What Is a Digital Wallet? How It Works and What To Look For

A digital wallet is a mobile app that stores digital versions of your credit cards and other payment methods, but it can also hold cryptocurrency security keys or serve as a hub for managing separate banking, credit, investing and budgeting tools all in one place, without having to switch between multiple apps.

Key Takeaways

• A digital wallet stores your payment cards and more on your phone or watch. Depending on the type, it can hold credit and debit cards, loyalty cards, event tickets, boarding passes, IDs or cryptocurrency security keys.

• Tap-to-pay runs on near-field communication (NFC). Your phone transmits payment data to a compatible terminal, or you scan a QR code — no physical card required.

• Your card details are tokenized during each transaction. The wallet swaps your real account number for a unique character string, so thieves can't reuse the data.

• There are three main types of digital wallet. Payment wallets, all-in-one finance wallets that manage banking, credit, budgeting and investing, and crypto wallets that store security keys.

• Look for biometrics, tokenization and encryption when choosing a wallet. Turn on two-factor authentication and keep PINs and passwords private to help protect your account.

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What Is a Digital Wallet?

A digital wallet is an app that stores payment methods and other items electronically so that you can access them with your phone or watch. Depending on what kind of wallet you have, you might use it to store credit cards, loyalty cards, event tickets, boarding passes, IDs or cryptocurrency security keys.

However, some wallets go a step further by combining contactless payments with tools you can use to monitor and manage your finances.

The expanded wallets let you not only see checking and savings account balances, but some allow you to check your credit score and transfer money. That feature didn't wasn't available until more recently. The best wallets have advanced anti-fraud features and give you access to investing tools and crypto-wallets.

Here’s an at-a-glance look at the different types of digital wallets.

How Does a Digital Wallet Work?

A digital wallet uses certain protocols to facilitate secure contactless payments.

• Tap-to-pay transactions use near-field communication (NFC), where your digital wallet uses your phone or watch to transmit payment information to a compatible point-of-sale terminal, which relieves you of having to remove your credit card from your wallet in order to swipe or tap it when you check out.

• Payments using QR code: Alternatively, depending on the merchant and the system they use, you might be able to make payments by scanning a quick-response (QR) code with your phone’s camera.

• Tokenized data: In either case, your credit card or banking information is tokenized, or converted to a unique character string, to keep the information secure.

How To Pay With a Digital Wallet in 7 Steps

The technology might seem complicated, but using it is easy once you get used to it. Here's how:

1. Open the wallet on your phone.

2. Select the option to add a payment method

3. Follow the instructions for adding your compatible credit card, debit card or payment account. 

4. When you’re ready to pay, open your wallet and select the card you want to pay with.

5. Position your phone over the contactless symbol on the point-of-sale device.

6. Alternatively, scan the QR code and follow the instructions to complete the transaction.

7. Watch for confirmation that the transaction is complete.

What To Look for in a Digital Wallet

The first decision to make when you're choosing a digital wallet is whether you want a basic wallet to store credit cards and digital documents, or an all-in-one wallet that also lets you manage your banking, credit, investing and fraud protection in a single app. 

The best wallets are the ones that let you:

• See your linked accounts in a single view

• Track payment due dates for your bills and manage autopay

• Monitor your credit score

• Access investing tools that help you invest according to your risk tolerance and budget

• Protect your sensitive financial information against fraud

• Manage your money in one easy-to-use app

When considering an all-in-one mobile banking app, review each feature to determine whether it'll make your financial life easier to manage or complicate things unnecessarily.

A case in point: MoneyLion's budget analysis and subscription-tracking could prove invaluable to someone juggling expenses across several accounts. But someone with a single checking account and no credit cards or investments might consider those features to be overkill.

Also consider how the wallet handles money you store inside the app. The money held in a linked bank or credit union account is usually FDIC- or NCUA-insured, and the cash in the app might be, too, as is the case with MoneyLion Spend accounts. If your app doesn’t provide FDIC insurance protection, you could lose your money if the app’s developer goes out of business. 

Is a Digital Wallet Safe?

Generally yes, since digital wallets employ a range of security methods to protect your device and the information stored in it. Keep in mind, though, that not every system is risk-free. Methods vary from one provider to another, so read your wallet’s privacy and security disclosures carefully. Here are some things to look for.

• Facial recognition, fingerprint or other biometric authentication technology that verifies your identity

• Tokenization that renders your account information useless to data thieves during tap-to-pay transactions

• Encryption to encode your sensitive data during transmission, rendering it unreadable to anyone who doesn’t have the security key needed to decode it

Choose a wallet that has a robust and transparent security policy, and then do all you can to safeguard your data. Take advantage of two-factor authentication and other security options for your device, your app and your financial accounts, for example, and always keep your PINs, passwords and security questions private. 

FAQ

Still have questions about digital wallets? Find the answers below.

Is a digital wallet the same as a mobile banking app?

No. A mobile banking app gives you direct access to your bank or credit union, where you can check your account balances, transfer money, make mobile deposits and pay bills. Digital wallets store your credit or debit card information and sometimes link to your accounts, but access is limited.

Is a digital wallet the same as a crypto wallet?

No. A crypto wallet has just one purpose, which is to store the security keys needed to buy, sell or trade crypto. However, some all-in-one digital wallets link to crypto wallets. 

Do digital wallets cost money to use?

Sometimes. The major payment wallets don’t charge for standard payments. All-in-one apps are often free for basic use as well, but some might require a subscription or offer optional features you must pay to use. Read disclosures carefully before downloading a digital wallet.

Can I use more than one digital wallet at the same time?

Yes. You can install multiple wallets on your phone and use different wallets for different purposes. That can actually work to your benefit because payment methods aren’t necessarily compatible with every wallet, and a particular wallet might not be compatible with every merchant that accepts digital payments.

Key Terms

• Digital wallet: A mobile app that stores digital versions of your payment cards and other items, and that can also manage banking, credit, budgeting and investing in one place.

• Near-field communication (NFC): The short-range wireless technology that lets your phone or watch transmit payment data to a contactless terminal when you tap to pay.

• Tokenization: The process of replacing your real card or account number with a unique character string during a transaction, so your actual details are never exposed.

• QR code: A scannable square barcode some merchants use to accept mobile payments through your phone's camera.

• Contactless payment: A transaction completed by tapping or scanning rather than swiping or inserting a physical card.

• Crypto wallet: A wallet that stores the security keys needed to buy, sell or trade cryptocurrency, rather than the coins themselves.

• FDIC insurance: Federal deposit insurance that protects money in an insured bank account up to $250,000 per depositor if the bank fails. Credit union equivalents are NCUA-insured.

• Two-factor authentication (2FA): An added security step that requires a second form of verification — such as a code or biometric — beyond your password.

Sources

• Consumer Financial Protection Bureau. Consumer Advisory: Your Money Is at Greater Risk When You Hold It in a Payment App, Instead of Moving It to an Account With Deposit Insurance.

• Federal Reserve. Developments in Noncash Payments for 2019 and 2020: Findings From the Federal Reserve Payments Study.

• Federal Trade Commission. Protect Your Personal Information From Hackers and Scammers.

• Stripe. Digital Wallets 101: What Businesses Need to Know About Accepting a Digital Wallet.

• Fidelity. What Is a Crypto Wallet?

Jacinta Majauskas contributed to the reporting for this article.