How the Payment Ecosystem Works: Cards vs. Wallets

The payment landscape has transformed dramatically over the past few decades, driven by advancements in technology and shifts in consumer preferences. Two major players in this evolving ecosystem are traditional payment cards (credit and debit cards) and digital wallets (such as Apple Pay, Google Pay, and PayPal or other popular digital wallet applications like Samsung Pay, Venmo, and Alipay). This article aims to provide a comprehensive analysis of how these two payment methods work, their advantages and disadvantages, and their roles in the modern financial world.

Traditional Payment Cards

Payment cards, primarily credit and debit cards, have been a staple in the financial world for decades. These cards work on the principle of linking a physical or virtual card to a bank account. When a transaction occurs, the cardholder provides their card details, and the funds are transferred from their bank account to the merchant's account. The process can be summarized as follows:

1. Card Issuance: The cardholder receives a physical card or a virtual card with cardholder details and a unique card number.

2. Authentication: The cardholder presents the card information at the point of sale (POS), which can include the card number, expiration date, and security code.

3. Transaction Authorization: The merchant's terminal sends the transaction details to the card issuer for authorization.

4. Funds Transfer: Upon authorization, the funds are transferred from the cardholder's bank account to the merchant's account.

Traditional payment cards offer convenience and ease of use, allowing consumers to make purchases both online and in physical stores. They also provide additional benefits, such as reward programs, established networks, and secure and rapid transactions. Offers like cashback rewards or points can be redeemed for travel or merchandise. These rewards incentivize cardholders to use their cards for everyday purchases and can result in significant savings or benefits over time. Additionally, traditional payment cards are widely accepted by merchants around the world, making them a convenient and reliable method of payment for travellers.

A 2021 study by the Federal Reserve Bank of San Francisco found that credit cards were used for 28% of all payments - it’s the highest level since the beginning of this study in 2016, which indicates that credit cards are moving to the top of transaction methods. This trend has been confirmed by the 2023 study, which rated credit cards as the most used payment method in 2022.

However, disadvantages for card users include the risk of fraud or unauthorized transactions if the card details are compromised and the likelihood of higher transaction fees. Despite this, payment cards continue to play a crucial role in the modern financial world, providing a widely accepted and reliable method of payment for individuals and businesses alike.

Digital Wallets

Digital wallets, on the other hand, represent a more recent innovation in the payments industry. These applications store payment information securely and facilitate transactions with the help of near-field communication (NFC) technology or QR codes. Frictionless, near-instantaneous payment speeds were considered one of the most requested innovations in e-commerce in 2023. This consumer demand also returns within open banking and Banking-as-a-Service (BaaS).

The global contactless payment market was valued at USD 34.55 billion in 2021 and is expected to expand at a compound annual growth rate (CAGR) of 19.1% from 2022 to 2030. The growth is attributed to the increasing global adoption of digital payment platforms designed to facilitate customer payments at a faster rate. Contactless payments include intelligent hardware, innovative software, and smart services that improve traditional payment systems and introduce intelligent transactions. Additionally, card issuers are increasingly implementing contactless mechanisms for payment cards across the globe, thereby contributing to the growth of the market.

The workings of digital wallets can be summarized as follows:

1. Registration: Users download and install a digital wallet application, and they register their payment cards or bank accounts.

2. Authentication: To make a payment, users authenticate themselves using a PIN, fingerprint, or facial recognition.

3. Transaction Initiation: Users can initiate transactions by bringing their smartphone or smartwatch near an NFC-enabled terminal or by scanning a QR code.

4. Transaction Verification: The wallet communicates with the user's linked accounts to verify the availability of funds.

5. Transaction Completion: Upon verification, the funds are transferred to the merchant, and a digital receipt is generated.

