speed and convenience by enabling customers to checkout much faster when making payments, as they don’t need to spend time taking their cards out or entering card details every time a transaction is made. Faster checkouts in turn could lead to increased conversion rates and less cart abandonment, ultimately benefiting both consumers and merchants. In 2020, digital wallets were used for around 45% of online transactions and about 25% of transactions at physical stores, globally.
Better security against fraud and theft: Payments via digital wallets can only be authorized via mobile PIN or biometric identification. Therefore, in case of theft, it would be impossible for anyone else to authorize payments via digital wallets without the necessary authorization. This makes it comparatively safer than carrying physical wallets, which can easily be stolen and misused.
Promote wider financial inclusion: Although most digital wallets require individuals to have bank accounts, some allow users to carry out functions such as P2P payments and other transactions without one. This promotes wider financial inclusion and allows unbanked people to make and receive payments without a traditional bank account. Some digital wallets, such as PayPal, also issue prepaid cards that allow users to pay for things using money stored in their PayPal accounts, offering an alternative to debit cards to those who are unable to gain access to a bank account.
How does usage differ by region?
So far, digital wallet usage has been dominated by Asia—predominantly the Far East region, China, and India, who were early adopters. This is reflected by China’s high mobile contactless payment penetration (reflecting digital wallet usage) of 87.3% in 2021, far ahead of the US (43.2%) and the UK (24.4%). For a region that has traditionally been backed by the ideology of “cash is king,” digital wallet adoption in the region has been quite impressive, especially given that smartphone penetration in Asia-Pacific is just about 64% (2020), much lower than developed counterparts such as the US (around 85% in February 2021). The high uptake of digital wallets in the region has in large part been due to its popularity among the region’s unbanked population. To complement this, merchant adoption has also been growing in the region, especially in more urban areas, where digital wallets are commonly used to pay for day-to-day transactions like food delivery, taxi transportation, and ride-sharing.
Mobile contactless payment penetration of selected countries in 2021
Asia’s high penetration is also reflected in its contribution to digital wallet transaction value, with the Far East region and China alone contributing to around 70% of usage in 2020, in terms of value. In comparison, digital wallet usage in Europe has been hindered by high dependence on cash, while privacy concerns have limited its usage in North America. Over the next few years, however, Europe and North America are expected to fuel growth in digital wallet usage, with expected transaction values growing at CAGRs of 30.4% and 16.3%, respectively, between 2020 and 2025. Growth in the regions is mainly expected to be spurred by growing digital wallet usage among younger demographics.
Digital wallet usage by region by transaction value
So, who are the key players in the space?
The digital wallet industry is largely dominated by products developed by tech giants, which include Apple (Apple Pay), Google (Google Pay), and Samsung (Samsung Pay). From a consumer standpoint, the choice of digital wallets largely depends on the mobile operating system of the individual. iPhone or Apple Watch users for instance will gravitate toward Apple Pay, while Android users are more likely to lean toward Google Pay or Samsung Pay. Apple Pay alone contributed to 5% of all global card transactions in 2020; this is expected to grow to reach 10% by 2025.
PayPal is another major player in the space. Aside from having its own digital wallet offerings via its app, the company also acquired the digital wallet app Venmo in 2013 to further strengthen its presence in the space. Many retailers, such as Amazon and Walmart, have also developed closed wallets to allow customers to pay for purchases from their stores.
List of selected companies operating in the digital wallet space
What are the challenges?
While digital wallet use may undoubtedly bring about benefits such as speed and convenience, widespread adoption may still face challenges. The challenges are mainly underpinned by low awareness of how digital wallets work and their associated benefits. These are particularly prevalent when paying for in-store transactions using digital wallets. A few key challenges have been highlighted below.
Security concerns: Despite the secure nature of digital wallets, many are still reluctant to try them out due to perceived security threats. As of May 2019, around 65% of smartphone users in the US cited security concerns as the main deterrent to digital wallet usage. This may be due to inadequate knowledge on how digital wallets work and the technology that is used to safeguard consumer data. Therefore, more awareness may need to be created on usage, if adoption is to increase.
Low awareness: As of May 2019, 17% of smartphone users in the US stated that they didn’t know how to access digital wallets, while 15% didn’t know how to “tap-to-pay” when checking out at a store. Low awareness and know-how concerning accessibility and usage may create barriers to adoption.
Slow adoption among retailers: Digital wallet acceptance among merchants is a prerequisite for boosting usage at physical stores. Even if customers want to use their digital wallets to pay, they are unable to do so unless merchants accept payments via this method. Many merchants still lack the infrastructure needed (such as NFC terminals) to facilitate payments via digital wallets, which may hinder usage for these transactions.
Card compatibility remains low: Debit and credit cards cannot be integrated into digital wallets unless they have been made compatible by the issuing bank. While newer technology-focused banks, such as neobanks, offer cards that can integrate with digital wallets, incumbent banks have been slow to develop cards that are digital wallet-friendly. This is even more prominent in developing countries, where card compatibility with digital wallets remains particularly low.
Will adoption continue to grow?
Even before the onset of the COVID-19 pandemic, consumers were increasingly moving toward alternative, more convenient payment methods. This was further heightened by the pandemic, which urged consumers to shift toward contactless methods of doing things, with many using digital wallets for the first time. In line with this, brick-and-mortar stores have also been increasingly installing the necessary infrastructure to accept digital wallet payments.
Despite these efforts, digital wallet adoption remains in its early stages. However, it is likely to continue its growth trajectory over the next few years, as tech-savvy consumers, particularly within younger demographics, look for more digitized options to carry out financial transactions. Digital wallet adoption in ecommerce transactions is expected to grow at a particularly accelerated rate, with digital wallet adoption for POS payments trailing slightly behind. Globally, digital wallets are expected to contribute to 52% of ecommerce payment volume and 30% of POS payment volume by 2023. In North America alone, digital wallets are expected to account for 40.5% of ecommerce payment volume and 15.5% of POS payment volume by 2024. Additionally, digital wallets are also expected to continue playing a key role in less developed markets, as they continue to offer the unbanked population a means of sending and receiving money.
Digital wallets may however not completely replace physical wallets, at least in the near term. This is mainly because certain forms of identification, such as government-issued IDs and driver’s licenses, still need to be carried in their physical form.
In conclusion, when looking at the broader benefits of speed, convenience, and flexibility brought about by them, it appears that digital wallets are here to stay.
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