Wallet is an important yet confusing web3 term. That is because the name refers to multiple concepts depending on context: the wallet client, the passphrase, account manager software, or a public account address. Let’s dig in and disambiguate.

Wallets

A wallet is software for managing web3 accounts.

Wallet clients are responsible for private key management, application UI, and transaction/asset management. However the boundaries of what a wallet is are blurry and still evolving. Some have described wallets as the operating systems of web3, or the browsers of web3. Neither analogy is perfect, but the idea is correct: wallets are a powerful and foundational piece of the web3 ecosystem.

From an end-user’s perspective, a wallet is the software needed to interact with blockchains: and help with the experience of performing transactions (send tokens, sign using private key, interact with smart contract). Since the data is public, they typically also list token balances, and the transaction history.

Wallets, unlike the physical wallets in our pockets, don't hold tokens directly (that analogy is misleading). Rather, they are a mechanism in which the owner can prove (s)he owns custody by signing transactions with the private key. The blockchain stores the token ledger (a mapping of wallet addresses to their respective balance). This is why transferring tokens is so cheap, we're not moving anything around, simply debiting from one account and crediting another in our global, shared ledger.

Custody

When the end-user is directly responsible for the private key (by memorizing the seed phrase), the wallet is called self-custodial or non-custodial (Metamask, Ledger, Rainbow). When a company or other 3rd party manages the private key for the end-user, it is called a custodial wallet (Coinbase, Binance, Magic Link). This is where the adage "not your keys, not your coins" comes in: it is referring to the custody property: whoever controls the private key controls the wallet.

It is hard to exchange fiat money (like dollars) for cryptocurrency tokens without going through a centralized exchange, and use a custodial wallet in the process. Most users therefore have multiple wallets, some custodial and others not, and transfer tokens from the custodial ones to the self-custodial ones to gain custody.

Architecture

Just like web browsers allow users to interact directly with the web through URLs, wallets allow users to interact directly with web3 nodes through JSON-RPC calls, which are handled by providers (Infura, Alchemy).

Blockchains introduce new software constructs and paradigms. One difference with the web2 world is how accounts are defined, registered, and controlled.

Accounts

Blockchain state –  at its simplest –  is a set of account balances and the transactions between them. Each account has a publicly known address, a public key to which also exists a counterpart private key. The public key is shared publicly, while the private key should be kept securely by the account owner. Examples of public addresses are 0x1dA4FDf7029bDf8ff11f28141a659f6563940642 on Ethereum or bc1q3yz87mhky7c30y9v38aggypw8jrda7ettefxgr on bitcoin.

There are 2 types of blockchain accounts:

• Externally Owned Accounts (EOAs)

• Contract Accounts (only exist on smart contract chains like Ethereum & Solana, not bitcoin)

Externally Owned Accounts (EOAs)

EOAs are not registered to blockchains like you’d register a gmail address to a centralized provider (google). Instead, they simply already exist: there is a space of trillions of billions of public keys, and “creating” an account means generating a new random private key, and then deriving its public key (or address). Knowing the private key allows to sign transactions (proving ownership) and therefore control the account.

Note: Losing the private keys means that controlling that account is no longer possible, and the currency in it is inaccessible forever.

How does one know how to generate a new random private key? With conventionally adopted standard cryptography algorithms, that have been proposed and approved by the community. This approach avoids the need of a central authority in charge of account management in favor of shared cryptography methods (which is permissionless and censorship resistant). Most of these algorithms went through the BIP (bitcoin improvement proposal) mechanism.

You might have heard of “seed phrases” or “mnemonics”, these are from BIP39: a proposed method of generating private keys in a more human friendly way. From the seed phrase (12 to 24 english words), we derive a private key (optionally using an extra passphrase), then from that private key we derive a root key. Finally, we can create multiple public/private key pairs (accounts) from this single root key. This technique was proposed in BIP32, and is called Hyper Deterministic (HD) wallets.

The idea is that remembering mnemonics is hard, but one might still want many accounts for privacy and security reasons. This gives us the best of both worlds! This also allows interoperability, you can use the same passphrase in any wallet client for that ecosystem and everything works, and you can deterministically re-create all of your accounts from a passphrase.

Contract Accounts

Contract Accounts are programs (smart contracts) which simulate EOAs. They can therefore only exist on smart contract chains like ethereum or Solana, as code.

What’s their purpose? Arbitrary functionality makes them safer, more powerful, and can improve the user experience.

For example, it allows techniques like “multisig”, requiring multiple confirmations before using the private key to sign transactions (similar to 2FA auth, in web2): see Argent or Gnosis-Safe.

A major drawback from Contract Accounts today (in Ethereum) is that they cannot sign transactions like EOAs can, making them less useful. This is an active area of proposed improvement for Ethereum, called “Account Abstraction” (see EIP-2938 and EIP-4337), a sizable opportunity to improve web3 UX and security.

Summary

I am @nichochar, a software engineer who has recently started dabbling and building things in web3. As thrilling as it is, learning web3 can quickly get overwhelming. This is a whole new world full of technical and cultural jargon. There is a significant barrier to entry for crypto-curious and crypto-learners. In this newsletter, I will summarize web3 concepts in 420 words or less (and maybe some diagrams 🙈). I’m a beginner myself so the goal is to learn together.

Welcome, thanks for being here, and I hope that you enjoy it!

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