Multi-signature Wallets—How Do They Work? To process and execute a cryptocurrency transaction, a multi-signature wallet (also called a shared wallet) needs several signatures, as the name implies. A multi-sig wallet uses multiple private keys to access or transfer cryptocurrency assets. Due to their rising volume and popularity, there is an increasing demand for solid crypto storage and security protocols to safeguard digital assets and cryptocurrencies. Multisig wallets add protection for digital assets by utilizing many keys. It eliminates the potential security hole using just one private key.
Following the 2014 crash of the Mt. Gox Bitcoin exchange, the first multi-sig wallet—launched by BitGo in August 2013—gained popularity as a security measure. The wallet had 45,361 Bitcoins. Numerous cryptocurrency exchanges, custodians, and blockchains provide multi-signature addresses to safeguard their workflow, client trust, and assets. Cryptocurrency wallet services like Trezor, Argent, Safe, and Coinbase are just a few of the many available.
How Does a Multi-sig Wallet Work?
An exchange or self-custody multi-sig wallet setup requires generating a unique multi-signature address. You can receive funds at this address linked to the wallet. With a multi-signature wallet, you need a certain amount of co-signers before starting a transaction. In a two-of-three multisig setup, for instance, authorization can only be granted using two of the three private keys.
Each participant in a multi-sig wallet transaction must use their private key to sign the transaction before any money can be sent jointly. The transaction can be broadcasted to the blockchain for processing after collecting the necessary signatures. Increasing the keys needed to access cryptocurrencies makes multi-signature wallets more secure. For a hacker to be able to complete a transaction, they would still need access to all of the necessary keys, not just one private key.
Type of Multi-signature Wallets
Differentiating features of multi-signature crypto wallets include the maximum number of signatures needed to approve a transaction and the quantity of existing private keys. Some popular varieties of multi-sig wallets are:
M-of-N multi-sig wallets
A total of “N” private keys are needed for authorization in this multi-signature wallet type. A subset of the total number of keys, “M” out of “N,” is required for a transaction to be approved, executed, and processed. Standard configurations can be two of three, three of five, etc., where the numbers represent the percentage of keys that need to be signed.
N-of-N multi-sig wallets
For a transaction to be processed and performed in a shared crypto wallet or multi-sig configuration, all co-signatories must validate it. For instance, in a two-of-two or three-of-three approach, the transaction’s validity depends on each party signing with their private key.
In addition to the varieties above, a smart contract can enforce a sequential multi-signature crypto wallet. In this case, the private key signing sequence is predetermined. A specific sequence of signatures from each private key is required to execute a transaction. As an additional time-based security precaution, time-locked multisig wallets can only authorize transactions after a predetermined delay.
Setting up a Multi-signature Wallet
Coordination and adherence to crypto security best practices are essential while setting up a multi-signature Bitcoin wallet. The particular multi-sig wallet provider may have slightly different exact methods and procedures. To learn how to set up a crypto multi-signature wallet, users can consult the manufacturer’s instructions; however, below are some typical steps:
Choose a suitable multi-sig configuration
Choose a cryptocurrency wallet that allows for multiple signatures. Whether it’s two-of-three, three-of-five, two-of-two, or the desired configuration must be decided. Based on this, we can calculate how many private key signatures are needed to approve a transaction.
Generate a public key
A separate public key, often called a master public key by some wallet providers, is required of each co-signer. Making a recovery/seed phrase is as easy as following the wallet’s setup instructions. This recovery phase is essential for users to remember to proceed with the process and access their purses later. Confirming and reentering the recovery phrase will be asked for during the multisig wallet setup. You can generate a public key if you have done everything correctly. Do this separately for each co-signer.
Generate multi-sig wallet address
Creating the multisig wallet address is possible after all co-signers have their public keys. When setting up your wallet, be sure to input the public keys of all co-signers. The wallet address will be generated automatically during setup after all co-signers public keys have been entered. After creating a public address, the multi-sig wallet can accept incoming cash from other wallets or exchanges.
Transact with the multi-sig wallet
The ideal approach for security in a multi-signature wallet is for all parties to password-protect their purse. The multi-signature wallet requires all co-signers to use their registered wallets to collaborate to complete a transaction. Blockchain multi-signature wallets are thus analogous to digital banking’s two-factor authentication (2FA) or multi-factor authentication security methods.
Advantages and Disadvantages of Multi-signature Wallets
Assessing the benefits of increased security against the complexity of using a multi-signature wallet should guide the decision. There are definite pros and cons to using a multi-signature cryptocurrency wallet. Multisig wallets are great because they increase security by needing many private vital signatures to authorize a transaction. This makes it a more appealing choice for protecting digital assets because it lowers the vulnerability linked with a single compromised key.
Since a hacker would require access to multiple private keys, the likelihood of fraudulent transactions and hacks is reduced. Ideal for collaborative circumstances like company assets, decentralized autonomous organization (DAO) finances, or shared family accounts, multi-sig wallets spread trust across several parties. An advantage of using a multi-sig wallet is that it prevents the misuse of power, makes everyone feel responsible, and ensures that no one may transfer money without the proper approval.
Multisig wallets offer extra security for user assets and are widely used by cryptocurrency exchanges and wallet providers. There is adaptability for a wide range of applications thanks to the user-configurable security policies and the possibility of connection with smart contracts. The downside of multisig wallets is that they can be more complicated to set up than regular wallets because they need parties to coordinate the use of several private keys. Key management is crucial because several key holders might lead to misunderstandings or human errors.
In a multi-signature wallet, the approval of a transaction is contingent upon the collaboration of numerous vital holders. The deal could fall if one side is slow to respond or refuses to sign. Users should also ensure their cryptocurrency and blockchain platforms are compatible before implementing multi-signature capability because not all do.
Use Cases of Multi-signature Wallets
There are many different use cases for digital assets, and multi-signature cryptocurrency wallets provide a flexible and safe solution.
Managing business treasury
Businesses and decentralized apps use shared wallets for treasury management to disperse financial power among critical decision-makers, lowering the danger of cash being misappropriated.
The safety features of multi-signature wallets are ideal for blockchain escrow services. A multi-sig wallet ensures that all parties involved have a say in approving the release of funds in transactions where a third party holds them until specific conditions are met, increasing security and transparency.
Decentralized autonomous organizations
Members of the DAO work toward a system of proposals, voting, and management and allocation of open and equitable funds. One way to protect the DAO’s cash from rug-pulls and other scams is to use a shared multi-sig wallet, which allows multiple users to access the funds simultaneously.