What is a Multisig Wallet?
25 July 2022 byMarlo Pluto
Reading time 5 min
Read all you need to know about such a safe and secure solution as a multisig wallet. And find your best type of cryptocurrency wallet.
Multisig technology and how does it work?
Multisig or multi-signature technology is a scheme that allows multiple users to sign a single digital object. In the world of cryptocurrency, it means that multiple signatures are required in order for the transaction to occur. The wallet is shared by multiple parties that possess equal rights within the system, with each holding a separate private key. A certain number of parties (and sometimes everyone involved) is needed to approve the transaction for it to go through. The main reason to use such an approach is increased security but it’s far from the only one.
The multi-signature wallets are often used by brokers, funds and crypto exchanges in order to distribute the risk: the hackers will need several private keys to access a multisig wallet, which adds an additional layer of protection.
Types of multi-signature wallets
Multisig transactions are also called M-of-N transactions. Same with the wallets. M refers to a number of signatures required to issue the transaction, while N is the total number of involved parties. There are multiple options that will be described below.
2-of-2 Multisig wallets
The most common example. There are 2 separate parties, and each has to approve the transaction in order for it to proceed. Can be useful for various situations, where both parties are equally important and the same decision must be made by both.
1-of-2 Multisig wallets
A very simple solution. If there are 2 parties, only one must approve the transaction. Very useful in cases where all of the parties are equal but it’s important to know who interacted with the wallet. All of the 1-of-N solutions are very similar to this one and each other.
2-of-3 Multisig wallets
The transaction can be approved by any two parties out of three. The main use case would be the escrow purposes. Two parties engage a third one that would act as an arbitrator if something goes wrong.
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What are Multisig Wallets Used for?
If two or more parties need to approve the transaction, then a multisig wallet is a more secure solution. The reason is that it’s obviously easier to get access to one private key than to two. The risk of relying on a single device is also significantly reduced. This can be beneficial for exchanges and cases when every additional layer of protection can be useful, especially if there are large sums of money involved.
It’s possible to set up a multisig wallet as a form of two-factor authentication (2FA). The most obvious choice would be using the 2-of-2 scheme and using two devices (each having a different private key) to gain access. Obviously, there are risks involved in such a scenario, since losing one device means losing complete access. To mitigate this risk, using the solutions where not all parties are required (such as the 2-of-3 ones) can be beneficial.
In traditional finance, escrow is an arrangement where a third party holds funds until certain conditions are met. Using a 2-of-3 multisig wallet for such purpose means that there are two counterparties and a mutually trusted third one. If there is a dispute, the third one will make a final decision.
Similarly to the escrow solution (described above), the multisig wallets can be used for decision making and voting within a company or team. For example, setting 4-of-6 or 5-of-7 multisig wallets (or any other, where the majority’s approval would be needed) can be used for such purposes. In this case, the agreement between the most key holders will be required in order to get access to the funds.
Pros and Cons of Multisig Wallets
Apart from the strong points mentioned above, it’s worth mentioning that using multisig wallets provides more flexibility to the world of cryptocurrency. The wallets can be set up in various ways, which is especially useful for businesses, teams and exchanges. .This can enhance credibility in the cases where large sums of money are involved. The versatility and security offered by multisig wallets might help speed up adoption of cryptocurrency.
The risks are there as well: if the wallet is set up in a way, where all of the involved parties need to approve anything, there can be a single point of failure.
Another disadvantage is that setting up a multisig wallet requires a certain level of technical expertise (but these days the process is easier than ever: there are also various software solutions that make it simple and straightforward). Such wallets also offer a slower transaction speed compared to the regular ones, which can be a problem for frequent usage. When the recovery is needed, the process is rather cumbersome, since it’s required to import each recovery phrase from each device There is also a lack of a third-party custodian, which can result in several legal difficulties if something goes wrong. Such wallets are non-custodial.