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LeoGlossary: Wallet

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leoglossary
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Wallets are believed to be a part of human history, dating as far back as 3300 BC. These early editions did not store money as we think of it today. At that time, hunting was a bigger part of daily life. To properly conduct this act, both hands were required. For this reason, early forms of wallets were created although they were more like a purse.

In many cultures, especially during this period, money was not a currency as such. People often traded items that were a part of everyday life.

When month moved into the coin and bill phase, we can see how the wallets started to take on the concept we understand today.

It is believed the current bifold style with slots for credit cards started to appear in the 1950s. This tracked the evolution of money. Obviously, in the developed world, fiat currency was made up of mostly banknotes. While checks and other forms of electronic payment were commonplace, cash was still heavily utilized. This carried through the 1980s when other forms of payment took over.

Digital Wallets

With the introduction of the Internet, wallets saw a major transformation. Companies such as PayPal became payment services, allowing individuals (and businesses) to store money in the individual wallet. This truly was nothing more than an account on the company's servers. It did bring a new structure to the monetary system.

PayPal became a competitor to the banks since it served the most basic of banking functions. With a digital wallet, the ability to send, store, and receive currency was provided. This facilitated what most people used banks for.

Digital wallets are, for the most part, centrally controlled. This is akin to a bank account as compared to the wallet in your pocket with some cash in it. It is also something that is identified with Web 2.0, a generation of the Internet whereby major corporations control the online activity.

Cryptocurrency Wallets

The introduction of Bitcoin changed all this.

When Satoshi Nakamoto introduced his decentralized monetary system, the control of money went from governments or companies to individuals. Using a private key system, each Bitcoin address effectively became a wallet. Since the blockchain utilizes distributed ledger technology, it was able to replicate the banking system. Even today, when reading Bitcoin transactions, it is similar to that of a bank or financial institution.

With the expansion of blockchain networks, applications built on top of them were able to incorporate wallets. Since the chains are permissionless, anyone can access the on-chain data. This is pulled into different wallets, requiring the private key to access. The public key can be seen by anyone, thus being pulled into the application. Transactions can only occur when that is joined by the wallet's private key.

Over time, as layer 2 solutions were created, and tokens generated using smart contracts, the wallet system once again expanded. This followed the shift to multiple blockchains such as the forks of Ethereum. A wallet such as Metamask uses the same address on multiple chains and users can access all the EVM related coins and tokens through it.

Cryptocurrency wallets come in two forms. They can either be:

Cold wallet storage is the epitome of security. Since it is not tied to the Internet, hacking becomes impossible. The early paper wallets of Bitcoin and Litecoin are examples of cold storage.

These wallets did not provide convenience. People opt for hot wallets since it allows for them to instantly transact.

Threat To Commercial Banks

Digital wallets, including cryptocurrency, provide a threat to the commercial banks. These entities depend upon deposits from which they lend. This is all part of fractional reserve banking which most of the world utilizes. Under this system, banks take in deposits and make loans based upon the amount on hand. They can also use this to purchase securities such as sovereign debt or mortgage backed securities (MBS).

This is how banks make a profit and can, in turn, pay interest.

If digital wallets become popular, and the majority of society uses them to store money, we can see how deposits in banks could diminish a great deal. This could hamper the entire banking system.

Another pitfall could come from the idea of a central bank digital currency (CBDC). This is similar to cryptocurrency except that it is not decentralized. This is issued by the central bank, likely at the urging of the government. Part of the CBDC system will be digital wallets, presenting the commercial banks with the same problem.

In the end, it does not matter who is creating the wallet, only that it exists and can eat into the deposit base.

Much of the debate regarding CBDCs is based upon the impact it will have to the banking system. While politicians are after control, the banking industry in most countries is very powerful.

Another topic of discussion is that of privacy. A CBDC would mean that governments could control spending and basically close people's wallets without a court order. This has many advocating against the ideas of CBDCs.

Custodian

Cryptocurrency presents a major challenge for the existing financial system and Wall Street. A major part of the problem resides in custodian.

A coin or token has to reside in a cryptocurrency wallet. These are virtual currencies with no centralized ledger. Hence, to access it, whatever address they are sent to, requires the private key tied to the wallet.

Who is in control of this and how do investors know it is safe? Here is where counterparty risk becomes a major issue. It is something that is trying to be handled through regulation yet without a clear solution.

The collapse of centralized exchanges such as FTX show how the not your keys, not your crypto tenet holds true. A digital wallet is the control mechanism over the funds. .

When an exchange has ones coins or tokens, the individual is no longer in control. Under this circumstance, the money is passed along to a counterparty. It is one, as people found out, that carries a great deal of risk along with it.

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