The Development Prospects of Web3 Wallets: Innovation, Challenges, and Key Issues

Introduction

This article will delve into the current state of Web3 wallets, the progress of account abstraction (AA), and the ERC 4337 that is driving the development of the next generation of wallets, Wallet 2.0. We will also discuss the potential risks and limitations associated with Wallet 2.0.

Considering the rapid development in the Web3 wallet space, this article aims to establish a framework to help builders and investors identify long-term value. The framework will revolve around five key questions:

1. Is this a great business opportunity?

2. Can Wallet 2.0 create a brand new problem-solving method that improves effectiveness by 10 times?

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

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

5. What assumptions must we believe in order for it to be more successful than existing Wallet solutions?

Let's first understand the current state of the Web3 wallet field.

"Not your keys, not your coins"

The emergence of cryptocurrencies has completely changed our perception of money and assets. However, the pervasive distrust in traditional financial institutions has made it necessary to develop reliable and secure storage solutions. The recent collapses of financial intermediaries such as FTX, BlockFi, and SVB have highlighted the fact that the security of customer assets depends on the provider's solvency. As a result, users are increasingly turning to crypto instead of intermediaries for greater security. The advent of Web3 wallets has addressed this issue, allowing users 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 crypto assets while maintaining full control over their private keys.

Key Features of Web3 Wallet

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

Decentralization: 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 wallets can work with various blockchain protocols and cryptocurrencies, allowing users to manage multiple assets in one place.

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

User-friendly: The Web3 wallet is designed to be simple and intuitive, making it easy for anyone to use.

The Current State of Wallet 1.0

Currently, digital wallets are mainly divided into two categories: custodial wallets and non-custodial wallets.

Custodial wallets are held and managed by third-party companies like centralized exchanges (, which manage the user's private keys and essentially hold the user's cryptocurrency assets.

Non-custodial wallets give users complete control over their private keys, ensuring that the user is the sole custodian of their 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 Wallet is the most common cryptocurrency digital wallet. Users need to hold a private key, which is usually provided by centralized exchanges or wallet providers. Examples of EOA wallets include Metamask, Backpack, Phantom, Rabby, and Rainbow.

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

3. MPC Wallet uses threshold encryption technology to enhance security. The private keys required for authorized transactions are divided 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. Examples of MPC Wallets include Fireblocks, ZenGo, Coinbase MPC, and Particle Network.

In addition, there are some emerging infrastructure teams developing solutions that allow other developers to more easily create and customize wallets for end users.

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Challenges Facing Current Wallet 1.0

Despite significant progress in cryptocurrency wallets in recent years, there are still some challenges that need to be addressed to make them more user-friendly and widely adopted. The main challenges currently faced by cryptocurrency wallets include:

Difficult for ordinary users to use: Cryptocurrency wallets are challenging for ordinary users to understand, hindering their ability to leverage the advantages of blockchain technology.

Logging in is complicated: setting up an encrypted Wallet can be a complex process involving multiple steps. This can be a barrier for new users, especially non-technical ones.

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

Fragmented chains: Different chains require different wallets, increasing complexity and making it difficult for users to seamlessly manage assets across various blockchain networks.

Innovation of Account Abstraction

The emergence of account abstraction )AA( in the Ethereum network has brought significant progress 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 scope of functionality for smart contracts.

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 usability and accessibility of Wallet 2.0:

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

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

Use ERC20 tokens to pay transaction fees: Smart contracts can now use ERC20 tokens to pay transaction fees, offering more flexibility in payment options.

Paymaster: Wallet 2.0 allows third-party Paymasters to pay 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 adoption of Web3 wallets.

The Future Development 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, requiring the joint efforts of developers, entrepreneurs, and investors to achieve.

The development of ERC-4337 has led to the emergence of a new type of Wallet, which could fundamentally change the way we store and manage digital assets.

Although Wallet 1.0 provides a good starting point, it still has limitations 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 developers have begun working on Wallet 2.0. These wallets focus on user accessibility, security, and interoperability, leveraging 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.

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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 of Wallet 2.0. Here are five key questions to consider when evaluating Wallet 2.0 solutions:

) 1. Is this a great business opportunity?

A successful Wallet 2.0 solution requires more than just a useful tool; it must also have a sustainable business model. Builders need to consider factors such as revenue sources, customer acquisition costs, and profitability. Additionally, potential market size and competitive landscape must be assessed to determine whether the business can expand and thrive in the long term.

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

2. Can Wallet 2.0 create a completely new problem-solving approach that improves efficiency by 10 times?

Wallet 2.0 has the potential to address many issues of traditional wallets. For example, social recovery and atomic multi-operation features can significantly improve existing solutions.

Social recovery provides a more secure and 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 can offer advantages that traditional wallets do not have.

However, it is also important to consider Peter Thiel's principle - that a successful product must be at least ten times better than its competitors. 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 features 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?

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 builders must establish a sustainable competitive advantage to succeed in the long term. This advantage can be based on technology, network effects, or branding.

Wallet builders must identify a unique value proposition to distinguish themselves from competitors. That said, I do believe that certain specific areas will exhibit defensive advantages. Here are two examples, but this list is not exhaustive:

1. Unique proprietary distribution channels: Having unique proprietary distribution channels allows startups to stand out. It provides a unique way to reach an elusive customer base, thereby creating a unique advantage. This uniqueness can attract customers and differentiate the startup from similar products in the market.

2. Embedding viral growth into products: Embedding viral growth into products is not about luck, but rather the result of careful design. Many of the best companies have growth loops - over time, the flywheel spins faster and faster. This is Amazon's famous growth loop. What is your growth loop?

Can enterprises find a distribution channel to add smart contract functionality to existing products?

Another important issue is whether companies can leverage existing partnerships and relationships with current businesses to distribute Wallet 2.0 to a broader audience. This is particularly important given the current challenges in guiding users to use Wallet 2.0.

A potential distribution channel for Wallet 2.0 is to collaborate with centralized exchanges, which currently hold most of the user assets in the cryptocurrency ecosystem. By integrating Wallet 2.0 features into their platforms, exchanges can provide users with enhanced security and self-custody options while maintaining control over their funds. This also helps exchanges stand out in a competitive market, attracting users who value autonomy and security. The key question is how to convince exchanges to collaborate with you rather than build their own solutions? Learning from past successful cases may be beneficial.