Decentralized Wallets: Harnessing the Power of Software Wallets

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RSK

Smart contract platform on top of Bitcoin

Through Michel Mendes

Decentralized finance (DeFi) has been a hot topic for several years and continues to attract attention, resources and innovation from all corners of the world. This article aims to provide information for those who wish to deepen access to this exciting universe of decentralized applications, where rabbits with pancakes on their heads and unicorns accompany the territory.

Decentralized portfolios, also labeled as DeFi Wallets, are the gateways in these vast ecosystems of decentralized applications otherwise known as dApps. Basically, a wallet is a service that allows a user to store their digital assets and is available under two structures: centralized and decentralized.

Centralized and decentralized portfolios

Most of us are familiar with a centralized authority acting as the custodian (or custodian) of our assets, this is true in traditional markets (e.g. banks) and with digital assets, the most common being centralized exchanges like Coinbase, Binance, Bitstamp and so on. In fact, centralized exchanges are a starting point for many to move funds from fiat to crypto and then work their way into the DeFi ecosystem.

With decentralized wallets, the user self-guards the funds retain full ownership, responsibility and control of the funds within them. These usually come in the form of software wallets – as a browser extension and / or app download – and as physical hardware device. This article mainly focuses on software wallets which are the most common wallets used to connect to dApps and I discuss how hardware wallets can be used with software wallets to exponentially improve security.

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For mobile users, this table does not fit well and can be found here

Passwords and seed phrases / private keys

As mentioned, if you forget your password, there is no entity you can interact with to recover it. The user must store their password and seed phrase preferably offline. A start sentence (also called a recovery sentence) is your encrypted private key which is usually represented by a string of words that you can grab if you forget your password and / or lose access to your wallet. If you lose your seed phrase, your funds will be sunk!

To better understand these concepts, this lykke.com article does a brilliant job of explaining it using your house as an analogy.

For optimal security, there is a recommended approach that uses a hardware wallet to store your private key offline. Many software wallets, for example Metamask – the most widely used decentralized wallet – offers integration with hardware wallets such as Trezor and Ledger, ensuring maximum security with the flexibility to process on decentralized applications. With this integration, whenever the user needs to make a transaction on an app, they will need their connected hardware wallet to approve the transaction, which requires a sequence of physical contact on the hardware wallet.

The key to remember is that decentralized portfolios are the gateways to interact with decentralized applications across the blockchain spectrum. This is where the power really leans in favor of users who choose to hold their funds on their own.

Some apps worth mentioning are Aave and Compound, which are dedicated to lending / borrowing, as well as Uniswap, Sovryn, and Pancakeswap, which primarily focus on Decentralized Exchanges (DEX) – where you can trade between a wide variety of of cryptocurrencies and stablecoins.

The above examples are only the tip of the proverbial iceberg[1] because there is a myriad of decentralized applications that cover a multitude of blockchains (blockchains like Ethereum, Binance Smart Chain, RSK and Solana to name a few) and the user can connect to them through their wallet decentralized.

Which software portfolio is right for me?

After reading this article, you might be wondering which is the best software wallet to use, as there are a number of options. Remember, software wallets cover browser extensions and / or app downloads. In order to stay focused, I will devote a separate article to wallet options as it is highly depends on a number of factors, including the blockchain you are looking to interact with.

Where from here?

Software wallets have evolved their value proposition, for example Liquality, where one can store one’s favorite digital assets and perform a atomic exchange (peer-to-peer cross-blockchain exchange of one cryptocurrency against another without a trusted third party). It’s as powerful as we can exchange cryptocurrency on a blockchain for example ETH (on the Ethereum blockchain) to a completely different asset for example RBTC (the native currency linked to Bitcoin on the RSK blockchain). This is a fantastic use case for anyone looking to move their funds to another blockchain so they can then interact with these new and exciting dApps!

This article is not to say that decentralized wallets are better than centralized equivalents. Both structures can (and do) coexist and providing access to services in different ways. The aim of this article is to give an overview of the growing DeFi ecosystem which, at the time of writing, represents $ 120 billion in market capitalization, with decentralized portfolios being the entry point.

Have you been impressed with any wallets, whether software or hardware?

Leave a comment or contact us to discuss!

Footnotes

[1] Be careful there. While the innovation is amazing, hacks are common in this space and not all dApps are considered “secure”.

Disclaimer: The above post does not constitute financial advice. It is very important to do your own analysis / research before making an investment and based on your personal situation.

Thanks to Owanate Amachree and Brendan Graetz for returns!

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About George H. McWhorter

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