Smarter crypto storage: What’s a smart contract wallet in crypto?

When Ethereum (ETH) burst onto the crypto scene in 2015, it expanded blockchain’s use case from facilitating peer-to-peer (P2P) transfers to powering decentralized online experiences. From its launch to today, the key behind Ethereum’s paradigm-shifting network has been a set of novel commands called smart contracts – decentralized applications or digital contracts that enable blockchain programmers to create intermediary-free protocols and build a new ecosystem of self-sovereign applications.

In 2023, Ethereum took smart contracts a step further with an upgrade called EIP-4337, also known as account abstraction. EIP-4337 brought smart contract functionality to cryptocurrency wallets, introducing a blockchain-based interface for users to store, send, and swap their digital assets.

With developments like EIP-4337, more crypto enthusiasts are asking: What are smart contract wallets, and how do they differ from traditional wallets? Are smart wallets truly an upgrade, and could they make web3 more user-friendly?

In this guide, we’ll tell you what you need to know.

What’s a smart wallet in crypto? 

Smart contract wallets are crypto storage solutions integrated into intermediary-free blockchains. These next-gen apps combine smart contracts with the standard functions of a cryptocurrency wallet, such as storing and sending digital assets and interacting with decentralized applications. Instead of simply using smart contract code to execute agreements on blockchain applications, these programs serve as the foundation of a smart contract wallet and allow users greater flexibility to customize preferences within their accounts.

Think of a smart contract wallet as a more dynamic, decentralized way to store and send cryptocurrencies. With a smart contract wallet, users can fine-tune virtually every aspect of their web3 experience while benefiting from enhanced security through complete reliance on decentralized technology.

How do smart contract wallets work? Smart contracts explained 

To better understand how smart contract wallets work, it helps to compare them to traditional crypto wallets, which use a public-private key model. In a standard crypto wallet, the private key functions like a password, granting full access to the user’s digital assets. Each private key is paired with a public key, which is safe to share when receiving cryptocurrency funds.

Although private and public keys are mathematically connected, the encryption used to link them makes it impossible to reverse-engineer a private key from a public address. Anyone with access to the private key in a traditional crypto wallet can transfer funds, which is why users must keep this data secret.

Rather than relying on individuals to manage their own private keys, a smart contract wallet encrypts the private key within the smart contract code. A smart contract’s logic is stored on a blockchain like Ethereum or Solana (SOL) and can be interacted with via a 3rd party wallet interface.

Smart contracts utilize determinacy, decentralization, and transparency to maintain high security standards while unlocking additional functions not available in traditional wallets, including multi-signature authentication, automated transaction approvals, and customizable recovery options.

This shift marks a fundamental change in how users interact with digital assets, making security and automation intrinsic to smart contracts. Blockchain networks act as the backbone for these innovations, ensuring that transactions remain immutable, transparent, and resistant to third-party interference.

Because of this, users with a smart contract wallet don’t need to manually copy their private key after login, and their wallet doesn’t rely on a single private-public key pair to verify ownership. Instead, they interact with their smart contract through a user-friendly public interface and customize their security settings as needed.

The best features of smart contract crypto wallets 

Many crypto enthusiasts are excited about the programmability and personalization that smart contract wallets bring to decentralized applications (dApps). Despite their novelty, smart contract wallets offer advanced features – and potentially greater protection – for users of all skill levels.

• High security standards: The customizability of smart contracts gives smart wallets security features that are impossible in traditional crypto wallet designs. In addition to encrypting user data on immutable public ledgers, smart contracts can implement extra protections like multi-factor authentication or advanced private key recovery options, reducing the risk of unauthorized access.
• Programmable and personalizable: Beyond simply storing virtual assets and connecting to dApps, smart contract wallets can execute a wide range of automated functions. Users can automate crypto preferences, from spending limits and decentralized identity to gas fee restrictions and payment instructions.
• Complete decentralization: Smart contract wallets run entirely on blockchain technology, which eliminates concerns about third-party interference. With no reliance on centralized entities, there's no risk associated with cloud servers, relayers, and other centralized points of failure.
• Transparency and auditability: Another benefit of embedding wallets within smart contracts is the transparency and auditability they provide. Every transaction is permanently recorded on the blockchain, giving traders complete visibility that makes it easy to verify transaction history. 

