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Fintech: How Digital Wallets Work


Tuesday, June 25, 2019

By Julie Stackhouse, Executive Vice President

This post is part of a series titled “Supervising Our Nation’s Financial Institutions.” The series, written by Julie Stackhouse, executive vice president and officer-in-charge of supervision at the St. Louis Federal Reserve, appears at least once each month.

This blog post is the fourth in a series about fintech and how it is affecting the banking industry. Last month, we looked at technology-enabled lending, or marketplace lending. This month, we examine digital wallets.

New payment options made possible by financial technology are changing the way we transact with friends, family and businesses. Digital wallets—called mobile wallets when associated with a cell phone—allow purchases and money transfers without the physical use of cash, checks or credit/debit cards.

Digital Wallet Basics

Person-to-person (P2P) payments and person-to-business (P2B) payments can now be made through mobile applications on phones or even watches.

  • P2P payments use the internet, mobile applications and/or text messages to move funds through the Federal Reserve’s automated clearing house service or debit and credit card networks.
  • P2B payments use a number of technologies to transfer payments data between mobile devices and businesses, including QR codes and wireless communications.

Providers such as PayPal and its P2P payment service, Venmo, offer users numerous ways to make and receive payments from individuals and businesses.

Some digital wallets—such as those associated with Apple, Samsung and Google—allow consumers to transact with a varied number of merchants; other wallets are specific to a given merchant, such as Starbucks or Walmart.

Banks have gotten into the market, too. Zelle, a digital payments network owned by some of the nation’s largest banks, allows users to send funds directly to bank accounts.

Security Features of Digital Wallets

Digital wallets use authentication, monitoring and data encryption to secure personal information.  Other typical security features include tokenization—where sensitive information is replaced by randomly generated numbers that are then transmitted using existing debit and credit card networks.

The use of sandboxing architecture on mobile operating systems adds to the security. Sandboxing refers to the isolation of individual applications from malicious malware.

Younger Consumers Lead the Way

Experian reports that digital payments topped $720 billion in 2017,Dickler, Jessica; and Epperson, Sharon. “Digital wallets are safe, yet Americans remain wary.” CNBC, March 3, 2018. and the outlook for future growth is positive. Not surprisingly, younger consumers have been quicker to adopt the technology than their older counterparts.

A 2016 Fed report on consumers and mobile financial services found that, of those consumers with cell phones in 2015, 30% of 18- to 29-year-olds and 32% of 30- to 44-year-olds used their phones to make mobile payments. Among those older than 60, just 13% reported making mobile payments.Consumers and Mobile Financial Services 2016.” Board of Governors of the Federal Reserve System, March 2016.

These results have been backed up by other surveys. A 2015 FDIC survey showed that the underbanked made and received P2P payments at higher rates than the fully banked.2015 FDIC National Survey of Unbanked and Underbanked Households,” Federal Deposit Insurance Corp., Oct. 20, 2016

Why Digital Payments Aren’t for Everyone

Some consumers are not comfortable using digital wallets. In fact, an American Bankers Association survey released in 2017 showed that just 12% of consumers trust alternative providers to protect their payments.Survey: Americans Trust Banks Most to Keep Their Payments Safe.” American Bankers Association, Oct. 9, 2017.

One consumer concern is data privacy. Depending on the wallet service, data may be stored by a third party and used for purposes not intended by the consumer.

Some consumers also worry about balances kept in the wallet and the applicability of federal deposit insurance to those balances. They may also worry about loss of payment and personal data if a mobile device is hacked, lost or stolen—or even if a payment is sent to the wrong person.

Looking Ahead

The enthusiasm for digital wallets by younger consumers suggests that usage will continue to grow. It is reasonable to expect that advances in technology and industry standards and/or that the introduction of privacy laws and regulations will serve to reduce privacy concerns. Moreover, publications such as Consumer Reports are providing assessments of payment services to assist consumers in understanding their risks.

In the meantime, digital wallet users should read the disclosures provided by their payments service to ensure they understand the product(s) they are choosing.

Notes and References

1 Dickler, Jessica; and Epperson, Sharon. “Digital wallets are safe, yet Americans remain wary.” CNBC, March 3, 2018.

2Consumers and Mobile Financial Services 2016.” Board of Governors of the Federal Reserve System, March 2016.

32015 FDIC National Survey of Unbanked and Underbanked Households,” Federal Deposit Insurance Corp., Oct. 20, 2016.

4Survey: Americans Trust Banks Most to Keep Their Payments Safe.” American Bankers Association, Oct. 9, 2017.

Additional Resources

Posted In Banking  |  Tagged julie stackhousebankingfintechdigital walletsmobile walletsp2p paymentsp2b paymentstechnologysmartphonesmobile applications
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