What Is a Multi-Sig Wallet, and How Does It Work?

According to Glassnode, the total number of BTC wallets exceeds 1.21 billion as of November 2023. These figures reflect how much cryptocurrency has grown and is growing.

 

Total number of Bitcoin addresses as of November 2023 | Source: Glassnode

 

In a digital economy where the internet gives everyone easy access to all information, securing one's data has become imperative for companies, governments, and individuals. 

 

Cryptocurrencies are digital versions of money, and their value growth continues to attract different kinds of malicious actors wanting to access the digital asset one way or the other. There's also the possibility of human error that makes users lose funds. 

 

Today's article will consider a multi-signature (multisig) wallet as one of the ways to fight against hacking or prevent human error to keep your cryptocurrency safe as much as possible.

 

Multisig wallets fall under crypto wallets. So, it's a good idea to start here. A cryptocurrency wallet is any physical device or application software that allows you to store, send, and receive cryptocurrency. 

 

There are different kinds of crypto wallets, all of which differ based on online or offline presence, centralized or decentralized, and the number of private keys needed to access them. 

 

Learn all about how crypto wallets work. 

 

A multisig wallet can be likened to a multiple-key deposit box that requires the manager and the box owner to insert their unique keys simultaneously to access the deposit box or a bank vault that needs two or more keys inserted simultaneously and rotated clockwise or anticlockwise for opening it. The point is that multiple-signature wallets are crypto wallets requiring two or more private keys to approve transactions. 

 

The issue of security against hacks or human error brings multisig wallets to the limelight. Traditional crypto wallets require a single private key to access an account for sending and receiving funds. But often, these private keys and corresponding seed phrases can be misplaced or stolen. For non-custodial crypto wallets, this means no way of recovering funds once a private key is compromised or forgotten. 

 

Multisig wallets solve this problem by offering multiple signatures to a single account. It could be 2-of-2, 2-of-3, 3-of-5, 4-of-5, etc. You can still access your funds even if you lose one private key as long as the other keys are intact. You can strengthen security by sharing these private keys among "signatories'' instead of one person holding all. 

 

Each signatory must sign with their digital signature (private key) for a transaction to occur. In a 2-of-2 multisig wallet, two out of two signatories must sign to approve a transaction. For a 2-of-3 multisig wallet, two out of three private keys must sign to approve a transaction, etc. 

 

The multisig wallet concept follows the famous saying, "Do not put all your eggs in one basket," which is tied mainly to diversification, distribution, and security, either financially or socially. 

 

Here's a summary of the features of a multisig wallet:

 

• All signatories with a unique private key can see transaction details in the wallet.

• All signatories receive a unique seed phrase for account recovery.

• All signatories have to sign a transaction with their private key to approve.

• In the case of one private key signing, a transaction will show "pending" until the required number of private keys sign the transaction for approval.

The process involved with a multisig wallet starts when one of the signatories to the account initiates a transaction on the multisig wallet address. For this transaction to occur in a 3-of-4 multisig wallet, all three signatories must append their private keys to finalize it. Anything less than the required amount of private keys shows a "pending" transaction. 

 

Another thing to note is that no private key or signatory is ranked higher than the rest. Transactions do not have to be signed in a particular order; any three out of four or two out of three can sign the transaction. 

 

An example. Suppose you create a multisig wallet and choose the 3-of-5 option. Say you pick John, Alex, Alice, Sam, and you as the account's signatories. For a complete transaction to occur, either John, Alex, and Sam, or you, Sam, and John, can sign the transaction.

 

If approving the transaction was put to the vote, and five out of five agree, any three can append their signature. If three out of five agree (a majority), those three can append their signature. If two out of five agree, even if they both append their private keys, more is needed to approve a transaction. 

 

 

The default way of storing cryptocurrencies involves wallets using a single private key. These kinds of wallets are most popular because they are the most convenient for most people using crypto, which is individuals. A single-key wallet needs just one private key to approve a transaction and is held by one direct owner. While this is faster, it bears its risks and becomes uncomfortable for storing large amounts in the case of a company.

 

Mutltisig wallets require multiple keys to approve a transaction and help with boards of directors or finance executives in a corporate setting. A single key wallet is ineffective in this case because losing or compromising that key affects the entire fund. Multisig wallets create an extra layer of security and guarantee that puts the table on two or more legs instead of just one. 

 

There has been a case of a company losing $137 million to a single key wallet because the direct holder of the private key, the CEO, died.

 

Multisig wallets may be safer and more reliable but are not the easiest to comprehend. It requires a level of technical know-how for effective utilization. But it's nothing you can't understand if you commit time.

