The COVID-19 pandemic accelerated the growth of many digitized areas within financial technology services, and the use of digital wallets was no exception. By 2020, digital wallets had become the leading payment method for e-commerce (44.5%) and point-of-sale (POS) transactions (25.7%). Their adoption surpassed all other payment methods, including credit cards, debit cards, bank transfers, and cash. Over the next five to ten years, digital wallets are expected to further dominate the payment landscape.
In this in-depth report, we examine the asset types and payment methods associated with digital wallets, how they function, and—most importantly—the numerous advantages they offer consumers, businesses, and payment technology platforms every day.
Understanding Digital Wallets: Asset Types and Payment Methods
A digital wallet is a payment method used for online transactions via a computer or mobile device. It combines secure storage with a payment gateway, offering services similar to those of a debit or credit card. However, instead of physical plastic, digital wallets operate in a fully digital format, eliminating the need to carry a traditional wallet.
So how does this business model work for merchants, startups, or fintech companies entering the market? Its operation depends on the asset type of the digital wallet and the chosen revenue structure. Primary asset types support fund storage and ensure security. Let’s examine each in detail:
- Closed-Loop Wallet Applications: These allow users to store funds but only transact with the wallet issuer—examples include Amazon Pay. Refunds, returns, and canceled payments can also be deposited into these wallets. They offer revenue opportunities for companies selling products or services, as some can earn micro-interest on stored funds.
- Semi-Closed Wallets: These provide more flexibility by enabling consumers to make payments at predetermined merchants and locations. PayPal is a classic example. It serves as a centralized e-money storage network usable both online and offline, operating under electronic money licenses to issue e-money into virtual wallets.
- Open-Loop Wallets: Typically issued by banks or in partnership with banking institutions, these wallets are secure and widely accepted at most retail terminals. Examples include Visa and Mastercard. They offer all the features of semi-closed wallets, support online shopping and contactless in-store payments, and even allow cash withdrawals at ATMs or physical locations.
For anyone entering the digital payment ecosystem, identifying the right starting point and the most suitable wallet type is essential. Adhering to fintech service design principles can also be transformative for the end product. Regardless of the stage, thorough market research is crucial to lay a foundation for future growth.
How Digital Wallets Store Money—And Where
All digital wallets use advanced encryption to protect users’ payment information. Many platforms also implement additional security measures like one-time PINs and two-factor authentication. When it comes to storing money, digital wallets use two distinct structures:
Centralized Systems: As fully digital entities, digital wallets often rely on a backend financial system and a database holding account and currency information. These databases are owned and operated by a central third party with ultimate authority over the wallet, account details, and all transactions. Account and fund information is typically stored in a single data center or across multiple horizontally scaled data centers.
Key Examples: Neobanks and fintech apps like Revolut and N26 provide users with virtual wallets to store and use funds directly from their devices. Through mobile apps, users see their private accounts or wallet lists, but these are backed by one or more real bank accounts, depending on the company structure. Many of these centralized neobanks are growing through innovative Bank Identification Number (BIN) projects and Banking-as-a-Service (BaaS) offerings.
Decentralized Systems: Most commonly associated with cryptocurrency and blockchain technology, these applications store funds in a system where a distributed ledger—verified and maintained by a peer-to-peer network of computers—records transactions. Unlike centralized systems, decentralized digital wallets provide digital tools to access and use funds without storing currency in a central database. These technologies offer a less regulated space and have seen explosive global growth.
Key Examples: In crypto and blockchain networks, the distinction between custodial and non-custodial wallets is critical. Custodial wallets are essentially “centralized” platforms where a third party controls the funds. Thus, even if you can buy, sell, and trade cryptocurrency on platforms like PayPal and Coinbase, they are considered less secure in the crypto world. Non-custodial wallets are considered classic decentralized system wallets because they give users full control over their funds. In these systems, only the user has access to private keys; third parties do not. APIs like Exodus and Ledger are typical non-custodial wallets.
Next Steps: Utilizing Your Assets
With centralized and decentralized systems forming the foundation, banks, companies, and third-party startups have developed various secure and convenient ways for users to access their funds. In recent years, this broad digital functionality has expanded in the following ways:
- Mobile Device Access: Both online and offline wallets are accessible via mobile devices. These APIs are especially popular in neobanks and major wallet platforms, allowing users to add and manage accounts, transfer money, and make payments all within an app. At POS terminals, users can also pay using Near Field Communication (NFC) technology.
- Internet Access: More common in large banks and traditional systems, this often takes the form of websites or desktop applications that store all user assets and data. This form of online banking lets customers access and manage accounts and often provides digital wallet functionality.
