A brief analysis of the fat wallet theory: blockchain value redistribution

Author: Robbie Petersen Source: X, @robbiepetersen_ Translation: Shan Ouba, Golden Finance

In the history of cryptocurrency, the discussion about where value will eventually accumulate in the blockchain stack has never stopped. The core of the past debate was mainly between protocols and applications, but there is an overlooked third layer in the stack - wallets.

The "fat wallet" argument advocates that as the protocol and application layers gradually "thin down", more space will be freed up to the party with the two most valuable resources - distribution channels and order flow. Moreover, as the ultimate front end, I believe that no role is more conducive to monetizing this value than the wallet.

This article aims to accomplish three goals. First, we will outline three structural trends that will continue to commoditize the protocol and application layers. Second, we will explore the multiple ways in which wallets can profit from their position close to end users, including payment for order flow (PFOF) and distribution as a service (DaaS). Finally, we’ll explore why two alternative front ends—Jupiter and Infinex—may ultimately outcompete wallets in the battle for end users.

Towards Thinner Protocols and Applications

The question of where value will ultimately accrue in the blockchain stack comes down to a simple framework. For each layer of the crypto stack, consider the following questions:

If that layer increases its cut, will users switch to a cheaper alternative?

In other words, if Arbitrum increases its cut, will users switch to another protocol, such as Base, or vice versa? Similarly, at the application layer, if dYdX increases its cut, will users switch to the next undifferentiated perpetual contract DEX?

Based on this logic, we can identify the layers with the highest switching costs, and therefore who has asymmetric pricing power. Similarly, this framework allows us to identify the layer with the lowest switching costs, and thus which layer will become commoditized over time.

While the protocol layer has historically had disproportionate pricing power, I believe this is changing. There are three structural trends that are thinning the protocol layer:

• Multi-chain applications and chain abstraction: As multiple chains become a basic requirement for applications to remain competitive, the user experience between blockchains will become increasingly undifferentiated, so the switching costs of the protocol layer will be further reduced. In addition, chain abstraction will further compress switching costs by abstracting cross-chain operations. As a result, applications will no longer rely on the network effects of a single chain, and instead chains will become increasingly dependent on the distribution capabilities of the front end.

• Maturation of the MEV supply chain: While MEV will never be completely eliminated, there are already many initiatives at the application layer and beyond to gradually redistribute the amount of MEV extracted from users. Importantly, as the MEV supply chain continues to mature, value will gradually rise up the MEV supply chain and asymmetrically accumulate on entities with the most exclusive user order flow. This means that the bargaining power of the protocol layer will be weakened, while the leverage of front-ends and wallets will be enhanced.

• A Shift in the Proxy Paradigm: In a world where transactions are primarily executed by proxies and "solvers", attracting this proxy traffic will become critical to the survival of blockchains. Importantly, given that proxies and "solvers" are designed to primarily optimize for best execution, protocols will no longer rely on intangible factors such as "atmosphere" and "consensus", but will only compete on transaction fees and liquidity - this will further "thin" the protocol layer, as protocols will have to compress fees and incentivize liquidity to remain competitive.

So, returning to the original question - if a protocol increases its commission percentage, will users switch to cheaper alternatives? While it may not be obvious now, I think the answer will increasingly tend to "yes" as switching costs continue to compress.

Intuitively, one would think that if the protocol layer becomes "thin", then the application layer will become "fat" accordingly. Although the application layer does recapture some value, the "fat application" theory alone is not enough. Value will accumulate in different ways in different application verticals. Therefore, the question is not "will applications become fatter?", but "which specific applications will become fatter?"

As I described in the article "Crypto Market Moat Identification Framework", the structural differences for crypto applications - easy forking, composability, and token-based customer acquisition - have led to the effect of lowering barriers to entry and customer acquisition costs (CAC). Therefore, although a few applications have some characteristics that cannot be easily forked or subsidized, it is still difficult for them to cultivate moats and maintain market share as crypto applications.

Going back to our initial framework - if an application increases its commission rate, will users switch to cheaper alternatives? - I think the answer is "yes" for 99% of applications. Therefore, I expect most applications will have difficulty capturing value because turning on the fee switch will inevitably cause users to switch to the next undifferentiated application that provides higher incentives.

Finally, I think the rise of AI agents and solvers will have a similar impact on applications as it has on protocols. Given that agents and solvers will mainly optimize for execution quality, I expect applications will also be forced to compete fiercely in attracting agent traffic. While liquidity network effects should lead to a winner-take-all dynamic in the long term, in the short and medium term, I expect applications to gradually fall into price wars.

This begs the question, if both protocols and applications continue to “thin”, where will the main accumulation of this value be?

The “Fat Wallet” Argument

In short, value will accrue to the party that owns the end user. In theory, this can be any front-end application, but the “fat wallet” argument argues that no one is closer to the user than the wallet. Five sub-arguments supporting this logic are as follows:

1. Wallets dominate the mobile user experience of cryptocurrency: On the mobile side, a good way to understand who owns the end user is to ask: “Which Web2 application does the user ultimately interact with?” Although most users trade through Uniswap’s front end, their entry point to this front end is their crypto wallet application. This means that if mobile gradually dominates the crypto user experience, wallets may further consolidate their relationship with end users and become an important application access portal.

2. Wallets meet user needs "on the spot": Crypto applications are essentially financial applications. Unlike Web2, almost all on-chain transactions are some form of financial transactions. Therefore, the account layer is crucial to crypto users. In addition, the wallet layer also has some unique synergistic features, such as payments, native returns on idle deposits, automated portfolio management, and other consumer-oriented use cases (such as cryptocurrency debit cards). For example, Fuse leads the way in this area, offering features like Fuse Earn and Fuse Pay, which allow users to spend their wallet balances in real life using a Visa debit card.

