Narrative Point for the Next Cycle in the Wallet Sector

Narrative Point for the Next Cycle in the Wallet Sector

Background

According to data from the TokenTerminal website, the number of daily active addresses on major blockchains such as Ethereum, BSC, and Polygon is currently around 2 million. In 2022, a16z predicted in a report that Web3's user base could reach 1 billion. Clearly, Web3 is still in an early stage, with significant growth potential. Wallets are a crucial infrastructure in the crypto world, serving as the gateway to Web3 and the first stop for users entering the Web3 ecosystem.

However, the current crypto wallets have a high barrier for new users, with a low conversion rate for completing the seed phrase process. The seed phrase model requires users to securely store the seed phrase themselves. In practice, many users fail to understand the importance of the seed phrase and private keys, often losing their crypto assets due to leaking or forgetting the seed phrase. Although later industry solutions like multi-signature wallets can distribute the security risk of a single seed phrase, they are challenging to integrate into application-based projects and are usually used only by institutions or large holders to safeguard assets. To avoid the inconvenience of directly using native crypto wallets, some applications first centralize bookkeeping and only connect to crypto wallets when users need to deposit or withdraw, but this centralized method keeps assets under the control of the project party, meaning users do not truly own their crypto assets, which goes against the spirit of Web3.

Consequently, some new wallet products that balance user experience have started to emerge. Reviewing various existing technical wallet solutions and related products in the market, we find that features like seedless operation, gas-free transactions, and social recovery are becoming the new narrative points in the crypto wallet sector.

Traditional Crypto Wallets (Hierarchical Deterministic Wallet, HD Wallet)

Since Satoshi Nakamoto created Bitcoin, in the decentralized digital currency system based on blockchain technology, people can access and control their digital assets through private keys. The private key is a core component of a crypto wallet—a long string of random letters and numbers. An HD wallet uses a hierarchical deterministic algorithm to generate and manage private keys, where all private keys are derived from a master private key. The mnemonic phrase that users back up is a human-friendly, easy-to-remember representation of the master key.

Thus, in a sense, the private key is the asset and should be securely kept in the user's hands without being exposed. If someone else gains access to the user's private key, they can steal funds or conduct unauthorized transactions. Current crypto wallets generally offer various security mechanisms to protect users' private keys, such as encrypting private keys and providing mnemonic phrase backups. To balance security and convenience, wallet developers have created different product types within the HD wallet framework, such as browser extension wallets, mobile wallets, and hardware wallets, to meet the needs of different user groups.

Browser Extension Wallet

Mobile Wallet

Hardware Wallet

However, understanding the concept and importance of private keys can be challenging for many. Although users do not need to fully grasp the technical details of cryptography to use a crypto wallet, they may not comprehend the significance of private keys or mnemonic phrases. With users solely responsible for managing their private keys, news of assets lost due to accidental exposure or loss of private keys is not uncommon. As blockchain technology advances, Web3 applications like GameFi are attracting many traditional Web2 users, yet the native HD wallet design is evidently a barrier to entry. Many project teams must educate users on wallet security. Although HD wallets, as non-custodial wallets, allow users direct control of their assets, they may not be the best practice for beginners. Users need time for education to better understand and manage their private keys.

Custodial wallets, where a third party manages the user's private key, might be more suitable for some newcomers, even if they don't directly control their assets. Several non-custodial wallet solutions are available, including MPC (Multi-Party Computation) wallets and smart contract wallets.

MPC Wallets

MPC, or Multi-Party Computation, is a cryptographic technology that allows multiple parties to jointly compute a function without revealing their inputs. In the context of crypto wallets, MPC wallets often use threshold signature schemes (TSS) to eliminate the single point of failure associated with traditional private key wallets. In this scheme, the private key is split into multiple shares distributed across different parties involved in the computation, a process known as Distributed Key Generation (DKG). This means no single party can access the entire private key, helping prevent unauthorized access to user funds.

MPC wallets have several advantages. First, they do not have a single point of failure, meaning the private key is never concentrated on one device. Second, MPC wallets feature adjustable signature schemes, allowing organizations to dynamically adjust them as needed without updating the address each time. Moreover, MPC wallets offer an off-chain private key management approach, avoiding on-chain storage or management, making them compatible with multiple blockchains. Since private key sharing and signature generation occur off-chain, MPC wallet transactions are no different from traditional HD wallet transactions.

