What is a Multisig Wallet and How Does it Work?

Multisig wallets allow for multiple signatures to be required to move funds, providing an extra layer of security for cryptocurrency holdings. They are useful for businesses and shared assets, and can facilitate secure and mutually agreed-upon transactions. However, multisig wallets require technical expertise to set up and come with inherent risks and limitations. Understanding the benefits and drawbacks of multisig technology is crucial in making informed decisions when it comes to securing cryptocurrency assets.

Basics

When multiple unique signatures combine to produce a single signature, this is known as multisig, short for multi-signature. It allows groups of two or more users to sign documents collectively. While it has been present in the world of cryptocurrencies, it is not exclusive to it and predates the emergence of Bitcoin.

In 2012, the technology was initially implemented on Bitcoin addresses, paving the way for the development of multisig wallets one year later. Although multisig addresses can have various applications, they are predominantly utilized for security reasons. In this discussion, we will concentrate on their use within cryptocurrency wallets.

How Does It Work?

Imagine a bank vault with two locks and two keys. John has one key and Mary has the other. To open the vault, both keys must be inserted simultaneously. Otherwise, it remains locked.

A multi-signature address works similarly. Access to the funds stored there requires two or more signatures. Therefore, using a multisig wallet adds an extra layer of security to the user's assets. However, it is crucial to first understand the fundamental workings of a standard Bitcoin address, which relies on a single key (also known as a single-key address).

Single-Key vs. Multisig

In general, Bitcoins are stored in single-key addresses, which allow access to the funds with the corresponding private key. This means that anyone who holds the key can initiate transactions without requiring approval from anyone else.

Despite being more straightforward, single-key addresses come with several security issues. They offer a single point of failure, making them vulnerable to cybercriminals who use phishing techniques to steal cryptocurrency funds.

Single-key addresses are also not a viable option for businesses that handle cryptocurrency. Large companies storing funds in a single-key address would have to entrust the private key to a single individual or multiple people simultaneously, which is not secure.

Multisig wallets can mitigate these concerns. Unlike single-key addresses, they require multiple signatures to move funds, generated using different private keys. Depending on the configuration of the multisig address, a different combination of signatures may be necessary. For instance, 2-of-3 is the most common combination, meaning that two signatures are needed from a group of three possible signers. Other variations include 2-of-2, 3-of-3, 3-of-4, among others.

Multisig technology has several use cases, including the following:

• Offering an extra layer of security to cryptocurrency holdings.
• Enabling businesses to distribute access to funds among multiple parties while still maintaining security.
• Preventing fraud by requiring multiple approvals for transactions.
• Making it easier for families to manage shared cryptocurrency assets.

Multisig Wallets and Increased Security

When it comes to safeguarding cryptocurrency funds, a multisig wallet can offer valuable benefits to users. One of the most significant advantages is the ability to mitigate risks associated with private key loss or theft.

By creating a multisig address with multiple private keys, a user can ensure that their funds remain secure even if one of the keys is compromised. For instance, Mary can create a 2-of-3 multisig address and store each private key in a different location, such as a mobile phone, laptop, and tablet. This ensures that even if one of her devices is lost or stolen, the thief won't be able to access her funds without all three keys.

Multisig wallets also provide added protection against phishing attacks and malware infections. If a hacker gains access to one of Mary's devices, they would still need the other two keys to access her funds.

Furthermore, even if one of Mary's private keys is lost, she can still access her funds with the remaining two keys. Overall, multisig wallets provide a layer of security that is not present in standard, single-key addresses.

Two-Factor Authentication

To increase the security of her funds, Mary creates a multisig wallet that requires two private keys. This two-factor authentication mechanism ensures that only someone who has both keys can access her funds. Mary could store one key on her laptop and the other on her mobile device or even on a piece of paper.

However, using multisig technology as two-factor authentication can be dangerous, especially if it's a 2-of-2 setup. Losing one of the keys would mean losing access to the funds. Therefore, it is safer to use a 2-of-3 setup or a third-party 2FA service. For crypto exchange trading accounts, it is highly recommended to use Google Authenticator to improve security.

Escrow Transactions

A multisig wallet with a 2-of-3 setup can facilitate an escrow transaction involving Mary, John, and a mutually trusted third party, Steve.

To begin, Mary would deposit the funds into the wallet, which would then be locked and require both Mary and John's keys to access. If John fulfills the agreed-upon terms of the transaction, both parties can use their keys to sign and finalize it.

In the event of a dispute, Steve would serve as the arbiter and use his key to create a signature that would be provided to either Mary or John, based on his judgment. This way, the multisig setup allows for a secure and mutually agreed-upon transaction to take place, with the assurance of a trusted third party.

Decision Making

To ensure that a company’s funds are managed responsibly, a board of directors could use a multisig wallet. One way to set this up is by creating a 4-of-6 wallet where each board member holds one key. This means that no single board member can decide without the majority's agreement. To execute a transaction, at least four of the six board members would need to provide their signature, ensuring a safe and transparent decision-making process.

Disadvantages

It is important to be mindful of the potential drawbacks and limitations that come with multisig wallets. Technical expertise is required to set up multisig addresses, especially if you wish to avoid using third-party services.

Moreover, given that both blockchain and multisig addresses are relatively new technologies, it can be challenging to seek legal remedies if something goes wrong. Shared wallets with multiple keyholders lack a legal custodian for the deposited funds.

Conclusion

Multisig wallets offer a valuable solution for users looking to increase the security of their cryptocurrency holdings. By requiring multiple signatures to move funds, multisig wallets provide an extra layer of protection against theft, loss, and fraud. They can also facilitate secure and mutually agreed-upon transactions, making them useful for businesses and shared assets. However, multisig wallets do come with inherent risks and limitations, and users must be aware of these before implementing them. Overall, understanding the benefits and drawbacks of multisig technology can help users make informed decisions when it comes to securing their cryptocurrency assets.