What’s the Outlook for Crypto Wallets in 2023?

July 2023

Fintech & Payments

Michael Greenwood

Senior Research Analyst

As we discuss in our latest digital wallets research, crypto wallets are a subset of wallets that hold a user’s public and private key, keeping their crypto assets safe and accessible. They also allow the sending, receiving and spending of cryptocurrencies.
 
It is important to emphasise that crypto wallets do not store the cryptocurrencies themselves. The wallet holds the public key, which allows the user to receive transactions, and the private key, which confirms the address of the wallet allowing it to make transfers. The public key is accessible to anyone, whereas the private key is a set of code and how it is stored determines what type of crypto wallet is being used.

Physical vs Digital

Crypto wallets can be both physical and digital.

An example of a physical crypto wallet is Ledger, which is similar to a USD stick. Another form of physical crypto wallet is a paper wallet, where the private key code is printed out on paper. This is immune from hacking but risks being lost or damaged, and it is not popular. The more common kind is a digital crypto wallet, which is normally an app like Coinbase or MetaMask.
 
These digital crypto wallets, sometimes called hot wallets, can be web, mobile, or desktop based. These wallets are easy to use and allow for more convenient access to the user’s cryptocurrency.  For security, hot wallets’ private key is encrypted. As they are held offline, other kinds of crypto wallets do not need this.

Custodial vs Non-custodial Wallets

The wallets above can be further separated into custodial and non-custodial wallets.
 
A custodial wallet is a wallet where the private key is held by a third party. This is most common for online wallets, particularly crypto exchanges. The primary advantage to these is that if the user loses the private key, the third party can provide a replacement. These are also easier to use for users new to crypto wallets. They also tend to have KYC and AML processes.
 
A drawback is that the security of the wallet is down to the third party, meaning if the third party is not using strong encryption, the assets stored in the wallets are vulnerable to hacking. These wallets are inherently more vulnerable than offline wallets, meaning individuals who know what they are doing can always hold assets more securely than these third-party wallets. The third party will often implement additional security measures to protect the wallet, such as MFA, OTPs, and biometric authentication. It is also common for exchanges to transfer a portion of a wallet’s balance into an offline wallet, where it cannot be hacked.
 
For non-custodial wallets there is still a way of recovering a lost private key. When starting the wallet, the user will be given a list of 12 recovery phrases. These phrases can be used to generate the wallet’s private key in the event of it being lost. This does mean that if these recovery phrases are lost by the user than the private key is unrecoverable, and any assets stored are lost. These wallets are usually offline, as offline wallets are inherently noncustodial. There are software-based non-custodial wallets such as the Coinbase.com DeFi Wallet.

Multi-signature Wallets

For the highest level of security, a user can use a multi-signature wallet.

This is a wallet that requires the use of two or more private keys to authorise a transaction. It is common for a wallet that requires two keys to authorise payments to give users three keys as standard; helping to protect users in instances where they lose a key, as they will still possess the two keys required to use the wallet.
 
This system also makes shared wallets more secure, as a user that wishes to move assets has to seek authorisation from at least one other user trusted with a key; a useful feature for companies who may wish to use a crypto wallet.

NFT Wallets

In the case of NFT wallets, there are several factors to consider:

• Compatibility: Not all NFT wallets are compatible with all NFT marketplaces. A good NFT wallet should integrate into the most popular marketplaces. Wallet providers should be aware of how which marketplace they integrate may change the kind of users they will have and how that will change their expectations. More experienced NFT users are more likely to want offline wallets with longer recovery phrases. Whereas, the large exchanges with more beginners will look for ease of use in their wallet.
  
  
• Security: Security is one of the most important aspects of an NFT wallet, as the industry is largely unregulated and does not provide the users with the same legal protections as conventional bank accounts or stock exchanges. As with conventional wallets, MFA authentication and the incorporation of OTP, biometric authentication, and liveness checks can be used to greatly increase security.
  
  
• User Experience: For any offering, user experience is essential in keeping customers. In the crypto space this is especially the case for users new to it, as it can seem extremely complex with a lot of jargon. Many new users will be looking to make small transactions and be less concerned with security than those who have significant crypto assets. The ease of use can be the determining factor for new users.
  
  
• Accessibility: Most NFT wallets are accessible via web extensions or as applications. Making a wallet available on multiple devices allows it to appeal to a broader range of users. Being able to access the same wallet from different devices can be an added convenience for the user.
  
  
• Cross-chain Compatibility: To allow the user a greater range of flexibility, it is useful for a wallet to be able to access multiple different blockchain networks. The most popular network is Ethereum, but there are others that a user may want to access, so allowing the greatest range of options can give a wallet an advantage over its competitors.

Challenges

It is perhaps an understatement to say that the crypto space has faced significant challenges within the last year. The bankruptcy of FTX and collapse of Silicon Valley Bank did significant damage to the health of crypto markets, and public perception of the technology; and, as a result, demand for crypto wallets of any kind has taken a significant hit.
 
In June 2023, the US SEC (Securities and Exchange Commission) also announced a lawsuit against Coinbase and Binance, two of the largest cryptocurrency exchanges in the world; alleging that the exchanges has not registered assets as securities with the commission - bringing more negative headlines, driving away potential users, and bringing in the possibility of cryptocurrencies being regulated in the same way as traditional securities.
 
This is a double-edged prospect. Any regulation of this type may encourage new users into the space as they would feel more secure with the regulations in place. However, this would also bring new compliance costs for wallet providers, and, ultimately, make launching a new crypto wallet product more difficult.

Future Market Outlook

There is a great deal of uncertainty around crypto wallets, given that the health of the crypto wallet space is inherently linked to the health of the crypto space in general.
 
In our view, wallet providers who offer conventional digital wallets would be taking a risk to launch a standalone crypto wallet, as it is not clear what future growth is capable by the market. It is also worth noting that the future regulatory landscape is uncertain, it being entirely possible that different countries will regulate crypto assets in very different ways. With all this uncertainty around the space, it would be a high-risk strategy to invest resources into developing a crypto wallet.

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