Digital wallets offer a more streamlined and secure way to make payments. They often provide added benefits like loyalty programs and simplified peer-to-peer payments. At the same time, most digital wallets allow the user to store additional information or assets, such as loyalty cards, hotel reservations, and plane tickets. This can be particularly beneficial for businesses that frequently make travel arrangements for employees, as it ensures they have everything they need and mitigates the risk of a misplaced boarding pass or unnecessary confusion at the check-in desk.

However, digital wallets are largely dependent on the merchant's acceptance of the technology. If a merchant does not accept digital wallets as a form of payment, users may need to rely on traditional payment methods. Additionally, digital wallets typically require users to set up and maintain accounts, which may involve providing personal information and ensuring the security of their login credentials.

While digital wallets have gained popularity in recent years, their adoption and usage rates vary across different demographics and regions. Some factors that may influence consumer adoption include familiarity with technology, trust in the security of digital wallets, and the availability of supporting infrastructure.

Cards vs. Wallets: A Comparative Analysis

Security

With instances of credit card theft and financial fraud on the rise, it’s more important than ever to ensure all business transactions are secure to the point of redundancy. Digital wallets deliver this level of protection through a process called tokenization, as well as biometric authentication and device-specific encryption, which ensure that all payment information is constantly encrypted throughout the checkout process and further guarded by advanced identity verification technology such as facial recognition or two-factor authentication (2FA). Digital wallets often have the upper hand in terms of security. In contrast, physical cards can be vulnerable to theft and fraud.

Convenience

Digital wallets provide a seamless and contactless payment experience, which has been especially relevant in the context of the COVID-19 pandemic. When it comes to placing online orders, digital wallets remove the need to manually type out credit card numbers or enter personal and/or business-related information. And when making an in-store purchase, most mobile wallets allow transactions to be executed in seconds, often by simply waving a phone or smartwatch in front of a payment terminal.

Traditional cards, however, continue to be widely accepted and can be more convenient in areas where digital wallet adoption is low. Another bonus for credit card users is that if the transaction amount is high, then the credit card users can convert it into Equated Monthly Instalments (EMI) by using their credit cards. For e-wallets this option is not accessible.

Acceptance

While payment cards have global acceptance, digital wallets may not be as widely accepted, especially in regions with limited technological infrastructure. As a result, the choice between cards and wallets may depend on geographical location.

In 2022, mobile wallets accounted for roughly half of global e-commerce payment transactions. The market size of such wallets varied significantly between regions, however. Estimates are that out of approximately 2.8 billion mobile wallets in use worldwide, nearly half were in Asia-Pacific alone. Four of the five biggest real-time payment markets are in Asia-Pacific. North America and Europe are developing such systems, but for interbank payments.

Fees

When it comes to cost, both credit cards and digital wallets can have varying factors that impact overall expenses. Some credit cards come with annual fees, foreign transaction fees, and interest charges if the balance is not paid in full. However, there are also many credit cards available with no annual fee and competitive interest rates, making them a cost-effective option for responsible individuals.

Digital wallets, on the other hand, generally do not have any direct fees associated with their use. However, some digital wallet providers may charge a fee for certain transactions, such as transferring funds from the wallet to a bank account. Additionally, users should be aware of any fees charged by the linked payment methods, such as credit card cash advance fees if using a credit card within the digital wallet.

Overall, transaction fees associated with digital wallets tend to be lower than those associated with traditional cards. This cost-effectiveness can be a compelling factor for businesses and consumers.

Conclusion

The payments ecosystem is in a state of continuous evolution, with traditional payment cards and digital wallets coexisting as prominent players. The choice between these two payment methods depends on various factors, including security, convenience, acceptance, and fees. As technology continues to advance, the payment industry is likely to witness further innovations and changes. This could include advancements in biometric authentication, increased adoption of digital wallets, and the integration of payment methods with emerging technologies such as blockchain. The future of payments is undoubtedly digital, but it is important to recognize that the path to this future will be marked by a harmonious coexistence of traditional payment cards and digital wallets as they continue to meet the diverse needs of consumers and businesses.