The Future of Web3 Wallets: Innovation, Challenges, and Key Issues

Introduction

Recently, the Web3 wallet sector has developed rapidly. This article aims to delve into the current innovations, challenges, and core issues that need attention, rather than simply reviewing the development history. We will first analyze the current status of Web3 wallets (Wallet 1.0), as well as account abstraction (AA), especially the driving role of ERC 4337 in the development of the next generation of wallets (Wallet 2.0). We will also discuss the potential risks and limitations related to Wallet 2.0.

Considering the rapid changes in this field, this article presents a framework to help developers and investors identify long-term value. The framework revolves around five key questions:

1. Is this a high-quality business model?

2. Can Wallet 2.0 create a new method that is 10 times better than existing solutions?

3. How can enterprises establish sustainable competitive advantages in a situation that highly relies on first-mover advantages?

4. Can the company find a distribution channel to add smart contract functionality to existing products?

5. What assumptions do we need to believe for Wallet 2.0 to be more successful than existing wallet solutions?

Let’s first review the current state of Web3 wallets to provide context for the subsequent discussion.

"Not your keys, not your coins"

The emergence of cryptocurrency has fundamentally changed people's perceptions of currency and assets. However, the widespread distrust of traditional financial institutions has made it necessary to develop reliable and secure storage solutions. Recent failures of financial intermediaries like FTX, BlockFi, and SVB highlight the fact that the safety of client assets depends on the solvency of the service provider. As a result, users are increasingly turning to cryptocurrency means rather than intermediaries for greater security. The Web3 wallet has emerged, providing users with the ability to securely store and manage their crypto assets while maintaining complete control over their private keys. As the saying goes: "Not your keys, not your coins."

If you cannot control the private keys of your crypto assets, you cannot truly own these assets. The emergence of Web3 wallets solves this problem, allowing users to securely store and manage their crypto assets while fully controlling the private keys.

Key Features of Web3 Wallets

A Web3 wallet is a digital wallet designed to seamlessly interact with decentralized applications based on blockchain technology (dApps). Unlike traditional wallets, Web3 wallets allow users to have full control over their assets without the need for third-party intermediaries such as banks. Some key features of Web3 wallets include:

Decentralization: The Web3 wallet is decentralized, operating on a peer-to-peer network without relying on centralized servers. This makes it more secure and able to withstand security threats such as hacking.

Interoperability: Web3 wallet is designed to support various blockchain protocols and cryptocurrencies, allowing users to manage and store multiple assets in one place.

Security: The Web3 wallet uses advanced encryption technology to protect sensitive information such as private keys, preventing theft and fraud.

User-friendly: The design of the Web3 wallet focuses on user-friendliness, with a simple and intuitive interface that is convenient for anyone to use.

The Current Status of Wallet 1.0

Currently, digital wallets can be roughly divided into two categories: custodial wallets and non-custodial wallets.

A custodial wallet is a service where a third-party company (, such as a centralized exchange ), holds and manages the user's private keys, essentially managing the user's cryptocurrency assets.

A non-custodial wallet is a wallet solution where users have complete control over their private keys, ensuring that they are the sole custodian of their encrypted assets. Non-custodial wallets can be further divided into three categories: externally owned accounts ( EOA ) wallets, smart contract wallets, and multi-party computation ( MPC ) wallets.

1. EOA Wallets are the most common type of digital wallets for storing and managing cryptocurrencies. These wallets require users to hold private keys, which are usually provided by centralized exchanges or wallet providers. Examples of EOA wallets include Metamask, Backpack, Phantom, Rabby, and Rainbow.

2. Smart contract wallets are decentralized wallets that use smart contracts to manage assets. Compared to EOA wallets, these wallets are more secure and flexible, supporting advanced features such as social recovery and multi-signature. Examples of smart contract wallets include Argent, Safe, and Sequence.

3. The MPC wallet uses threshold encryption technology to enhance security. The private keys required for authorizing transactions are divided into multiple parts and distributed to different parties, ensuring that no single party can independently access the keys. This method significantly reduces the risk of single points of failure or attacks, making it harder for hackers to steal funds. Examples of MPC wallets include Fireblocks, ZenGo, Coinbase MPC, and Particle Network.

In addition, it is worth mentioning the emerging category of infrastructure, where some teams are developing solutions and primitives that enable other developers to create and customize wallets for end-users, thereby simplifying the wallet creation process.

Challenges Facing the Current Wallet 1.0

Despite the significant progress made in cryptocurrency wallets in recent years, there are still some challenges to making them more accessible and user-friendly. The main challenges currently facing cryptocurrency wallets include:

Difficult for ordinary users to use: Crypto wallets are hard for ordinary users to understand, making it difficult for them to take advantage of the benefits of blockchain technology.

Complex login process: Setting up an encrypted wallet can be a complicated procedure involving multiple steps. This may pose a barrier for new users, especially those who are not tech-savvy.

Lost or stolen mnemonic phrase: Cryptocurrency wallets rely on mnemonic phrases to recover wallets when devices are lost or stolen. However, if the mnemonic phrase is lost or stolen, it may result in the loss of all funds stored in the wallet.

Fragmentation of chains: The use of different wallets for different chains adds another layer of complexity, making it harder for users to seamlessly manage assets across various blockchain networks.

