What is Multi-signature? Multi-sig Wallets in Crypto Explained
- You can create time-locked transactions as a multisig wallet functionality. This is to ensure that all parties had a chance to review the transaction.
- Some popular multisig wallet choices in 2023 are WH Cypher, Electrum and Ledger Nano X.
What is a multi-signature wallet?
As the name suggests, a multi-signature wallet refers to a particular type of crypto wallets that requires the signing of two or more private keys to perform tasks. Sometimes multisig wallets are referred to as multisig safes or vaults. All this is done to enhance the security of crypto assets stored in such a wallet.
The multisig technology was first applied back in 2012 to Bitcoin addresses. This led to the creation of multisig wallets one year later.
Multi-signature wallets require multiple signatures from a number of predetermined addresses. If there is a signature missing, the transaction won’t be able to happen. You can imagine it as a vault with a set of specific keys that need to be used together to open it.
To understand multisig wallets, knowing how a crypto wallet works is essential. Every crypto wallet has private and public keys. The case with multisig wallets is that they encompass more advanced functionality.
Public keys are cryptographically paired with private keys. Anyone can send a public key, but you need associated private keys to access the funds. A public key is similar to a bank account number, and a private key is like a bank account PIN – a secret number that is needed to access the funds.
That is the case with multi-signature wallets. Each signature is a unique cryptographic private key, and the transaction must meet an agreed threshold for signing.
If you are not sure how a cryptocurrency wallet works, we suggest first reading this article: ‘How to use crypto’,
Single-signature wallet vs Multi-signature wallet
The difference is evident; a single wallet, also known as a basic digital wallet, requires one signature to sign off a transaction. When you want to send funds from your wallet, a transaction needs to be signed. When you sign the transaction, you are basically stating that you are the owner of the assets and that you approve this transaction.
On the other hand, when using a multi-signature wallet, approval by only one user isn’t enough. Such crypto wallets are shared by multiple parties. Depending on the type of wallet in question, the number of signatures required to sign a transaction should be lower or equal to the number of users holding the wallet.
Single-key wallets are suitable for small transactions, like fast payments from one end-user to another. However, they are not recommended for businesses or even individuals that need to store considerable amounts of cryptocurrency.
Multi-signature wallets add up to the overall security. If you lose access to your single-key wallet, you can kiss your crypto funds goodbye.
How do multi-signature wallets work?
Imagine a safe deposit box with two keys and two locks. One key is held by Dean, and the second one belongs to Rachel. The only way to open the deposit box is to put both keys in the locks at the same time. In other words, Dean cannot open without Rachel’s consent and vice versa.
The process to conduct a transaction in a multi-signature wallet includes the same steps regardless of the type of wallet in question. One of the holders needs to input details of the transaction in the wallet and use the corresponding private key to sign it. The transaction is now pending (sometimes, called partially signed) until the other key or keys are submitted to complete the signature.
Therefore, to access the digital assets stored on a multi-signature address you need two or more signatures, depending on the type of the multisig wallet and the number of private key holders. By requiring more than one signature, this type of technology provides an additional layer of security, eliminates key person risk, and mitigates any single point of failure.
When it comes to private keys and their use, there is no hierarchy. The only thing that matters is the number of keys required to sign the transaction. Additionally, there is no expiration date in multisig transactions. The transaction will remain in the pending status until all the keys are present.
Types of multisig wallets
Multi-signature wallets can be differentiated by the number of existing private keys and the number of signatures required to authorise a transaction.
Based on how a multi-signature address is formed, there are a few divergent private key combinations.
A. 1-of-2 multisig wallet
A multi-signature crypto wallet can be used to share assets among multiple users. However, if you want to share the access in a single wallet with a person you trust, you can set up a 1-of-2 wallet that enables any of your two private keys to sign a transaction.
Since any of these two keys can authorise a transaction, there is no need to wait for the other party to consent to the transaction. Both users can operate independently.
B. 2-of-2 multisig wallet
Digital wallets that are protected by the two-factor authentication technique use the 2-of-2 multi-signature algorithm. The idea behind this type is to keep private keys on two different devices.
Find out more about setting up two-factor authentication by reading this article: ‘How to use crypto: Sending & Receiving Crypto’.
