A digital wallet is an app, or a part of an app, that stores your payment details or money you have loaded in advance, so that you can pay with one tap. It is also called an e-wallet or a mobile wallet. In India, a wallet that holds preloaded money is officially called a prepaid payment instrument, or PPI.
There are two kinds of digital wallet.
The first kind holds money. Say you load ₹1,000 into the wallet from your bank account. Later, you pay ₹240 for an auto ride from that balance, and the wallet shows ₹760 left. The wallet company keeps all its customers' money in a separate account at a bank. Ride and travel apps often have a wallet of this kind, so that you can pay the fare at the end of a ride without any extra step. A FASTag on a car works on the same idea. The toll plaza deducts the toll from the money loaded on the tag, through electronic tolling.
The second kind stores your cards. When you add a card, the wallet does not keep your real card number. It keeps a token, a different number that represents your card. When you tap your phone at a shop, or pay with the wallet on a website, the wallet sends the token. On a website, it sends the token to the shop's payment gateway. The card network, such as Visa or RuPay, then converts the token back into your real card number, so that your bank can approve the payment.
How is a wallet different from a UPI payment app? A UPI app holds no money of its own. It moves money straight from your bank account. A wallet of the first kind holds its own balance, separate from your bank account. Today, many wallet apps offer UPI payments as well, so one app can do both.
Wallets also matter outside shopping. For instance, metro systems, EV charging apps and college campus cards often use a prepaid balance of this kind, because small payments from a balance are quick and cheap.