Multisig wallets, also known as multi-signature wallets, are a type of cryptocurrency wallet that require two or more private keys to carry out certain tasks, like executing transactions. They are designed to provide assets with increased security by ensuring that they cannot be used unless approved by multiple parties with predetermined addresses.
In this AAG Academy guide, we’ll explain in detail what multisig wallets are and how they work, and look at the types of multisig wallets that are available today. We’ll also cover the advantages and disadvantages of using them, and answer some frequently asked questions.
A traditional cryptocurrency wallet app works much like a mobile banking app. You can use it to view any digital assets you might own, and to facilitate transfers to other users. Usually, that’s as simple as entering another person’s wallet address and approving the transaction with your own private key. But for some cryptocurrency users, an extra level of security is required.
Mobile banking apps typically use two-factor authentication, which requires you to enter a code that is usually sent by text message or email. But the cryptocurrency industry has developed another solution for bolstering the security of your funds. Multisig wallets prevent any of your digital assets from being used unless a transaction has been approved by multiple private keys.
Although multisig wallets can be used by the general public, they are particularly useful for groups or organizations that require multiple people to sign off on a transaction. Since they were first introduced in 2013, multisig wallets have grown in popularity and are now available in a number of different flavors — each of which we’ll look at later in this guide.
How does a multisig wallet work?
Traditional cryptocurrency wallet apps, which are typically created by the general public to interact with blockchains, are technically known as externally owned accounts (EOA). They are created by users and controlled by private keys, which the wallet app itself holds onto. Multisig wallets work differently. Instead of being controlled by an end user, they use smart contracts.
In other words, a multisig wallet is essentially a piece of code on the blockchain. It is executed when one user initiates a transaction and then enters their own private key to sign it, but nothing happens at this point; the transaction sits in a pending state until other users of the multisig wallet enter their private keys. Once enough keys are entered, the transaction can go ahead.
At this point, the wallet itself signs the transaction and sends the funds to the appropriate address. If a certain number of signatures is not obtained, the transaction remains incomplete and sits in a dormant state within the multisig wallet. Proposed transactions do not expire, so there is no need for them to be completed within a certain period of time.
It is important to note that there is no hierarchy among the different users of a multisig wallet. Every signature is as valuable as another, and no specific signature is needed before funds can be moved. For instance, if a certain wallet requires four out of five users to enter their private key, any four users can do this in any order.
What are the types of multisig wallet?
As we touched on above, there are a number of different types of multisig wallet, all of which operate a little differently when it comes to the number of keys and signatures required to approve a transaction. This gives groups and organizations a variety of options to choose from depending on how they want their multisig wallet to work.
Here are the most common types of multisig wallet in use today:
2-of-2 Multisig wallets that use the 2-of-2 system require two different private keys from two separate devices. For example, one key might be stored on a mobile device, and the other might be stored on a desktop. Transactions cannot be authorized without both keys.
2-of-3 Multisig wallets that use the 2-of-3 system operate in much the same way as 2-of-2 wallets, except they are created with three different keys. Only two of these are required to approve a transaction, so if one user is unavailable, the other two don’t need to wait.
1-of-2 You might have guessed how 1-of-2 wallets work already. These are created with two signatures, but only one of them is required to authorize a transaction. These are useful for users who want to share funds but have the power to use them individually.
What are the benefits of multisig wallet?
In addition to the obvious security benefits a multisig wallet provides, there are some other advantages that they offer. One of the biggest of which is sharing responsibility for funds and eliminating the need for a “key person.” This is crucial in organizations because it provides flexibility and prevents funds from being lost if an individual leaves the organization.
This is a common risk within the cryptocurrency industry, which has predominantly relied on EOA wallets since its inception. In December 2018, QuadrigaCX, Canada’s biggest crypto exchange at the time, learned this the hard way when its CEO, Gerald Cotten, died with $190 million worth of crypto in a personal wallet that no one else had access to.
The other big benefit of multisig wallets is greater transparency. Because multiple people have to sign a transaction before it can go ahead, it’s not possible for one person to secretly use shared funds without the knowledge of others in the group. What’s more, multisig wallets are open source, so anyone can view the code that governs them to ensure they work as intended.
Finally, multisig wallets are buildable. In addition to the common types we’ve listed above, groups and organizations can easily adjust a wallet’s specifications to meet their own needs. This gives DAOs the ability to create multisig wallets that allow for more complex implementations, like the ability to vote on transactions and more.
What are the disadvantages of a multisig wallet?
Before you rush off to set up a multisig wallet for your organization, it’s important to understand their disadvantages, too. One of those is transaction speed. The greater the number of people required to sign off on a transaction, the longer it is going to take to get all of the keys required. This can be a problem if you need to execute an urgent payment.
However, a greater number of people does reduce the risk that funds could be lost in the event that one or a number of people disappear or leave the organization. If your wallet requires three out of five keys, for instance, it’s less risky than a multisig wallet that requires two out of two keys that essentially cannot be used if the holder of one of those keys passes away.
It should be noted that multisig wallets are more difficult to create than standard cryptocurrency wallets. They typically require the input of a third-party wallet provider, and even then, the process can be complex — and difficult to understand by any members of a group who are unfamiliar with multisig wallets or cryptocurrency in general.
We should also be aware that multisig wallets have been used to scam unsuspecting crypto users in the past. Although it is rare, bad actors have created multisig wallets and used friends or other scammers as signatories, so when their victim adds funds, they can easily steal them without requiring any input from the victim.
Once a multisig wallet has been created, using it isn’t that different to using a regular crypto wallet. Users can initiate transactions by entering the necessary details and signing it with their key. However, the transaction won’t go ahead until other parties have signed it, too.
Yes, it is possible to be scammed with a multisig wallet, so it is important to ensure that you confirm any wallet you use is trusted and genuine before adding funds to it.
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About the author
Senior content writer
Senior copywriter for AAG Marketing team with the focus of educating our community on all things web3, blockchain and Metaverse.
This article is intended to provide generalized information designed to educate a broad segment of the public; it does not give personalized investment, legal, or other business and professional advice. Before taking any action, you should always consult with your own financial, legal, tax, investment, or other professional for advice on matters that affect you and/or your business.