For example, one private key is stored on a computer, and the other one is on a mobile device. To authorise a transaction, you need a signature from both devices.
Even though a 2-of-2 multi-signature wallet adds a second layer of security, keep in mind that there is a risk of losing access to crypto funds if one of these two devices is compromised.
C. 2-of-3 multisig wallet
This type of crypto wallet requires 2 of a maximum of 3 private keys to sign a transaction. It is commonly used by crypto exchanges to increase the security of so-called hot wallets. Unlike hardware cold wallets, hot wallets are connected to the Internet and store private keys online.
To mitigate risks associated with hot wallets, multisig addresses used by exchanges hold one private key online and the second one offline on an isolated device. The third private key is kept safe by a separate security company.
Therefore, two entities hold the private keys. In case one of them gets compromised, the wallet still remains safe. The offline backup stored on an isolated device adds another layer of security in case a security partner goes out of business due to insolvency or a similar reason.
D. 3-of-5 multisig wallet
This type of crypto custody requires two private keys that should be, in an ideal situation, separated territorially. To access funds and sign a transaction, there should be another third party, for example, a security company.
Then we have two private keys that are geographically separated, but to access the funds we also need the security company’s key.
Benefits & setbacks of multisig wallets
The main issue regarding a multisig wallet is linked to its security and end-user accessibility. Multisig wallets offer additional layers of security and other advantages, but they encompass certain disadvantages as well. That is why we have provided a list of the main pros and cons of these crypto wallets below.
Main advantages of multisig wallets
- A high degree of security: Using multisig wallets eliminates two main risks: the single point of failure risk and the key-person risk. Even if you lose your private keys, your funds remain intact due to a safe backup of other private keys that are stored on separate devices and locations. This makes it much harder for hackers to break your security because it relies on multiple parties as key holders or multiple points of safety. In some cases, it may be even impossible to compromise all these points at the same time.
- Escrow transactions: Using a multi-signature wallet basically means that you are using an intermediary in the form of a trustless escrow to conduct financial transactions in the digital world. Even though the main premise of blockchain technology is to remove the middleman and remain decentralised, there are a few differences between a centralised intermediary and a trustless escrow. The latter is a voluntary choice rather than an imposed one. You pick your escrow, and you can change it anytime you want. Secondly, the trust you need to put in such an intermediary is minimal since the chosen entity cannot access your assets in any manner without your private key.
- Numerous decision-making and business use cases: Similar to the escrow concept, multi-signature wallets have a valuable business-related use case. It can be used to control access to company funds. For example, a board of directors can set up a multisig wallet where each person holds one key. Therefore, only mutual agreement would be required to access the funds.
Main disadvantages of using a multisig wallet
- Technical knowledge barrier: Even though you can find many educational materials online to gain the skills needed for creating and using a multisig wallet, it still requires a certain degree of technical knowledge. Ordinary users might be intimidated when trying to configure a multisig wallet solution. On the other hand, there is a growing number of multisig wallet providers that are very proactive in helping end-users set up their wallets efficiently.
- Low transaction speed: Multi-signature wallets are typically slower when compared to single-signature crypto wallets because they rely on multiple parties’ consent to authorise a transaction. Since it provides more security, this is not a vital issue when it comes to a pleasant user experience. It can be solved by holding a smaller amount of funds in single-signature wallets to execute faster transactions.
- Difficult fund recovery: This issue is linked to the technical knowledge matter. When it comes to multisig wallets, the recovery process might present a challenge for users with less technical knowledge. The recovery process of a multisig wallet means that each recovery phrase has to be imported on each device.
Should I use a multisig wallet?
Despite certain setbacks associated with multisig wallets, the technology includes a number of upper hands and interesting use cases. In the end, it serves its main purpose – to mitigate security risks.
If you can’t figure out whether to use it or not, you should weigh the benefits and the setbacks based on your needs and the amount of crypto you plan to store.
The regular user who needs a small amount of crypto ready at hand to use quickly should stick to a regular wallet with a single private key.
But if you hold significant amounts, and particularly, take custody over funds belonging to others, you might want to consider sharing that burden of custody with a multisig wallet.