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Smart contract wallet: Use cases and applications 

Smart contract wallets are designed to simplify the web3 experience by removing complex technical barriers, enhancing usability, and offering familiar, user-friendly interactions. By making blockchain technology more accessible and intuitive, they have the potential to onboard millions of new users into the crypto space. As adoption grows, their integration with dApps and financial services could enable automated payments, personalized security settings, and more flexible digital asset management – all without requiring deep technical knowledge.

Simplified web3 onramping

Built-in smart contract integrations make it straightforward for non-crypto natives to access web3 applications. Rather than creating and managing a private key when setting up an account, smart contract wallets function similarly to social media logins and eliminate the burden of securely storing a private key’s seed phrase.

Beyond ease of use, smart contract wallets introduce built-in recovery mechanisms and customizable transaction controls, reducing friction for newcomers. Features like trusted recovery options and time-delayed transaction processing provide a more approachable entry point into blockchain technology. By combining intuitive design with flexible account management, smart contract wallets lower the barriers to adoption for non-tech-savvy users.

Decentralized finance (DeFi) opportunities 

Smart contracts already power decentralized finance (DeFi) applications, enabling decentralized exchanges (DEXs) and crypto lending protocols to operate without intermediaries. Integrating smart contracts into the wallets that interact with these dApps adds another layer of automation, creating a more dynamic and customizable user experience.

With smart contract wallets, DeFi traders can pre-set complex financial transactions and access unique income-generating opportunities, including staking, arbitrage, and liquidity pools. Also, because smart contract wallets feature programmable logic, users can define precise rules for their trading strategies, maintain collateral requirements, and automatically reinvest rewards for compounding gains.

Transaction batching

Another way smart contract wallets enhance efficiency in web3 is by bundling multiple transfers into a single transaction. Instead of paying separate gas fees for each step in a complex DeFi transfer, smart contracts batch these actions together, executing them in one go, which reduces costs for traders.

Transaction batching also helps alleviate network congestion, lowering average gas fees and reducing the risk of glitches, outages, or the dreaded “gas wars.”

Treasury management

DeFi protocols and dApps are increasingly adopting governance structures like decentralized autonomous organizations (DAOs) to democratize decision-making. A key feature of these governance models is a crypto treasury designated for community-approved protocol upgrades. However, if a DAO’s treasury is stored in a crypto wallet that just one or a few developers control, how decentralized – or secure – are the funds?

Using a smart contract wallet offers a potential solution to trust issues in decentralized governance. Embedding transparent, automated, and tamper-proof rules into a smart contract removes concerns about hidden interference. Also, thanks to multi-signature functions, treasury funds can only be accessed with approval from a predefined group, preventing unauthorized activity.

Payments

Smart wallets offer much more than simple transfers and token swaps. Lower fees and faster processing speeds from transaction batching make smart contract wallets ideal for microtransactions and everyday cryptocurrency payments. With their added programmability, these next-gen wallets can also automate recurring payments for subscriptions, taxes, or bills, making crypto more practical for real-world expenses.

There’s also potential that smart contract wallets could integrate with budgeting software, alert users to liquidity issues, and automatically shift funds to prevent emergency scenarios.

Streamline your smart wallet tracking with CoinTracker 

No matter which wallets you use, CoinTracker makes it easy to link all your accounts in one place. After creating a CoinTracker account, simply input your public addresses or use WalletConnect to view your balances and track transaction activity. CoinTracker also syncs with API keys and supports CSV file uploads for comprehensive crypto reporting.

Once all your connections are added to our Portfolio Tracker, you can analyze real-time performance, identify tax-loss harvesting opportunities, and generate IRS-compliant tax reports for transparent filing.

See how easy it is to link your crypto wallets to CoinTracker by getting started with a free account today.

Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.