What is a “Multisig” Wallet?
“Multisig” stands for multi-signature, which is a special type of digital signature that allows two or more users to sign documents together as a group. Therefore, a multi-signature is created by combining multiple unique signatures. “Multisig” technology exists in the world of cryptocurrencies, but this principle was known long before Bitcoin was created.
In the context of cryptocurrencies, this technology was first applied to Bitcoin addresses in 2012, which ultimately led to the creation of multi-signature wallets a year later. Multi-signature addresses can be used in a variety of contexts, but most use cases involve security concerns. We are now discussing their use in cryptocurrency wallets.
How it works?
As a simple analogy, we can imagine a secure locker with two locks and two keys. Alice has one key and Bob has the other. The only way they can open the box is to provide both of their keys at the same time, so one person cannot open the box without the other's consent.
In essence, funds stored in a multi-signature address can only be accessed using two or more signatures. Therefore, using a “Multisig” wallet provides users with the opportunity to create an additional level of security for their funds. But before looking any further, it's important to understand the basics of a standard Bitcoin wallet, which is based on a single key rather than multiple keys (a single-key address).
Standard key and Multi-signature
Bitcoins are typically stored in a standard single-key address, meaning that whoever has the corresponding private key can access the funds. This also means that only one key is needed to complete transactions, and anyone with a given private key can transfer coins at will, without authorization from anyone else.
Although managing a single-key address is faster and simpler than a multi-signature wallet, it poses a number of challenges, especially in the security area. With a single key, funds are protected in just one way, which is why cybercriminals are constantly developing new phishing techniques to try to steal users' funds.
Moreover, single-key addresses are not the best option for companies working with cryptocurrencies. Imagine that a large company's funds are stored at a standard address that has one corresponding private key. This will mean that the private key will be entrusted to one person or several people at the same time - and this is clearly not the most secure way.
“Multisig” wallets offer a potential solution to both of these problems. Unlike single-key, funds stored in a multi-signature address can only be moved if multiple signatures (which are generated using different private keys) are provided.
Depending on how the multi-signature address is configured, a different combination may be required: the most common is a 2 of 3 key, where only 2 of them are needed to access the facilities of a 3-signature address. However, there are many other options such as 2 out of 2, 3 out of 3, 3 out of 4, etc.
There are several possible applications for this technology. Below are some of the most common use cases for multi-signature crypto wallets.
Increased security
By using a multi-signature wallet, users can prevent problems caused by the loss or theft of the private key. This way, even if one of the keys is compromised, the funds are still safe.
Imagine that Alice creates a “Multisig” 2 of 3 address and then stores each private key in a separate location or device (e.g. mobile phone, laptop and tablet). Even if her mobile device is stolen, the thief will not be able to access her funds using only 1 of the 3 keys. Likewise, phishing attacks and malware infections are less likely to succeed since the hacker will likely only gain access to one device and key.
Apart from malicious attacks, if Alice were to suddenly lose one of her private keys, she would still be able to access her funds using the other two keys.
Two-factor authentication
By creating a multi-signature wallet that requires two keys, Alice can create a two-factor authentication mechanism to access her funds. For example, she might have one private key stored on her laptop and another on her mobile device (or even a piece of paper). This ensures that only someone who has access to both keys can complete the transaction.
Please be aware that using “Multisig” technology as two-factor authentication can be dangerous, especially if it is set to a 2 of 2 multi-digit address. If one of the keys is lost, you will not be able to access your funds. Therefore, it is safer to use setup 2 of 3 or a third-party two-factor authentication service that provides access to information using generated codes. When it comes to exchange trading accounts, using Google Authenticator is highly recommended.
Escrow transactions
Creating a 2 of 3 multi-sig wallet can allow for an escrow transaction between two parties (Alice and Bob) that includes a third party (Charlie) as a mutually trusted guarantor in case something goes wrong.
In this scenario, Alice first deposits funds that will be locked (no user will be able to access them themselves). Then, if Bob provides the goods or services as agreed, they can both use their keys to sign and complete the transaction.
Charlie, the guarantor, will only need to intervene if there is a dispute, after which he can use his key to create a signature that will be provided to either Alice or Bob, as determined by Charlie.
Making decisions
The board of directors can use a “Multisig” wallet to control access to company funds. For example, by setting up a 4 of 6 wallet in which each board member owns one key, no individual board member can misuse the funds. Therefore, only those decisions that are agreed upon by the majority can be implemented.
Flaws
While multi-signature wallets are a good solution for a number of problems, it is important to remember that there are certain risks and limitations. Setting up a “Multisig” address requires some technical knowledge, especially if you don't want to rely on third-party providers.
Additionally, since blockchain and Multisig addresses are relatively innovative, it may be difficult to go to court if something goes wrong. There is no legal custodian of the funds due to depositing into a shared wallet with multiple key holders.
Conclusion
While multi-signature wallets have a few drawbacks, they have many interesting applications that make Bitcoin and other cryptocurrencies even more useful and attractive - especially for businesses. By requiring more than one signature to transfer funds, “Multisig” wallets provide increased security and enable escrow transactions, and so the technology is likely to evolve in the future.