The Tie Research
Crypto Wallets: The Drivers of Mass Adoption
Your debit card does not hold your money. It only authorizes your bank account to send transactions to the banking system database. Similarly, your crypto wallet does not hold your coins. Instead, it holds the private keys to prove ownership of digital assets, which are stored on public blockchain networks. Private keys allow you to authorize transactions from crypto wallets. Since blockchain transactions are irreversible, whereas traditional bank transactions have more reversibility and safeguards, the stakes are higher for this safeguard than in traditional asset usage.
Losing your private key is the equivalent of losing your credit card, without third parties safeguards like bank card cancellation. While options like non-custodial wallets give you full control over digital assets, they impose greater responsibility and security knowledge to protect wealth.
Crypto wallets are the only entry point for everyone joining Web 3.0 economies, meaning wallet providers will generate significant traffic, allowing them to become attractive partners in the market. Greater demand also leads to more innovation from wallet providers, creating more streamlined user experiences, and enhancing security.
Crypto wallets come in many forms, each with different levels of security and convenience:
- Offline wallets (Cold): Keys are stored in a hardware device, like a USB stick (Ledger), that is only connected when you want to use your crypto.
- Online wallets (Hot): Keys are stored in an application or software and are connected to the internet whenever your devices are.
Wallets can also divide into custodial vs. non-custodial wallets:
- Custodial wallets: a trusted third party holds private keys and securely stores digital assets on the blockchain. This also means users do not have complete control over your funds. This type of wallet is offered mainly by entities such as major U.S crypto exchanges or professional custodial services.
- Non-Custodial wallets: a type of wallet which gives users complete control of their keys and funds. Non-custodial wallets can be browser-based, software, or hardware, among other options.
As the crypto wallet sector has matured, dozens of crypto wallets have emerged that increase not only security but also provide much friendlier user interfaces and better support services.
Before the rise of the modern banking system in the 1900s, it was much more common for people to self-custody their assets. With the rise of eCommerce, a huge portion of the economy (online transactions) became difficult to access without a bank account, or other form of trust in a third party protected by laws and regulations.
Without the current banking system, someone living in the US might need to carry a big suitcase full of cash and travel across half the world to buy art from Singapore. They would also need to invest heavily in securing their financial assets. Under the current status quo, asset custody is handled by a third party, and electronic trading worldwide is relatively seamless.
However, there are trade-offs for convenience. When you send large sums of money across the ocean, you need to trust that your bank will do what they promise, and that laws can protect you in a situation where the bank steals your money. Additionally, banks have working hours, and in some cases you can not settle international trades on weekends, which is very inconvenient.
What if you want to purchase something overseas but you live in a country where you can't trust your government or national banks?
This is a case where people might find non-custodial wallets, and blockchain payment rails helpful. However, this also requires a user to again take the responsibility of protecting assets themselves – in some sense a regression to how people preserved their cash and hard assets prior to modern banking.
Custodial wallets & services
With the rise of fintech and digital banking technology, people are increasingly used to trusting third parties to secure their assets. Younger generations in developed countries (and some developing countries) are no longer familiar with storing cash and gold in physical vaults at home. Instead, they leave most of their assets in the bank since they find the banking system and laws reliable.
Similar practices also apply to enterprises and large financial institutions. Therefore, it is reasonable for many of these to opt for crypto custodial services provided by trusted third parties. This practice allows them to offload cyber risk to specialist firms, while leveraging public blockchain applications to help enable what they do best.
However, as regulation around crypto custodians is not fully developed, even within strict regulatory environments like the U.S or Europe, customers could still find themselves vulnerable to financial loss trusting centralized custodian services like Celsius or FTX.
Additionally, there are distinctions between custodian services and technology providers. (1) Custodian services offer stores and manage customers' assets in an accessible, protected, and regulated manner. On the other hand, (2) custody technology providers service the underlying technology to enhance their custody solutions and experiences interacting with ecosystem applications. The critical distinction between custodian services and tech providers is that tech providers do not have access to move clients' funds. In contrast, custodians can freely move or leverage customers' funds with minimal oversight.
Third parties, like Bitgo (who helped provide information & data for the piece), provide a combination of both qualified custodianship and infrastructure, offer customers the flexibility to choose and modify their custody setups and needs.
When looking for reliable custodian services, there is confusion around "qualified" custodians for several reasons. Not only do different countries have different regulations for this business, but custodian and tech provider services also have different licensing requirements. Some countries allow custodian services to acquire technology provider licenses, but that does not mean they do and will obtain the custodian license to become qualified custodians.
Therefore, a good understanding about specific regulations, licenses, and insurance policies are the requirements for clients that will help them avoid financial losses from putting trust in the wrong places.
Given that 99% of the global transactions still settle in fiat currencies, it’s worth noting that crypto wallets can also be used to store pegged digital currencies like USDC/EURC (privately issued), or CBDCs (central banks issued) – not only volatile digital assets such as BTC and ETH. As the application layers on public blockchains grow, we can expect the rise in demand for digital asset custodians before any crypto-currency becomes multinational legal tenders.