 

Multisig wallets have several advantages that elevate them as a go-to solution for safer crypto storage, among which are:

 

Stronger Security 

Providing multiple private keys to a wallet and spreading them across different holders creates another level of security absent in one private key wallet. In a 2-of-3 multisig wallet, if a hacker compromises one private key, it is useless, as two private keys are needed to sign a transaction.

 

Should you misplace one of your private keys or forget it, all is not lost, as the other two keys can approve the transaction. Multi-signature wallets create an extra sense of security by increasing accessibility options to users.

 

Two-Factor Authentication (2FA)

Multiple signature wallets are another method of two-factor authentication. You can still prevent someone from withdrawing money from your account even if they manage to steal one of your keys. 

 

You can keep all private keys for yourself or distribute them to others. In either case, it ensures that every transaction is thoroughly verified before being finalized.

 

Helps With Consensus

A group can manage finances collectively when a wallet's keys are distributed among several persons. Everyone can access the funds and make adjustments, but nobody can transfer money independently. 

 

When making commercial decisions, this is common. The wallet effectively functions as a voting system, with transactions only approved by a specific percentage of users.

 

Escrow Agreements

Holding money in escrow during a transaction with another party might be helpful. In essence, escrowed transactions ensure neither party can obtain money, goods, or services without the other party upholding their half of the bargain.

 

Escrow contracts require using cryptocurrency in 2-of-3 wallets. The payer places money in the multi-signature wallet to initiate the transaction. When the other party has delivered the agreed-upon products or services, the payer and the sender can digitally sign the multi-signature wallet to transfer the money to the seller.

 

In a disagreement, an impartial third party with access to the key can decide whether to provide the money to the buyer or the seller.

 

It's normal for everything to have an up and downside to its dynamics. For multisig wallets, these are a few:

 

Slower Finalization Time

The extra layer of security with multi-signature wallets means additional time. In a single key address, the person initiating a transaction most likely holds the private key to the address and can input it to finalize a transaction in seconds. 

 

The case is, however, different with multi-signature wallets. It can go both ways; you could get a hold of other signatories immediately to sign a transaction; other times, getting a hold of other signatories to the multisig addresses can be time-consuming. 

 

Operational Knowledge 

Multisig wallets are relatively new security measures for cryptocurrency storage. The technical know-how for operating multisig wallets involves more than a single key address. There's the option to go with a third party to explain things, but as usual in the decentralized space, "third parties" are not always the best option. Learning a new technology can have a steep curve, but it's worth understanding. 

 

Insurance And Legal Regulations

The cryptocurrency space is relatively new compared to other financial markets. Therefore, some innovations or technologies that spring up within the crypto market are relatively new, not necessarily in the physical application but in digital versions. 

 

Funds secured in multisig wallets are not insured against loss or compromise. Technically, funds are stored at the owner's risk — even in most cases of hot wallets. 

 

The crypto market is largely unregulated for now, limiting the number of legal actions that can trigger should something go wrong.

 

Multisig Wallet Scams

Look out for the tricky ways scammers could utilize multisig wallets. A common practice is malicious actors setting up transactions as sellers and then sending victims who want to buy one private key in the pretense of a 2-of-2 multisig wallet, which is a 1-of-2 wallet. 

 

The unsuspecting buyer sends funds thinking they both have to use their private keys for both parties to access the product and payment, not knowing the seller has a one-way key and carts away with the funds. 

 

It doesn't happen often, but it's a possibility. Another scamming possibility is sharing your private keys with people who later turn on you to move your funds. It could be friends and family. The main thing is to be as selective and sensitive as possible. 

 

Multi-signature wallets create an extra layer of security. It increases the chances of users accessing their funds and reduces the chances of human error or malicious actors carting away your funds. The technology is relatively new and works for group control like companies, NGOs, governments, religious organizations, etc. 

 

Using a multisig wallet is a matter of choice and functionality. Still, if security and extra privacy are something you worry about, multisig wallets could be the best crypto storage option, either as a hot wallet or cold wallet. 

 

1. A multisig wallet, short for a multi-signature wallet, is a type of crypto wallet that requires multiple signatures or keys to authorize transactions.

2. Multisig wallets implement a unique security mechanism involving multiple parties, each holding a private key, to approve transactions.

3. Single-key wallets use only one private key for transaction authorization, while multisig wallets enhance security by requiring multiple keys.

4. Advantages of using a multisig wallet include increased security, reduced risk of theft or loss, and improved access control for shared accounts.

5. The downsides of using a multisig wallet include potential complexity in setup and management and the need for coordination among keyholders.

1. What Is a Crypto Wallet, and How to Choose the Best One for You? 

2. How to Back Up Your Crypto Wallet Private Keys

3. What Is the Safest Way to Store Your Cryptocurrencies?

4. The Difference Between Custodial and Non-custodial Wallets

5. The Use of Hardware Wallets in Crypto Investing and Trading