- IoT Device Integration: These assets can be used via the Internet of Things (IoT)—such as through cars or watches—and can facilitate shopping directly from IoT devices. For example, Samsung’s Family Hub refrigerator allows users to order groceries via the MasterCard app, and Whirlpool’s Smart Dishwasher, linked to an Amazon account, can estimate when detergent is low and automatically order more.
- Crypto Access: These wallets, usually mobile apps, store the keys users need to access cryptocurrency and execute transactions. Although most crypto wallets are digital, some exist as physical hardware, similar to USB drives (e.g., Ledger).
With the proliferation of new digital access technologies and smart devices, competition in the digital wallet ecosystem is intensifying, ultimately paving the way for new, industry-disrupting fintech experiences.
How Digital Wallets Make Life Easier
From a user experience perspective, the growing adoption of digital wallets can be attributed to several key factors:
- Reduced Reliance on Physical Banks: Network connectivity has largely eliminated the need for customers to visit physical banks to open and maintain accounts. Instead, users can handle everything easily and quickly from home.
- The COVID-19 Pandemic: Strict lockdowns and safety measures worldwide made consumers increasingly comfortable with online payments. Salesforce’s Q3 Shopping Index for 2020 and 2021 highlighted this shift: global digital transactions grew 63% year-over-year in Q3 2020, and rose another 11% in Q3 2021, indicating that online shopping quickly became a routine for many consumers.
- Convenience and Speed: The ability to seamlessly manage different financial accounts from a single platform is one of the biggest advantages of digital wallets. Users can track spending, organize various payment cards, and send or receive money from contacts with ease.
- Limitless Accounts: Users can create as many accounts as needed. Whether for individual, business, shared, or family use, accounts can be opened and closed flexibly within digital wallet platforms.
Key Opportunities for Payment Companies and Startups
Above all, remember: digital wallets are here to stay. They are a global phenomenon, and the best approach for today's fintech businesses is to seize emerging opportunities in this space, including:
- Truly Global Access: Rapid adoption of digital wallets by consumers and merchants worldwide has significantly lowered the barrier to entry for new products or services.
- Excellent User Experience: The ease of use and convenience of digital wallet applications are highly praised by consumers. They simplify many complex traditional financial processes—such as opening an account without visiting a bank and seamless peer-to-peer payment options—making this an area all fintech companies should focus on.
- Reliable Security: Users highly value the security of their funds, and digital wallets deliver exactly that. As security technology advances, new security service providers are emerging.
- Customization Options: With many different business models and revenue structures available today, fintech companies must make informed choices. One of the most creative digital wallet types currently available is the Buy Now, Pay Later (BNPL) service.
- Diverse User Functions: Compared to traditional financial services, digital wallets seem to offer limitless possibilities, thanks to today’s digital and mobile solutions. For any unmet consumer or merchant need, digital wallets can provide groundbreaking built-in application services.
To leverage the full potential of digital wallet products and services, a professional, holistic approach is essential. 👉 Explore advanced digital finance strategies to transform your ideas into tangible products in today’s competitive landscape.
Frequently Asked Questions
What is a digital wallet?
A digital wallet is an electronic tool that allows users to make online or contactless payments via a mobile device or computer. It securely stores payment information and can hold multiple accounts, cards, or even cryptocurrencies, providing a convenient alternative to physical wallets.
Are digital wallets safe to use?
Yes, reputable digital wallets employ advanced encryption, tokenization, and often additional security layers like biometric authentication or two-factor verification to protect user data and funds. However, users should always practice good security hygiene, such as using strong passwords and keeping software updated.
What’s the difference between a closed and an open-loop wallet?
A closed-loop wallet is restricted to transactions with a single issuer or merchant (e.g., Starbucks rewards app). An open-loop wallet is widely accepted across multiple merchants and locations because it is typically linked to major payment networks like Visa or Mastercard.
Can digital wallets be used without a bank account?
Yes, certain types of digital wallets, particularly some closed-loop and semi-closed systems, allow users to store value and make payments without requiring a traditional bank account. This feature is significant for promoting financial inclusion.
How do digital wallets make money?
Wallet providers generate revenue through various streams, including transaction fees from merchants, interchange fees, premium service subscriptions, interest on stored funds, and partnerships with financial service providers.
What is the future of digital wallets?
The future points toward greater integration with other financial services (lending, investing, insurance), expanded use of blockchain and CBDCs (Central Bank Digital Currencies), deeper IoT connectivity, and more personalized user experiences driven by AI and data analytics.