Additionally, it is impossible to predict whether the block-space market will see a "winner take all'' situation, where a specific blockchain dominates the market, or instead will see a multi-chain world with new blockchains (both public and private) frequently introduced to the market.
However, will that question even matter to typical users? Or will they even care?
When e-commerce users purchase from the internet, they only care about their packages being delivered securely and quickly at minimal cost. They do not care whether sellers ship packages via their own service, or partner with shippers like FedEx or USPS.
Similarly, when web 3.0 applications see wider adoption, their users probably will not be overly concerned about the details of which chains are used, or the wallet backend handling transactions. Expecting users to become experts in blockchain to use web 3.0 applications is not practical; it’s the equivalent of requiring internet users to become HTTPS experts.
Internet users do not care about what server or cloud provider their favorite platform is built on. They only care if their computer or smartphone can use the service. The most important factors have been, and will continue to be, user experience (convenience) and security (privacy, funds).
So, when average users find an interesting decentralized application, or an entertaining blockchain game, they likely won’t care about what chain those applications are built on and what cross-chain protocol they need to use to start playing the game. Instead, they only ask themselves the same question we ask when using web browsers: "Can I access those apps using this wallet?" and "Is that wallet more secure and easier to use than others?"
That leaves all the heavy lifting work for the wallet builders, who will be rewarded for solving these problems, and turning their solutions into a profitable business.
From B2C to B2B2C business
Since crypto wallets are the primary access point to web 3.0 economies, wallet providers will have the opportunity to gain bargaining power through increasing customer usage and on-ramp options (direct fiat trading volume, cross-chain swaps, etc…).
Currently, crypto wallet providers' most popular monetization models are either selling hardware devices, building a margin into crypto/fiat trading volume, or building a margin from integration of direct DEX swapping. As the traffic bottleneck for web3 economic activity, wallet providers have the opportunity to capitalize on cross-chain liquidity and traffic.
When trading volume increases as the market becomes more mature, wallet providers will start creating economic moats and entry barriers, while profiting off of the traffic they generate. This greater bargaining power will position wallet products as more attractive B2B partners for other DAapps and DEX protocols, turning them into a B2B2C business model.
The internet became popular thanks to the birth of the World Wide Web, search engines, and countless other innovations in the infrastructure and application layer. Fifteen years ago, users had to be cautious and knowledgeable to understand the risk of new computer viruses whenever they stuck a USB into a computer. Nowadays, users rarely think about virus risks, and spend more time finding and using applications.
While current crypto users are still faced with complexities around managing seed phrases, cross-chain transactions, and security risks using crypto wallets, thousands of builders are working hard to move the crypto industry forward by minimizing these pain points.
For example, major wallet providers such as Ledger (cold wallet) and Metamask (hot wallet) have now integrated with credit card vendors and banks in order to help streamline the process of funding wallets. This was driven by an understanding of how complex it was to buy crypto assets on exchanges and send them to your wallet. These providers also integrate with popular DEX protocols like Uniswap and Curve, so users can swap their tokens directly in the wallet without worrying about confirming the correct website & opening themselves up to phishing attacks.
To make the wallet experience even more natural and intuitive for crypto users, wallet providers are now working to offer popular features while also creating a user interface that minimizes the number of clicks needed to complete any on-chain action. With the same vision that multi-chain and cross-chain will continue to be the future, wallet providers such as Core Wallet and Coin98 focus on designing products that will be simple, secure, and convenient to use. Hopefully, by reducing the UX complexity of interacting with DeFi, it will become more accessible to non-blockchain native users.
With continuous developments and innovations on both infrastructure and applications layers, the demand and market size for secure crypto storage is becoming increasingly important, especially for financial institutions that are required to uphold their position as fiduciaries while managing their clients' funds.
While non-custodial wallets allow users to be responsible for digital assets themselves, we can expect the rise of custodian services and technology providers as global regulators develop the appropriate frameworks for this new asset class.
Although it sounds complicated for the average user to learn the concept of seed phrases, gas fees, and multi-chain, much of this complexity will ultimately be abstracted away from the end-user- just like the internet did. Down the line, it’s like that an end user won’t have to know what chains or infrastructure they’re interacting with; just like 99% of people today don't know about TCP/IP, but still participate safely online.
While popular solutions like Cosmos IBC, Polkadot XCM, LayerZero, and Avalanche Cross-Subnet need time to prove their respective models, wallet security will remain an industry bottleneck that will need to improve for scalable and secured cross-chain applications to become possible.
This report is for informational purposes only and is not investment or trading advice. The views and opinions expressed in this report are exclusively those of the author, and do not necessarily reflect the views or positions of The TIE Inc. The Author may be holding the cryptocurrencies or using the strategies mentioned in this report. You are fully responsible for any decisions you make; the TIE Inc. is not liable for any loss or damage caused by reliance on information provided. For investment advice, please consult a registered investment advisor.
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