However, MPC wallets also come with limitations and challenges. The off-chain management of signature authorization and approval strategies means these customized rules can still be susceptible to centralized failures. Additionally, because the entire private key is not stored on a single device, MPC wallets are not compatible with most traditional wallets like Ledger and Trezor. The lack of standardization in MPC algorithms, with most MPC libraries and solutions not being open-source, prevents the ecosystem from independently auditing and integrating them. Moreover, MPC wallets may be more complex, requiring specialized hardware and software, and higher bandwidth, making them unsuitable for all users.

Below are some wallets utilizing MPC technology. In addition to personal wallets, there are protocols specifically designed to provide wallet/authentication services for dApps, primarily targeting application developers by offering SDKs that allow users to log in using Web2 methods, reducing development difficulty for developers and lowering the entry barrier for users.

Compared to self-custody wallets, MPC-based wallets do not provide seed phrases. Instead, they can integrate private key shards with traditional Web2 login methods. In this design, MPC wallets can split wallet management rights into several parts, some bound to Web2 applications (e.g., email, password), where transactions can only be signed, sent, and confirmed once the cumulative signatures reach a certain threshold. For instance, MPC wallet developers obtain API credentials from Google and integrate them into the MPC wallet, allowing users to log in using Web2 methods, including email, Facebook, Apple, and Twitter.

Smart Contract Wallets

In Ethereum and similar EVM blockchains, there are two basic types of accounts:

1. Externally Owned Accounts (EOA): Controlled by private keys, these accounts typically represent users or entities interacting with Ethereum. They can be used to send and receive transactions, deploy and interact with smart contracts, and execute other blockchain actions.
2. Contract Accounts (CA): Self-executing contracts with logic directly written in code lines deployed on the blockchain, capable of interacting with EOAs and other smart contracts.

A smart contract wallet is a wallet solution based on CA, using smart contracts to manage and control digital assets. Smart contracts are self-executing agreements that can automatically perform transactions based on predefined rules and conditions. For example, if certain conditions are met, such as a specific date or receiving a payment, a smart contract can automatically transfer funds from a user's wallet to another address, simplifying and automating digital asset management. Compared to EOA, CA-based smart contract wallets have the following differences:

• Control: Smart contract wallets can be controlled by multiple parties using smart contract logic, while EOA wallets are controlled by a single private key.
• Compatibility: Smart contract wallets are usually compatible only with blockchains supporting smart contracts like Ethereum, whereas EOA wallets can be used on any blockchain supporting external accounts.
• Security: Smart contract wallets can provide additional security measures, such as multi-signature or social recovery options, implemented through smart contract logic. EOA wallets rely on the security of private keys.
• Functionality: Smart contract wallets can execute complex logic and business rules using smart contracts, whereas EOA wallets depend on EOA private keys for simple operations.

Smart contract wallets also have some limitations and challenges. Once deployed on the blockchain, smart contracts are typically difficult to modify or update, which may complicate changing the rules or conditions for managing a wallet. The security and functionality of smart contract wallets depend on the underlying blockchain, so any issues with the blockchain can affect the wallet's performance and reliability. Furthermore, the transaction fees for smart contract wallets are generally higher than traditional wallets, especially for frequent operations on Ethereum.

Smart contract wallets are also closely related to Ethereum's goal of achieving Account Abstraction (AA). Account Abstraction aims to make contracts the top-level accounts for fee payments and transaction execution, enhancing Ethereum's scalability and flexibility by enabling more advanced transaction and interaction types. The Ethereum community has been exploring Account Abstraction and proposed multiple EIPs, such as the well-known EIP-4337, to achieve the key goal of Account Abstraction: allowing users to use smart contract wallets containing arbitrary verification logic instead of EOAs as their primary accounts, completely eliminating the need for users to have EOAs.

Conclusion

Early wallets were primarily tools for users to manage digital assets, such as storing assets and transferring payments. As Ethereum smart contracts gained popularity, and with the proliferation of various dApps or decentralized applications, wallets have also become Web3's gateway. However, traditional crypto wallets emphasize asset management security, lacking consideration for convenience, especially for Web2 or novice users.

MPC wallets and smart contract wallets are not new technologies. Each has unique characteristics to meet different user needs. Traditional crypto wallets focus on the security of asset self-custody, suitable for crypto veterans. MPC wallets offer a shared security, decentralized private key management solution, where users do not need seed phrases and can directly experience Web3 products in a Web2 way. Smart contract wallets extend dApp functionality, offering more possibilities, including gas-free transactions and social recovery. It is believed that in the next wave of mass adoption, wallets that accommodate Web2 users' habits will have more opportunities.