Digital Payments: What Are They and How Do They Work?

A digital payment is a financial transaction in which money is transferred electronically from one party to another without the exchange of physical cash. 

For example, when you order food through a mobile app and pay digitally, the money is transferred electronically from your bank account to the restaurant’s account. No cash changes hands. The entire transaction occurs digitally, facilitated by payment networks through your smartphone. 

The process requires both the payer and the payee to have digital payment methods, such as a bank account linked to a mobile app or a credit card. It also depends on a secure technology infrastructure that supports instant money transfers. Digital payments can happen between individuals, businesses, or a combination of both, leveraging technology to make financial transactions faster, more convenient, and traceable compared to traditional cash exchanges. 

Digital payments involve a complex network of participants working together to complete a single transaction. At its core, the process involves four key entities: the consumer (payer), the merchant (payee), the issuer bank, and the acquirer bank.  

The consumer initiates the payment, who might be browsing at an e-commerce website or shopping at a retail outlet. The merchant represents the entity receiving the payment, which can range from small local shops to large online retailers. 

Behind the scenes, the issuer bank is the consumer’s bank, responsible for debiting the payment amount from their account. Conversely, the acquiring bank is the merchant’s bank, which receives and credits the payment.  

This transaction, which appears simple on the surface, involves sophisticated checks and processes to verify account details, confirm fund availability, and process the payment securely and efficiently. This intricate system ensures that digital payments are not only convenient but also reliable and safe. 

Digital payments encompass three distinct types that reflect the gradual transformation from traditional cash transactions to fully electronic exchanges. 

involve a digital transfer of funds with some cash elements. For example, a worker in a city sends cash through a money transfer office who then facilitates a digital transfer. The recipient, a family member or friend, collects the cash at a different location. While the physical cash transaction happens at the brick-and-mortar locations, the actual transfer of funds between the money transfer office is digital.

begin electronically but end with a cash disbursement. Again, consider a person working in a city who sends money to a family member in a rural area. The sender uses a digital wallet to send money through a transfer agent close to their family member who then collects the cash. The transfer is digital until the recipient, who may lack digital banking access, receives cash.  

conduct transactions digitally at every stage of the payment process. A good example is paying for a streaming service subscription through a digital wallet or paying for an online purchase with a credit card. The payment is initiated digitally, transferred through digital networks, received digitally, and can be immediately used for other digital transactions or stored in digital accounts.  

Digital payments bring numerous advantages for both consumers and businesses, enhancing convenience, security and efficiency. 

1. Speed and convenience: Payments can be made instantly, eliminating the need for people to carry cash or wait in line.
2. Security: Mobile devices offer additional layers of authentication, such as fingerprints or biometrics, and this can reduce the risk of fraud. Features like virtual credit cards also ensure safe, one-time use for specific transactions.
3. Cost savings: Many digital payment systems have few to no associated fees and may even offer rewards like cash back.

1. Risk reduction: Digital payments eliminate cash handling, which reduces the risk of theft and the cost of storage and security. Digital payments cost less to process than checks or other physical payment methods, cutting expenditures related to printing, postage and disposal.

2. Loyalty: Faster transactions reduce customer waiting time and can improve the overall shopping experience and potentially boost sales and brand loyalty. Additionally, immediate cash-flow visibility enables real-time tracking of income and expenses, and this allows for more informed business decisions.

3. Data insights: Digital payments enable businesses to collect valuable customer data for analytics and market segmentation. Retailers can also easily integrate loyalty and rewards programs, using targeted promotions to attract and retain customers effectively.

4. Global reach: Through digital payment platforms, even small businesses can now accept payments from customers around the world with minimal friction. These platforms allow companies to process transactions in multiple currencies and automatically convert funds at competitive exchange rates, which eliminates the complex and costly processes of traditional international banking.

At Pathward, we offer time-tested risk and compliance infrastructure for digital payment programs. Our tailored solutions provide the support you need to transact, manage, and grow confidently in a digital-first world. Learn more about how our experienced team can help you navigate the world of digital payments securely and seamlessly.