Rikkei Finance

<p>Cryptocurrency users frequently encounter a decision-making challenge when it comes to selecting a storage option for their funds: should they opt for a custodial or non-custodial wallet?</p><p>Custodial wallets, which are issued and managed by centralized exchanges, offer convenience at the cost of relying on a third party. On the other hand, non-custodial wallets provide enhanced security and minimize trust requirements, but they can be complex for average users to navigate.</p><p>However, what if there existed an alternative solution that combines both ease of use and security? This is where smart contract wallets come into play.</p><p>Specifically designed for this purpose, smart contract wallets provide a storage method for cryptocurrencies that offers a seamless user experience without compromising on security. In this article, we will dive deeply into the mechanics of smart contract wallets, exploring how they function and examining the benefits and drawbacks that users can anticipate.</p><h2 id="header-0">What are smart contract wallets?</h2><p>Smart contract wallets operate differently from traditional wallets, as they are managed by a contract account instead of an Externally Owned Account (EOA). Let’s review the two types of Ethereum accounts:</p><ul><li><strong>Contract Account</strong>: A contract account is governed by programmed logic embedded in the code. It doesn’t possess a private key and cannot initiate transactions on its own. However, it can execute various operations, such as calling other contracts or transferring funds, after receiving transactions from an EOA.</li><li><strong>Externally Owned Account (EOA)</strong>: An Externally Owned Account is controlled by an associated private key. With an EOA, the key holder can initiate transactions, either to EOAs or contract accounts, as the intended recipient. EOAs have limited functionalities since their account state doesn’t store any code.</li></ul><p>Currently, many wallets are managed by EOAs, allowing users to transfer Ether (ETH) and other tokens by signing transactions with their private keys. In contrast, smart contract wallets (also referred to as smart wallets) are controlled by contract code instead of a private key.</p><p>The contract code plays a crucial role in determining the conditions and criteria for accessing funds within a smart contract wallet, including the authorized individuals or entities. Furthermore, due to the programmable nature of smart contracts, smart wallets often incorporate more advanced features compared to traditional wallets.</p><p>While there are variations in the functioning of smart contract wallets, most follow a similar workflow outlined below:</p><ol><li>Upon registering with a smart contract wallet provider, a new wallet contract is deployed on the Ethereum network. It’s important to note that users need to sign up for the service using their regular Externally Owned Account (EOA).</li><li>The user’s original EOA is designated as the owner or administrator of the contract account linked to the smart wallet. Consequently, to access the funds stored in the wallet, users initiate a regular transaction and sign it with their private key, with the wallet contract as the designated recipient. As the smart contract retains the user’s wallet address, it can easily verify if a new request originates from the owner.</li><li>Many smart contract wallets provide users with the option to bypass paying transaction fees (in ETH, known as gas). This is achieved through meta-transactions, wherein users sign a transaction off-chain, while a third-party, known as a relayer, broadcasts it on-chain for execution. Typically, users can reimburse the relayer with ETH or tokens, which are automatically deducted from the smart contract wallet.</li></ol><h2 id="header-1">Advantages of Smart Contract WalletsSimplified User Experience</h2><p>Smart contract wallets offer a more user-friendly experience compared to traditional wallets. For instance, wallets like Argent provide a recovery method called social recovery, where users can designate trusted individuals as “Guardians.” If a user loses their phone or it gets stolen, a group of guardians can initiate a process to change ownership of the smart contract wallet. This eliminates the need for users to remember lengthy seed phrases or go to great lengths to securely store them.</p><h3 id="enhanced-security-features">Enhanced Security Features</h3><p>The programmable nature of smart contract wallets allows developers to implement advanced security measures to safeguard user funds. In contrast, the security of an Externally Owned Account (EOA)-controlled wallet solely relies on the private key — if the key is lost or stolen, users lose access to their funds.