Digital Transaction Definition, How It Works, Benefits

What Is a Digital Transaction?

A digital transaction is a seamless system involving one or more participants, where transactions are effected without the need for cash. The digital transaction involves a constantly evolving way of doing things where financial technology (fintech) companies collaborate with various sectors of the economy for the purpose of meeting the increasingly sophisticated demands of the growing tech-savvy users.

Understanding Digital Transactions

As the needs of investors and financial service users become more complex, there is a demand for effective tools to simplify the processes and transactions carried out by end-users. It is inevitable that financial institutions would have to increase the number of digitized services and offerings, given a rise in the use of automated services.

Implementing technology in the financial industry is a necessity for the survival of businesses as customers seek lower-cost alternatives to traditional financial services. Fintech companies have led the revolution in transforming the financial sector by digitalizing the end-client’s transactional eco-system.

How Digital Transactions Work

A digital transaction converts a traditional cash-operational society to a cashless one. It can be anything from paying for goods at a brick-and-mortar store to transferring money online to making investment trades.

Here's an example of an everyday transaction that looks quite simple but is actually embedded with digital intricacies every step of the way: 

Jane pays cash every time she goes to the grocery store (Fresh Chain). This means that every time she runs out of cash, she has to make a trip to her bank (Future Bank) in order to replenish her wallet. Unfortunately, if she needs some cash after closing hours or on a weekend, she will have to wait until the next workday when Future Bank is open for business. To include Jane in the digital finance world, Future Bank gives Jane a debit card linked automatically to her checking account. The next time Jane goes grocery shopping at Fresh Chain, she swipes her card through a hand-held payment processing device known as a Point of Sale (POS). The payment is made in seconds and Jane goes home satisfied.

Now let’s look at the behind-the-scenes digital transaction. The debit card issued to Jane is a Visa card. Visa creates cards like Jane’s which has a magnetic stripe that stores information digitally. When Jane swipes the magnetic stripe against the POS or payment processor, the transaction information is transferred to Visa. The payment processor acts as the intermediary between Visa and Fresh Chain. Visa makes note of the information received from the payment processor and forwards it to Future Bank for approval. Future Bank confirms that Jane has the necessary funds in her checking account to complete her purchase and authorizes the transaction. Visa then relays this information through the POS machine as an authorized transaction.

The exact amount of the transaction is debited from Jane’s checking account and a percentage of this amount, say 98%, is credited to Fresh Chain’s account. The remaining 2% is shared between Future Bank and Visa as their fee. Although the process seems lengthy, it actually happens in seconds.

Digital Transaction Benefits

The example of a digital transaction above was made to show how the benefits of technology adaptation outweigh the costs for businesses, financial institutions, and end-users. Still, there are digital initiatives that come up to disrupt the previous digital transaction setups. Just as credit cards are disrupting the use of cash, processes like online transactions and cryptocurrencies are disrupting the regimen where physical presence and credit cards, respectively, are required for transactions.

The e-commerce portal has provided a means by which buyers and sellers can engage in digital transactions; cloud service platforms have provided a digital process for storing data; crowdfunding gateways have provided a means by which individuals and startups can have access to funds; peer-to-peer lending forums have provided a way for individuals to lend to and borrow from each other without the hassles of the traditional banking regulation; roboadvising tools have provided a way for individuals to plan their retirement phase; etc.

These all constitute digital transactions that may eventually get disrupted by new inventions over the years.