What Are Smart Contract Wallets, and Why They Are Essential for DeFi

Interaction with any cryptocurrency for a user begins with a wallet. There are two common types of cryptocurrency wallets, and each of them is ideally suited for their tasks. First are so-called “hot” crypto wallets such as Electrum or MetaMask. They are extremely popular to buy and sell coins and NFTs with. They are constantly connected to the network, so they are the most convenient to make fast and regular transactions with.

Slightly less popular are “cold” wallets such as Keystone, Trezor, Ellipal and Ledger. These are hardware wallets stored on your device. They connect to the network only for the duration of their use. This adds to their security, since no information is stored on the Web. They are impossible to hack, the keys are stored only on your device, and they are more resistant to fishing attempts. But also these wallets are less convenient to use, and if you lose them or lose the keys to them, all your coins are gone.

But there is a third, most advanced type of wallets — Smart Contract Wallets. These “smart wallets” combine convenience with security, and allow for flexibility of use. If you don’t have such a wallet yet, it’s probably worth getting one, at least in order to understand how this technology works.

A smart wallet is a wallet (usually working with Ethereum or its sidechains) operated by a smart contract located on the blockchain. This allows it to interact more deeply with cryptocurrencies, and opens up unique new opportunities in DeFi. Advanced features include, for example, the ability to restore a wallet through trusted persons, to set daily limits on transfers, or to temporarily freeze a wallet if you aren’t going to interact with it in the near future. Basically, there are a lot of additional recovery and security features for no extra cost. That is why Ethereum founder Vitalik Buterin calls it the future of DeFi and says that people need to use wallets with smart contracts.

Some examples of current smart wallets:

• Authereum
• Argent
• Pillar
• Gnosis Safe

How Do Smart Wallets Function?

Logging into smart wallets and conducting fund transfers are done with the help of smart contracts, small programs uploaded to the blockchain. This gives smart wallets almost limitless features, and allows for more ways to secure and manipulate assets.

The fact is that the Ethereum chain right now supports the creation of two kinds of wallets:

• external wallets, that can on occasion be connected to the chain using a key or seed phrase
• special contract wallets that work only according to the predetermined smart contract code (they are mostly used by corporate entities).

Right now Ethereum accounts can be of either first or second kind (although these kinds of wallets potentially may be merged into one with the release of Ethereum 2.0). Most user-controlled wallets are external and because of that have rather limited functionality. In fact, usually they can only receive and transfer cryptocurrency. But smart wallets can already combine these two types of accounts, and therefore their audience can get the best of both worlds. On the one hand, they are able to remain secure, with only you alone holding the keys. On the other hand, they get access to many functions encoded in the blockchain. Also, unlike normal contract accounts, they can have a user interface that is familiar to the average user.

What Benefits Can Wallets With Smart Contracts Bring?

Additional features available only to smart wallets include:

• Wallet emergency lock. If your device was stolen, your account may be temporarily blocked. This feature seems basic, and yet most hardware wallets don’t support it.
• Transaction limits. You can set them both for a payment and for a day. This allows you to avoid a costly mistake and keeps you safe from hackers. They will not be able to withdraw all your money in a day, and so you will have time to notice that something is wrong
• Transactions only by major vote. For a transaction to go through, it must be approved by two or more users. This greatly improves safety, especially for a corporate account. A very useful feature for various DeFi platforms and application owners.
• Implementation of a white list. You can specify the addresses to which cryptocurrency transfers can be made. Transactions to other addresses will not be available.
• 2FA or 3FA. Some wallets allow you to interact with external authentication applications, which further enhances security.
• Application gas fees. DeFi app owners can set up their Authereum wallet to automatically pay for gas fees when transactions are made through their platform. This saves their audience from having to keep Ethereum in their wallet, which greatly improves the onboarding of new users. This feature might be mandatory for new DeFi apps in the future.

Another great feature of smart wallets is social recovery. People’s biggest fear in crypto is that they will lose the keys and all their cryptocurrencies will be gone forever. To address that, Argent client allows its users to appoint a few trusted custodians of their account. These guardians will be able to confirm certain actions, such as transacting with non-whitelisted addresses or changing transaction limits. Trusted guardians can also unlock the wallet or allow it to be used on a new device.

The good news here is that the possibilities to introduce new DeFi functions to smart wallets are almost endless. In theory we are capable of implementing anything that could be put into code and uploaded to the blockchain.

Additional Features of Smart Wallets

In addition to the security and ease-of-use features requested by regular users, some smart wallets have special features that are relevant for advanced clients.

For example, DeFi Saver Smart Wallet is able to conduct group transactions. It also features automated monitoring of your Vault disposal. If you enable this feature, the application will detect if the collateral ratio of your Vault is falling below the specified parameter. At this time it will change some of the various cryptocurrencies in the wallet to stablecoins. It is an additional mechanism for securing investments.

If you are building a dApp yourself, you can develop a smart wallet alongside it, or put some relevant smart contracts on the blockchain to improve user experience for your audience and help them with their first steps into crypto.

Smart Wallets Help Make DeFi Easier

Wallets that work in tandem with smart contracts could be the future of cryptocurrencies. They offer users many unique features and allow for better interaction with DeFi platforms. They make the world of cryptocurrencies safer and more convenient. And something tells us that in terms of the development of smart wallets, we are still at the very beginning of the journey.

By the way, to learn more about DeFi, crypto startups and Polkadot, read the Polkapad blog.

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