If I were to pick one thing dominating the world of payments today, impacting the daily lives of businesses and consumers alike, I’d say it is digital wallets. How significant is this global surge of digital wallets, you ask?
In less than two years, more than half the world’s population will be using digital wallets. Just last year, digital wallets accounted for 50% of e-commerce purchases and 30% of in-store purchases compared to credit and debit cards at 27% and 23%, globally. That’s a whopping $14 trillion in transaction value. This figure is expected to reach $25 trillion by 2027 . The numbers are loud and clear — a new age of global payments has dawned upon us and wallets are at the heart of it.
While digital wallets have been around for more than a decade now, their rapid worldwide adoption is relatively recent. Today, wallet capabilities are continuously expanding, from streamlining transactions to offering convenience and speed to transcending their role as mere payment tools and including services such as lending, bill payments, investments, and more within the same universe.
Not just consumers, but a growing number of businesses around the globe are increasingly embracing wallets. As the central component of the future of global payments, digital wallets are simplifying several challenges for business payments —potentially transforming the landscape.
As people and businesses around world continue to discover the vast benefits of wallets, let’s understand how wallets work and the technology behind the scenes.
What are wallets, exactly?
This is a useful starting point, because the term “wallets” means different things to different people, depending on which part of the world you are in, and who you ask.
Traditionally, apart from cash, business and people stored value in bank accounts and paid and got paid through those accounts. Then, a few decades ago, banks in the USA got together and created cards. So now business and customers had two common stores of value – bank accounts and cards. If the cards were linked to the balance in the bank account, they were debit cards, otherwise they were issued on a credit or prepaid basis. As our lives became more electronic, paying through bank accounts and cards became commonplace in the developed world, and made inroads into emerging economies. Networks and electronic devices became ubiquitous, and now pretty much every adult in most countries in the world has a mobile phone and potentially access to internet. Bank accounts, though, didn’t keep up with this growth. Due to a variety of reasons, bank accounts are not accessible to people on the lower levels of the income pyramid, and this lack of access to digital finance is part of a vicious circle denying them access to education, healthcare and employment.
At the same time, mobile network operators had another problem on their hand. They had achieved spectacular success in making mobile telephony accessible to everyone, even in emerging economies, by reducing entry barriers such as the cost of devices, and ongoing costs such as monthly minimum charges and cost of telephony and data. A large part of their user base was on a prepaid model, which meant they bought airtime and data in advance, and used them till they ran out, and then they would buy more airtime or data. But to do this without bank accounts and cards, in countries where ubiquitous electronic payments were not available, meant having a huge dealer network where their customers could go and buy airtime or data. To make it easier for their customers, the MNOs built prepaid top-up platforms, where their customers could keep money (as money) and use that money to buy airtime or data directly from their phones. Since the only use for this prepaid balance was buying airtime or data, it wasn’t considered electronic money by central banks, and prepaid top-up platforms started seeing huge growth. When operators made prepaid balances (or strictly speaking, airtime and data) fungible, they started seeing significant transactions between customers where airtime or data packs were transferred from customer to customer.
This led to the evolution of mobile wallets, where, in emerging markets, MNOs started creating accounts for their customers where their customers could deposit money, send money to other customers, pay merchants and receive money. These wallets were identified by mobile numbers (technically called MSISDNs) just like bank accounts had account numbers or IBANs, and cards had their PAN (the 16–19-digit card number). Unlike bank accounts and cards, mobile wallets were inherently digital – regulators considered them electronic money. And now that MNOs were financial institutions, they started getting licenses as financial institutions from the central banks or other appropriate regulators in their countries. As non-bank financial institutions, they had to keep 100% of the electronic money they issued in safeguarding accounts with commercial banks, and they had to follow regulations governing onboarding customers (KYC) and monitoring transactions (sanctions screening, AML/CFT, exchange control for cross border transactions etc.) This kind of mobile wallet (MNO-driven, store of value) grew explosively in countries with low banking penetration, and now account for an overwhelming majority of financial transactions in countries in Africa and Asia.