To address these challenges, Wallet developers are exploring new methods and technologies to create user-friendly and secure digital wallets that are easier for mainstream users to adopt.

Innovation of Account Abstraction ( "Why now?" )

The emergence of account abstraction (AA) in the Ethereum network has brought significant advancements to the development of Web3 wallets. AA introduces on-chain programmability through smart contracts, adding flexibility to Web3 wallets.

The key differences between EOA and smart contract accounts

Traditionally, only EOAs can control funds on the Ethereum network. This means that smart contracts must rely on EOAs to execute transactions, limiting the range of operations that smart contracts can perform.

With AA, smart contracts can now directly control funds, making them more powerful and versatile.

The importance of ERC 4337

ERC 4337 is an important advancement that achieves protocol-level AA without altering the consensus layer. ERC 4337 introduces several key features that enhance the user-friendliness and accessibility of Wallet 2.0:

Social Recovery: Wallet 2.0 can now have multiple owners, allowing for social recovery of lost private keys.

Atomic Multi-Operation: Smart contracts can execute multiple transactions as a single atomic operation, simplifying complex transactions and ensuring their integrity.

Pay transaction fees using ERC20 tokens: Smart contracts can now use ERC20 tokens to pay transaction fees, providing greater payment flexibility.

Paymaster: Wallet 2.0 allows third-party Paymasters to sponsor transaction fees on behalf of users, optimizing gas usage and improving efficiency.

These features make Wallet 2.0 more accessible and user-friendly, which is crucial for the widespread adoption of Web3 wallets.

The Future of Wallet 2.0

The development of Web3 wallets is still in its early stages, and there is a lot of work to be done before they become mainstream. Wallet 2.0 is the next development phase of Web3 wallets, which requires the joint efforts of developers, entrepreneurs, and investors to achieve.

The development of ERC-4337 has spawned a new type of Wallet, with the potential to completely change the way we store and manage digital assets.

Although Wallet 1.0 provides a good start, it still has limitations in many aspects, especially in terms of user accessibility and login complexity. The future of Wallet 2.0 lies in addressing these limitations while introducing new features to improve functionality and security.

"Some content being built by developers"

Some developers have begun to outline the landscape of Wallet 2.0. The focus of these wallets is on user accessibility, security, and interoperability. They leverage the power of smart contracts to provide features such as social recovery, atomic multi-operations, and gas fee sponsorship.

Some emerging Wallet 2.0s focused on ERC-4337 include Castle, Soul Wallet, Candide, Unipass, Biconomy, Banana Wallet SDK, Stackup, and Etherspot.

Assessing the 5 Key Questions of Wallet 2.0

As with any emerging technology, it is very important to assess the potential risks and rewards associated with Wallet 2.0. Here are five key questions to consider when evaluating Wallet 2.0 solutions:

1. Is this a high-quality business model?

A successful Wallet 2.0 solution not only needs to be useful for users, but it must also be a sustainable business model. Developers must consider factors such as revenue sources, customer acquisition costs, and profitability. In addition, they need to assess the potential market size and competitive landscape to determine whether the business can expand and thrive in the long term.

The competition in the Wallet 2.0 space is fierce, and new solutions must offer a compelling value proposition to succeed. The business model must be sustainable and have a clear path to profitability.

2. Can Wallet 2.0 create a new method that is ten times better than existing solutions?

The second question to ask is whether Wallet 2.0 can create a new method that is ten times better than existing solutions. Wallet 2.0 has the potential to solve many issues of traditional wallets. For example, social recovery and atomic multi-operation functionalities can significantly improve existing solutions.

Social recovery provides a safer and more user-friendly way to recover lost private keys, while atomic multi-operations allow multiple transactions to be executed as a single transaction, saving users time and funds. These features offer advantages that traditional wallets do not have.

However, it is crucial to consider Peter Thiel's principle - a successful product must be at least 10 times better than its competitors. When evaluating the potential of leveraging ERC-4337, businesses should assess whether this technology brings substantial improvements in productivity, creativity, or quality. Additionally, the economic feasibility of implementing smart contract features should also be evaluated to ensure that the benefits outweigh the associated costs.

3. How can enterprises establish a sustainable competitive advantage, especially in situations that highly rely on first-mover advantage?

The third question is how enterprises can establish a sustainable competitive advantage, especially in cases where there is a heavy reliance on first-mover advantage.

Social recovery and atomic multi-operations may be key differentiators for Wallet 2.0, providing a first-mover advantage. However, the competition in the Wallet 2.0 space is fierce, and developers must establish a sustainable competitive advantage to succeed in the long term. This advantage can be built on technology, network effects, or branding.

Wallet developers must define a unique value proposition that differentiates them from competitors. That said, I do believe that certain specific areas will present defensive advantages. Here are two examples, but this list is not exhaustive:

1. Unique and proprietary distribution channels: Having unique and proprietary distribution channels allows startups to stand out from their competitors. It provides a distinctive way to reach hard-to-replicate customer segments, thereby creating a unique advantage. This uniqueness can attract customers and differentiate the startup from similar products on the market. I will elaborate on this in the next question.

2. Embed viral marketing into products: Embed viral marketing