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

Web3 wallet is experiencing rapid development. This article will delve into the current innovations, challenges, and key issues that need to be considered.

This article will first examine the current state of the Web3 wallet (Wallet 1.0), as well as the progress of account abstraction (AA), particularly ERC 4337, which is driving the development of the next generation wallet (Wallet 2.0). Additionally, potential risks and limitations associated with Wallet 2.0 will also be discussed.

Considering the rapid development of the Web3 wallet field, this article aims to establish a framework to help builders and investors identify long-term value. This framework will facilitate their construction and investment in this field. The core of the framework should address five key issues:

1. Is this a great business?

2. Will building Wallet 2.0 open up a new way to solve problems that is 10 times better than before?

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

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

5. What assumptions must we believe for it to succeed compared to existing Wallet solutions?

We will explore these issues in more detail. However, let's first examine the current state of the Web3 wallet space to provide better context.

Key Features of Web3 Wallets

Web3 wallet is a type of digital wallet designed to seamlessly interact with decentralized applications using blockchain technology ( dApps ). Unlike traditional wallets, Web3 wallets allow users to maintain complete control over their assets without the need for third-party intermediaries such as banks and financial institutions. Some key properties of Web3 wallets include:

• Decentralized: The Web3 wallet is decentralized, operating on a peer-to-peer network and not relying on centralized servers. This makes them more secure and able to withstand hacking attacks and other security threats.

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

• Security: Web3 wallet uses advanced encryption technology to protect private keys and other sensitive information, safeguarding users against theft and fraud.

• User-friendly: The design of the Web3 wallet is user-friendly, featuring a simple and intuitive interface that allows anyone to access it.

The Current Status of Wallet 1.0

Currently, the landscape of digital wallets can be roughly divided into two types: custodial and non-custodial wallets.

Custodial wallets are services provided by third-party companies (, such as centralized exchanges ), that hold and manage users' private keys, essentially custodial of their cryptocurrency assets.

On the other hand, non-custodial wallets are wallet solutions where users have complete control over their private keys, ensuring they are the sole custodians of their crypto 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 type of digital wallet used for storing and managing cryptocurrencies. These wallets require users to hold their private keys, which are typically provided by centralized exchanges or wallet providers. Examples of EOA Wallets include Metamask, Backpack, Phantom, Rabby, and Rainbow.

2. A smart contract wallet is a decentralized wallet that uses 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 support. Examples of smart contract wallets include Argent, Safe, and Sequence.

3. MPC Wallet uses a technology called threshold encryption to enhance security. The private key required for authorizing transactions is split into multiple parts and distributed to different parties, ensuring that no single party can independently access the key. 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.

Finally, it is necessary to mention the emerging category of infrastructure, where 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 Current Wallet 1.0

Although cryptocurrency wallets have made significant progress in recent years, there are still several challenges that need to be addressed to make them more accessible and user-friendly. Some of the key challenges currently faced by cryptocurrency wallets include:

• Ordinary users cannot access: Encrypted wallets are difficult for ordinary users to understand, making it hard for them to take advantage of blockchain technology.

• Complicated login: Setting up an encrypted Wallet can be a complex process involving many steps. This may be a barrier for new users, especially those who are not tech-savvy.

• Lost or stolen mnemonic phrase: Encrypted wallets rely on mnemonic phrases, which are a series of words used to recover the wallet when the device is lost or stolen. However, if the mnemonic phrase is lost or stolen, it may lead to the loss of all funds stored in the wallet.

• Fragmented chain: Different wallets across different chains add another layer of complexity, making it more difficult for users to seamlessly manage their assets across various blockchain networks.

To address these challenges, wallet builders are exploring new methods and technologies to create user-friendly and secure digital wallets that are easier for the mainstream audience to adopt.

The Innovation of Account Abstraction ( "Why Now?" )

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, which limits the range of operations that smart contracts can perform.

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

Why is ERC 4337 important today?

A significant development today is ERC 4337. This Ethereum standard implements protocol AA without changing 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 now allows multiple owners, enabling the use of social recovery for lost private keys.

• Atomic multi-operation: 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, providing greater flexibility in 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 accessible and user-friendly, which is crucial for the adoption of Web3 wallet.

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 it becomes mainstream. Wallet 2.0 is the next development stage of Web3 wallets, and it requires the joint efforts of developers, entrepreneurs, and investors to make it a reality.

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

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

"What are some builders currently constructing?"

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

Some emerging Wallet 2.0 that will focus 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 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 great business?

A successful Wallet 2.0 solution requires more than just a useful tool for users. It must also be a sustainable business model in itself. Builders must consider factors such as revenue streams, customer acquisition costs, and profitability. Additionally, they must assess the potential market size and competition to determine whether the business can scale 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. Will building Wallet 2.0 open a new way to solve problems that is 10 times better than before?

The second question to ask is whether Wallet 2.0 will open up a new way of solving problems that is ten times better than before. Wallet 2.0 has the potential to address many issues associated with traditional wallets. For example, social recovery and atomic multi-operation functionalities can provide significant improvements over 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, which can save users time and money. These features can offer advantages over traditional wallets, which do not provide this functionality. However,

However, it is essential 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 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 may be the key differentiators of Wallet 2.0, providing a first-mover advantage. However, competition in the Wallet 2.0 space is fierce, and builders must establish a sustainable competitive edge to succeed in the long term. This advantage can be built on technology, network effects, or brand.

Wallet builders must determine a unique value proposition that sets them apart from their competitors. That said, I do believe that defensiveness will emerge in certain specific areas. I will discuss two below; this list is not exhaustive.

1. Unique and proprietary distribution channels: Having unique and proprietary distribution channels allows startups to stand out from competitors. It provides a unique way to reach customers that are not easily replicable, thereby offering a distinct advantage. This uniqueness can attract customers and differentiate startups from similar products in the market. I will elaborate on this in the next question.

2. Embedding viral growth into products: Embedding viral growth into products is not a matter of luck; viral growth is carefully designed. Many of the best companies have growth loops.