The Essential Wallet Guide, Part 5: Smart Contract Wallets

The Essential Wallet Guide, Part 5: Smart Contract Wallets

Smart contract wallets are the latest innovation in private key management for cryptocurrencies. Here's what you need to know about the technology.


3 min read

What really put the Ethereum blockchain on the map and laid the foundation for countless tokens is the use of smart contract technology to automatically perform actions on the blockchain with no need for a middle-man. These automated contracts are built on code to provide an immutable method for a specific functionality, such as sending tokens when presented with an ETH deposit from a user.

Since smart contracts are versatile and immutable, they provide a secure and encouraging playground for new innovations. Wallets built on smart contract technology share the same tenacity, and they prove to be a promising alternative to traditional wallets. Part of the benefit of a smart contract wallet is less reliance on other mediums of recovery. Every wallet we’ve covered thus far in our wallet series has required some sort of data for recovery (and access) purposes, such as a private key or mnemonic phrase. However, smart contract wallets use forms of recovery that don’t require writing down and remembering long strings of data.

That’s not to say these wallets are without their share of issues, though. Blockchain technology encourages a trustless protocol for your finances, but smart contracts reintroduce trust in the form of written code. Users who interact with smart contract wallets are at the hands of the developers who initially wrote the contract code, and all forms of code are vulnerable to bugs.

Security is the Priority

When it comes to wallet access and recovery, blockchain is a lot to handle for a newcomer. In many ways, a wallet’s security depends on the user’s unique handling of their sensitive information. A private key or mnemonic phrase can be hard to memorize, so this data is usually stored on a flash drive or piece of paper. If you lose that, you’ve lost access to your assets forever.

With a smart contract wallet, access and recovery are a bit easier to manage. One such method is known as the Social Recovery method, where a number of people are all designated as trusted backup friends. If you lose access to your wallet, you can call on your backup friends to all separately agree that you are indeed the owner of your wallet and should be given access. They don’t have to be real people though – these backup ‘friends’ can also be other wallets you own or hardware wallet devices.

Smart contracts also offer functions like two-factor authentication for transactions, limited withdrawal rates set by the user, time-locked transactions, personalized blacklists for outgoing transactions, and even emergency shutdowns in cases of perceived fraud. Some smart contract wallets even tout faster and cheaper transactions, automatic trading, and interest rates on crypto holdings. The applications for this technology are endless, but with new innovations come new possibilities for compromise. There are still a number of downsides to fully relying on smart contracts for your crypto.

Permanent, for Better or Worse

The immutable nature of a smart contract is both its greatest and weakest characteristic. Code always comes with bugs, and bugs are meant to be patched. While smart contracts are generally tested and true, bugs still happen. Importantly, smart contract bugs aren’t the types you can patch and they can result in the permanent loss of your assets.

There are other unintended consequences of smart contract immutability. Humans are fickle creatures, and we often change our minds. But smart contracts do not share this sentiment, they only work in one direction - forward. If a user wants to backtrack, change a decision, or play around with different options, smart contracts are not the way to go about it. All of blockchain is immutable, but smart contract wallets take it a step further with predetermined rules and time-sensitive requisites. Chaining your financial identity to a smart contract means you’re putting all your faith in the ones who built it, rather than in yourself. Social recovery poses its own set of problems – friends fall out and partners break up all the time, but in this case it’s like they have half of the key to your bank vault...

The idea of smart contract wallets inspires promise for a future of convenient key management, but the implementation is still in its infancy. As technology advances, so will these systems, eventually leaving us with a plethora of options for our crypto wallet needs. For now, we believe the safest bet is still owning a hardware wallet and pairing it with a non-custodial, web-based service like MEW, but we are excited to see smart contract wallet technology develop and become mature enough for widespread use.

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