At the same time, bank accounts and cards in developed countries had other, first-world, problems. There was no easy way to pay someone with a bank account instantly and with finality – issuing cheques was the default method, and cheques could bounce. Card payments used to be cumbersome, expensive, and had high fraud rates. Banks were slow to digitize the user experience, and third-party mobile applications stepped up to solve this issue. These applications (mostly) did not store value – they debited a bank account or a card – and they ensured payment finality to the merchant. As they needed to connect to the merchant, to banks and other card issuers and acquirers, and acquire customers who would download their mobile applications and onboard themselves, these were closed loop systems – you could only transact with other customers or merchants on these systems. Despite the restrictions of closed loop systems, these systems, also called “wallets” gained popularity, and some of these wallet platforms have a globally significant volume of transactions today. These could use any form of identifier, such as email addresses or mobile numbers, as they were not issued by MNOs.
These are the two kinds of wallets we discuss in this article. There are other mobile applications called wallets which store cryptocurrencies and do various things with them, but that’s a entirely different story.
Interfaces
So, you have a wallet. How do you pay a merchant? If you have a card, it’s straightforward. If you are physically at a store, you can use the magnetic swipe device (which is going away now), insert the card into the electronic chip reader, or tap the card on the NFC terminal. These are essentially three different technologies and devices, through you may see them all bundled into one device. If you have a bank account, it’s harder to pay at a merchant physically, unless you are in a very short list of countries.
If you have a mobile wallet (of the stored-value type), though, you have some other options:
- Using mobile numbers or merchant till numbers – you can pay the merchant using the merchant’s mobile number. This works for small single-owner merchants, but for larger shops, there are “till numbers” which are short numeric codes assigned to a merchant (or indeed to each till) which you can pay just like you pay anyone using their mobile number. This is a customer-initiated payment.
- Using QR Codes – some MNOs have their own QR code systems where every merchant displays a static QR code. In some countries, this has become a national mandate where every merchant is identified by a standardized QR code. What is a QR code? It’s a two-dimensional barcode that can store much more information than the traditional bar code. Static QR codes which may be pasted to a merchant’s wall contain the wallet till code of the merchant or bank account number of the merchant. Dynamic QR codes, which would be displayed on the merchant’s POS machine, can contain the transaction amount, currency and other transaction identifiers as well. When the customer scans the merchant’s QR code, they do it with their wallet app and it becomes a customer-initiated transaction. If a merchant scans a customer’s QR code (presented through the wallet app), it becomes a merchant-initiated request to pay transaction which the customer then authorizes through their app.
If you have a mobile wallet (of the pass-through store-of-value type), you may have other options:
- QR codes, just like the other mobile wallets, either closed loop or nationally standardized QR codes.
- NFC – some wallets automatically issue you tokenized card credentials liked to your preexisting card, or bank account which they pass to NFC-enabled POS machines. This creates a standard card transaction which can debit your card or bank account. It is possible that the app stores your card without tokenization, but that is unlikely and less secure.
Authorisation
Authorisation is the process by which your wallet issuer gets a specific approval from you for every transaction. One of the advantages of the mobile wallet ecosystem is that it’s new, and all digital, and by definition, always connected to the customer. Authorisation for mobile wallet transactions can be done in real time by the wallet issuer with the customer. How exactly this authorisation is performed differs by issuer and transaction type. Options include entering your secret passcode; using an one-time password; or device-based biometric authentication, where your smartphone’s ability to securely read your fingerprint or use facial recognition is tied in to the wallet’s transaction authorisation system.
Networks
Now that you know how wallets work, the next question is how do they interoperate? There was a time when banks did not interoperate. The evolution of cheque clearing leading to automated cheque clearing and inter-bank national payment systems, and SWIFT, enabled banks to seamlessly interoperate. Cards were designed to interoperate within their own network, and still do so today. Interoperability creates economic opportunities for merchants and customers and can supercharge economies.
Mobile wallet interoperability is in its early stages. In some countries, mobile wallet issuers have bilateral interoperability. This is cumbersome and not scalable. Other countries are looking at bring wallets on to national payment systems.
TerraPay, along with leading wallet issuers worldwide, has taken the initiative to form a wallet council to create seamless cross-border interoperability between wallets. Read more about this initiative here.