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

Introduction

This article aims to explore the current innovations, challenges, and key issues that need to be addressed in the field of Web3 wallets, rather than simply outlining the development process. We will first analyze the current state of Web3 wallets (Wallet 1.0), as well as account abstraction (AA), particularly the role of the ERC 4337 standard in promoting the development of the next generation of wallets (Wallet 2.0). We will also discuss the potential risks and limitations of Wallet 2.0.

Considering the rapid development in the Web3 wallet space, this article proposes a framework to help developers and investors identify long-term value. This framework focuses on five core issues:

1. Is this a high-quality business model?

2. Can Wallet 2.0 provide a solution that is 10 times better than existing options?

3. How can enterprises establish sustainable competitive advantages, especially in cases where they heavily rely on first-mover advantages?

4. Can companies find distribution channels to add smart contract functionality to existing products?

5. What assumptions need to be made for Wallet 2.0 to surpass existing wallet solutions?

Next, we will delve into these issues in detail. First, let us review the current state of the Web3 wallet to provide better background information.

"Not your keys, not your coins"

The emergence of cryptocurrency has completely changed our perception of money and assets. However, the widespread distrust of traditional financial institutions has made it necessary to develop reliable and secure storage solutions. The recent collapses of financial intermediaries like FTX, BlockFi, and SVB highlight the fact that the security of customer assets depends on the solvency of the service provider. As a result, users are increasingly turning to cryptographic technologies instead of intermediaries for greater security. Web3 wallets have emerged, providing users with the ability to securely store and manage their crypto assets while maintaining full 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 crypto assets while fully controlling the private keys.

Key Features of Web3 Wallets

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

Decentralized: Web3 wallet operates on a peer-to-peer network, relying not on centralized servers, which makes it more secure and able to withstand security threats such as hacking.

Interoperability: Web3 wallet can be compatible with various blockchain protocols and cryptocurrencies, allowing users to manage multiple assets in one place.

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

User-friendly: The Web3 wallet interface is simple and intuitive, making it easy 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.

Custodial wallets are held and managed by third-party companies ( such as centralized exchanges ), essentially custodial of the user's cryptocurrency assets.

Non-custodial wallets allow users to have full control over their private keys, ensuring that the user is the sole custodian of their encrypted assets. Non-custodial wallets can be further divided into three categories: externally owned account (EOA) wallets, smart contract wallets, and multi-party computation (MPC) wallets.

1. EOA Wallet is the most common cryptocurrency storage and management wallet. Users need to hold a private key, which is usually provided by centralized exchanges or wallet providers. For example, Metamask, Backpack, Phantom, Rabby, and Rainbow.

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

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

In addition, there are some emerging categories of infrastructure where development teams are building solutions and primitives to simplify the process for other developers to create and customize wallets for end users.

Challenges Facing the Current Wallet 1.0

Despite significant advancements in cryptocurrency wallets in recent years, there are still several challenges that need to be addressed to improve their usability and ease of use. Some of the key challenges currently facing cryptocurrency wallets include:

Difficult for ordinary users to use: Cryptocurrency wallets are hard for ordinary users to understand, hindering them from leveraging the advantages of blockchain technology.

The login process is complicated: setting up an encrypted Wallet may involve multiple steps, which is a barrier for new users, especially non-technical users.

Mnemonic phrase lost or stolen: Crypto wallets rely on mnemonic phrases to recover the wallet, but if the mnemonic is lost or stolen, it may result in the loss of all funds in the wallet.

Fragmentation of chains: Different wallets on different chains increase complexity, making it more difficult for users to seamlessly manage assets across multiple blockchain networks.

The 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 main difference 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 operational scope of smart contracts.

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

Why is ERC 4337 important now?

The ERC 4337 Ethereum standard implements protocol-level Account Abstraction (AA) without changing the consensus layer. ERC 4337 introduces several key features that enhance the user-friendliness and usability of Wallet 2.0:

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

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

Use ERC20 tokens to pay transaction fees: Smart contracts can now use ERC20 tokens to pay transaction fees, providing more flexible payment options.

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 user-friendly and accessible, 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 much work to be done before they become mainstream. Wallet 2.0 is the next stage of development for Web3 wallets, which requires collaboration between developers, entrepreneurs, and investors to achieve.

The development of ERC-4337 has given rise to a new type of Wallet that has 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 areas, especially in terms of usability and login complexity. The future of Wallet 2.0 lies in addressing these limitations while introducing new features to enhance functionality and security.

"Some content that some developers are currently building"

Some developers have begun to map out Wallet 2.0. These wallets focus on user usability, security, and interoperability. They utilize 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.

5 Key Questions to Ask When Evaluating 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 have a sustainable business model. Developers must consider factors such as revenue sources, customer acquisition costs, and profitability. Furthermore, they must assess the potential market size and competitive landscape to determine whether the business can scale and thrive in the long term.

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

2. Can the construction of Wallet 2.0 open a problem-solving method that is 10 times better than existing solutions?

The second key question is whether Wallet 2.0 can open up a problem-solving approach that is ten times better than existing solutions. Wallet 2.0 has the potential to address many issues related to traditional wallets. For example, social recovery and atomic multi-operation features can significantly improve existing solutions.

Social recovery offers 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 money. These features could provide advantages over traditional wallets.

However, considering Peter Thiel's principle - successful products must be at least ten times better than the competition - it is crucial. When evaluating the potential of utilizing ERC-4337, businesses should assess whether this technology brings substantial improvements in productivity, creativity, or quality. Additionally, the economic feasibility of implementing smart contract functionalities should be evaluated to ensure that the benefits outweigh the associated costs.

3. How can enterprises establish sustainable competitive advantages, especially in cases where they heavily rely on first-mover advantages?

The third question is how enterprises can establish sustainable competitive advantages, especially in cases where they heavily rely on first-mover advantages.

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

Wallet developers must identify a unique value proposition that sets them apart from competitors. That said, I believe certain specific areas will exhibit defensive advantages. I will discuss two aspects, but this list is not exhaustive.

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

2. Incorporate viral growth into your product: Viral growth is not a matter of luck, but the result of careful design. Many of the best companies have a growth loop - the flywheel spins faster over time. This is Amazon's famous growth loop. What is yours?

4. Can enterprises find distribution channels to add smart contract features to existing products?

Another important question is whether companies can leverage existing partnerships and relationships with current enterprises to distribute Wallet 2.0 to a broader audience. This is particularly important given the challenges currently faced in guiding users to adopt Wallet 2.0.

A potential of Wallet 2.0