Crypto custody has stuck in 2021

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Despite significant investment and real technical advancements, today’s crypto custody solutions remain stubbornly stuck in the past. Whether it’s vendors providing “Wallets as a Service” using multi-party computing like Web3Auth or “smart wallets” like Argent, everyone wants it to be easier to store, recover, and use crypto. And yet, custody still seems stuck in 2021. The reality of adoption has been mostly disappointing.

The riddle of convenience

Despite its flaws, traditional finance continues to offer unrivaled convenience and peace of mind (at least in middle- and high-income countries). Forgot your password? Send a quick reset link to your Gmail. Encounter unauthorized charges? Easily dispute them and freeze your card via the mobile app.

These security measures allow you to interact with the TradFi ecosystem safely, but they are almost non-existent in the crypto world (aside from risky centralized parties like the now-bankrupt Celsius). Managing private keys and securing transactions is complex and unforgiving, requiring a level of tech knowledge that most users don’t have. Using crypto is harder than buying it, which is already hard enough to turn many people off in the first place. The result? Crypto has been adopted more for gambling than as a better version of finance that people can use for everyday life (saving, lending, borrowing).

As the primary access point to crypto, custody solutions need to provide more benefits beyond simply holding assets. Users need to feel secure when engaging with the DeFi ecosystem.

TVL is not used

Consider Gnosis Safe, now rebranded as Safe. This platform is an industry leader in controlling and transacting funds while separating the private key requirements of an account (including requiring multiple signers to approve a transaction). Yet despite the $100 billion+ in assets stored in these Vaults, their potential is still woefully underutilized.

Source: Flipside Crypto

Over 5,000 Vaults are created every month on the Ethereum mainnet alone, but these Vaults are predominantly used for crypto cold storage rather than active DeFi engagement. These smart contract-based accounts allow users to rotate their keys or request a friend to confirm when these assets are moved.

Ideally, these Vaults should become the primary way for Vault creators/owners/signers to interact with DeFi. Over 100+ applications (including dedicated transaction generators and handy DAO tools) exist to facilitate the use of Vaults directly in a standard browser. However, despite these tools, many users still rely on External Owner Accounts (accounts secured by a private key and inherently risky) when interacting with DeFi. Whether it’s buying an NFT on Blur, trading on Uniswap, depositing funds into MakerDAO, repaying an Aave (AAVE) loan, or simply sending tokens to a friend, people often create Vaults with their EOA and then continue using their EOA—a risky practice that has taken root in 2021.

Source: Flipside Crypto

The data speaks for itself: specifically excluding raw Ethereum (ETH) (not an ERC20 token) for the Ethereum Mainnet, 99.4% – 99.9% of token transfer volume (in USD) occurs via a Safe Creator’s EOA, not via their Safe! This is not just a statistic; it is a blatant indictment of the industry’s current approach to combining utility and security through crypto custody.

Raw ETH usage could be a positive sign

To put this into broader perspective, consider how blockchains are used today. Raw ETH, which does not have a token contract, is often “wrapped” into Wrapped Ether (WETH) via a 1:1 smart contract to make it easier to use in DeFi. Still, less than 3% of the Ethereum supply is wrapped. A disproportionate amount of activity in crypto is peer-to-peer transfers of the native asset, and only a fraction of human-operated addresses interact with DeFi protocols.

Unlike DeFi tokens, we see Safe creators circulating raw ETH through their Vaults. When comparing the volume of raw ETH transfers between Vaults and Creator EOAs, we not only see an increasing pattern for Vaults, but as of May 2024, Vaults are seeing more raw ETH usage than the EOAs that created them, with approximately $2 billion in monthly volume on the Ethereum mainnet alone.

Source: Flipside Crypto The way forward: Simplify at the custody level, not the protocol level

To be clear, real progress has been made in protecting users since 2021, particularly at the wallet layer with projects like Rabby, Rainbow, Coinbase Wallet and industry leader Metamask focusing heavily on preventing user losses through transaction simulation, confirmation management and alerts for potentially malicious contracts. However, these still operate around users managing private keys that control their funds 1:1.

The industry is heavily experimenting with (and investing in) alternatives to this framework, including: giving your account to a smart contract (EIP-3074), converting your account to a smart contract (EIP-7702), abstracting how transactions themselves are created and managed (EIP-4337). These “account abstraction” projects vary in complexity and assumptions, and require changes to Ethereum itself.

Trying to reach widespread consensus on a single, complex, one-size-fits-all solution like “all wallets must agree to use the same unique contract” is likely a dead end. Instead, the industry should focus on practical UX solutions that can be easily adopted without requiring every application to create the Nth wallet for a user or fiddle (too much) with Ethereum’s inner workings.

The good news is that we are moving in the right direction. More L2s are coming online every week and the cost of DeFi is coming down. The industry is tired of hearing about infrastructure and more hard conversations about organic user growth instead of airdrop farmers. Apps are launching more mobile-native experiences like integrating wallets as a service and social recovery. The mission for a decentralized, robust, permissionless, censorship-resistant alternative to modern financial systems is alive and well.

Carlos Market

Carlos Mercado is a data scientist at Flipside Crypto, specializing in the convergence of data science, cryptocurrency, economics, and open source research. His expertise spans the Ethereum ecosystem and over 20 other blockchains, where he has developed innovative data models and analysis tools using SQL, R, Python, and Solidity. Carlos’ key contributions include creating the True Freeze DeFi primitive and leading the production of the 2023 Crypto Users Report, making a significant impact in the industry. Prior to Flipside, he applied his AI strategy and product development skills at Guidehouse and provided data science consulting services.