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How do online payments via digital wallet work?

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Last editedJun 20201 min read

The process for how digital wallet payments - like those through PayPal - work depends on one important factor: the source of funds.

In the same way the scale of Visa and Mastercard have relatively standardized the card payment experience globally, companies like PayPal have done something similar for digital wallets. Although, there can be noticeable differences from country to country and product to product.

Before we explore the process for how digital wallet payments work, there’s an important factor to consider - the source of funds. Digital wallets may act as either (or both):

  1. A storage mechanism for payment details (e.g. credit or debit card details, bank details).

  2. A storage mechanism for actual funds.

Either way, digital wallets essentially act as a layer over the top of other kinds of payment mechanisms.

1) Paying using stored payment details

If a customer makes a purchase using a digital wallet that they’re only storing their payment details for another payment method in, the process is nearly identical to a standard payment made with that method.

If it’s credit or debit card details they’re storing, they could effectively make a standard card payment. The only difference is that the digital wallet provider may be providing the merchant the facilities of a payment service provider.

If it’s bank details they’re storing, they could effectively set up a standard ACH debit authorization, provided the form is provided to them electronically.

In both these instances, the digital wallet is simply acting as an information store - like a digital brain.

2) Paying with stored funds

An alternative scenario is where the customer has funds stored within the digital wallet. These funds are usually transferred into the digital wallet via a variety of other online payment methods - e.g. bank transfers, credit or debit card payments, or transfers from other digital wallets.

When a customer wishes to make a purchase using these stored funds, the merchant must typically receive them into their own digital wallet from the same provider. Behind the scenes, no funds are really moved - the digital wallet provider simply applies a virtual debit to the customer’s wallet, and the relevant credit to the merchant’s.

If a merchant wants to transfer these funds from their digital wallet to their bank account, the process would be almost identical to a standard bank transfer, with the digital wallet provider transferring the requested amount to the merchant’s nominated bank account.

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