3. The switching cost of wallets is unexpectedly high: While switching wallets theoretically requires only copying and pasting a seed phrase, this is a psychological barrier for most average users. Since users implicitly place a high level of trust in wallet providers, I believe that brand and “reliability” are a strong source of defensiveness at the wallet layer. Going back to our original question — if a product in the stack increases its commission rate, will users choose a cheaper alternative? — at the wallet layer, the answer seems to be “no”; MetaMask’s 0.875% fee for intra-wallet exchanges is a reflection of this logic.

4. Chain Abstraction: Although chain abstraction is a technically complex problem, the wallet layer provides an attractive solution. The idea of ​​accessing cross-chain applications through an account balance is intuitive and convenient. Projects such as @OneBalance_io, @BrahmaFi, @Polaris_App, @ParticleNtwrk, @Ctrl_Wallet, and Coinbase's Smart Wallet are all working in this direction. In the future, more teams will meet user needs by solving chain abstraction at the wallet layer.

5. Unique synergy with AI: Although AI agents may further commoditize other parts of the blockchain stack, users still need to authorize agents to ultimately execute transactions on their behalf. This means that the wallet layer is best suited to become the standard front end for AI agents. Other low-barrier entry points for integrating AI at the account layer include automatic staking, yield farming strategies, and customized user experiences enhanced by large language models (LLMs).

Now that we have laid out the “why” wallets will increasingly own the end-user relationship, let’s think about the “how” they will ultimately monetize that relationship.

Profit Opportunities

The first monetization opportunity for wallets lies in ownership of user order flow. As mentioned above, while the MEV supply chain will continue to evolve, value will continue to accrue disproportionately to those with the most exclusive access to order flow.

Currently, the frontends with the majority of order flow are primarily solver models and decentralized exchanges (DEXs). But this chart alone lacks nuance. It is important to understand that not all order flow is the same. There are two types of order flow: (1) fee-sensitive flow and (2) fee-insensitive flow.

Generally speaking, solver models and aggregators dominate "fee-sensitive" traffic. These users typically trade more than $100,000, so execution is very important to them. They will not accept an additional fee of 10 basis points higher. Therefore, "fee-sensitive" traders are the lowest value customer group - even though these front ends own the majority of the market by volume, the value generated per $1 traded is much lower than other channels.

In contrast, wallet exchanges and Telegram trading bots have a more valuable user base - "fee-insensitive" traders. These traders pay fees for convenience rather than execution. Therefore, it does not matter to them to pay a 50 basis point fee on a trade, especially when they expect the outcome of the trade to be a 100x increase or zero. Therefore, Telegram bots and wallet exchanges generate much higher revenue per $1 of trading volume than decentralized exchange front-ends.

Going forward, if wallets are able to capitalize on these trends and continue to maintain relationships with end users, I expect in-wallet exchanges to continue to eat into the market share of other frontends. More importantly, even if they only increase their market share by 5%, this growth will have a huge impact, as wallet exchanges generate nearly 100 times more revenue per $100 of trading volume than DEX frontends.

This brings us to the second opportunity for wallets to profit from being close to end users - Distribution as a Service (DaaS).

As the standard frontend for user on-chain interactions, the distribution of applications ultimately relies on wallet providers, especially on mobile. Therefore, wallets seem to be well positioned to strike exclusive deals with applications in exchange for distribution support. For example, wallet providers could set up their own app stores and charge applications through revenue sharing agreements. MetaMask appears to have explored a similar direction with the launch of “snaps”.

Similarly, wallet providers can also direct users to specific applications and receive shared economic benefits. The advantage of this approach over traditional advertising is that users can make purchases and interact with apps directly from within their wallets. Coinbase is already experimenting with a similar approach by recommending “featured” apps and in-wallet quests to guide users.

Wallets can also help bootstrap growth for emerging chains by sponsoring user transactions for them. For example, if Bearachain wanted to attract users to its chain, they could pay MetaMask to sponsor cross-chain fees and gas costs on Bearachain. Since wallets ultimately own the end users, I expect they can negotiate some favorable terms.

As more users onboard through wallets as their primary on-chain access point, we may see a shift in demand from “blockspace” to “walletspace” as attention becomes the most precious resource in the crypto economy.

Strong Challenges for Ambitious Consumers

Finally, while wallets have an early lead in the race for end users, I’m still excited about the prospects of two alternative front ends:

1. Jupiter: @JupiterExchange has established a close relationship with end users through its DEX aggregator as an initial entry point, giving it one of the strongest starting points in the crypto space to expand other related products, including its perpetual contract DEX, launch platform, native LST, and latest RFQ/solving products. I am particularly excited about Jupiter’s upcoming mobile app, as this could push its user relationship position on mobile devices ahead of wallets and closer to end users.

2. Infinex: @Infinex_App By integrating EVM chains and Solana’s applications, Infinex hopes to provide a CEX-like experience while maintaining its non-custodial and permissionless principles. Infinex will initially offer spot trading and staking services, and plans to integrate perpetual contracts, options, lending, leveraged trading, yield farming, and fiat access. By abstracting the account layer and using features familiar to Web2 users such as cryptographic keys, I believe Infinex also has the potential to replace wallets and become the standard front end for cryptocurrencies.

While it is not yet clear who will ultimately win the battle for end users, it is becoming increasingly clear that (1) user attention and (2) exclusive order flow will continue to be the scarcest and most monetizable resources in the crypto economy. Whether it’s a wallet or an alternative front-end like Infinex or Jupiter, I expect the most valuable projects in crypto going forward will be those entities that own these two key resources.