</p><p>Smart contract wallets offer features like setting daily transfer limits, which mitigate the risk of attackers draining all funds in a single transaction after obtaining the user’s private key. Other security measures available in smart wallets include requiring approval from trusted parties for transactions, allowing trusted parties to lock the wallet if the owner’s device is compromised or misplaced, creating whitelists of authorized receiving addresses, and implementing two-factor authentication (2FA) for unauthorized access protection.</p><h3 id="access-to-advanced-functionalities">Access to Advanced Functionalities</h3><p>Having a wallet built as a smart contract provides users with access to complex functionalities, particularly for interacting with decentralized finance (DeFi) applications. Smart wallets like DeFi Saver and Instadapp are specifically designed for advanced use cases. These wallets seamlessly integrate with on-chain lending and trading platforms such as Compound, Uniswap, and Maker, enabling users to perform intricate interactions and batch multiple calls within a single operation. For example, DeFi Saver offers “recipes,” which are bundled actions that facilitate actions like borrowing Dai from Maker or contributing liquidity to the Compound Protocol.</p><p>In contrast, regular wallets are limited to basic payments and require users to navigate cumbersome processes when engaging with DeFi applications. Smart contract wallets streamline the integration with decentralized applications (dApps), making them a superior choice for expert users.</p><h2 id="header-2">Drawbacks of Smart Contract Wallets</h2><p>While smart contract wallets offer numerous advantages, they also come with a few disadvantages. These drawbacks can be categorized into security risks and administrative complexities.</p><h3 id="security-risks-in-smart-contract-wallets">Security Risks in Smart Contract Wallets</h3><p>Smart contract wallets introduce certain security risks due to their reliance on smart contracts. Bugs or vulnerabilities in the wallet contract can result in users being unable to access their funds or expose their funds to theft by attackers.</p><p>In contrast, private-key wallets are simpler and less prone to security issues. As long as the private key is secure, no one can initiate unauthorized transfers from the wallet, even in the event of a 51% attack on the underlying blockchain.</p><h3 id="concerns-with-malicious-counterparties">Concerns with Malicious Counterparties</h3><p>Unlike Externally Owned Account (EOA) wallets that are controlled solely by the user, smart contract wallets involve third parties for various functions such as multisignature validation, account recovery/locking, and transaction relaying. While these parties are essential for the operation of smart wallets, they can introduce counterparty risks, especially if they act maliciously.</p><p>Malicious relayers can censor transactions or grief users by partially executing a call, causing the transaction to revert on-chain while still incurring gas fees. Malicious guardians, who validate transactions and control account access, can refuse to approve necessary transactions, deny users access to funds during account recovery, or collude to transfer ownership of the wallet and authorize unauthorized withdrawals/transfers.</p><h3 id="administrative-overhead">Administrative Overhead</h3><p>Using smart contract wallets involves a learning curve compared to traditional wallets. Users need to familiarize themselves with actions such as requiring transaction approval, managing access to trusted accounts, and utilizing relayers. Additionally, executing transactions with smart contract wallets often incurs higher gas costs due to increased data and computational complexity in the Ethereum Virtual Machine (EVM). These storage and computation resources are expensive, contributing to the higher costs associated with smart contract wallets.</p><h2 id="header-3">Conclusion</h2><p>Smart contract wallets have revolutionized the world of wallets by offering a combination of user-friendly features, efficiency, and enhanced security. They have simplified the process of self-custody for new cryptocurrency users and have made interacting with DeFi protocols more convenient. However, it is important to acknowledge the drawbacks mentioned in the article. These include the presence of counterparty risks, potential flaws in contract code, the complexities associated with administration, and the susceptibility to phishing attacks and private key theft.</p><p><em>Disclaimer: The information herein is for reference purposes only and should not be considered financial, investment, or trading advice. Please conduct your own research and due diligence before making investment decisions. You understand that you are using the Information provided at your own risk.</em></p>

Smart contract wallets: Everything to know

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