What is Multisignature?
The use of multisignature is popularized in crypto wallets. Multisig wallets are more secure than wallets that use only one key.
What is a Multisig Wallet?
A multisig wallet is a crypto wallet that requires two or more digital signatures to authorize a transaction. They add an extra layer of protection by requiring approval from multiple parties. It is a lock that can only be opened by a set of keys.
There are various types of multisig wallets. The two most commonly used ones differ in the number of signatures required to approve a transaction:
- The first type requires all parties to approve transactions.
- The second type will only require a predefined number of parties to approve transactions (e.g., three of four, five of seven).
How Do Multisig Wallets Work?
Multisig wallets use smart contracts to establish rules on who the authorized signatories are and how many signatures are required to approve transactions. When creating a multisig wallet, users will have to define the following parameters:
- Number of authorized signatories
- Number of required signatures
- Public keys of authorized signatories
Once a multisig wallet is created, authorized signatories will get notifications when transactions are initiated. They can choose to authorize transactions by providing their signature.
The multisig smart contract will validate the signatures against the public keys provided during the creation of the smart contract. It will only execute the transaction when all the conditions are met.
Advantages of Multisig Wallets
Here are the advantages multisig wallets hold over traditional single-signature wallets:
- Enhanced security: Mutlisig wallets are used due to the higher level of security that they offer. As multiple private keys are required to authorize a transaction, it becomes significantly more challenging for hackers to access funds held in a multisig wallet.
- Reduced single point of failure: Single-signature wallets have a single point of failure which is the private key to the wallet. However, in multisignature wallets, the risk is distributed across multiple private key holders. Key holders may be able to successfully approve the transaction, even when authorized signatories lose their keys, in 2-of-3 or 3-of-5 multisig wallets. An example of this risk was the sudden death of the founder of the crypto exchange QuadrigaCX, who was the sole key holder of the exchange’s cold storage wallet, which held customer deposits.
- Institutional use: Multisig wallets offer a practical solution to institutions such as cryptocurrency exchanges and financial services providers, who have several individuals or teams managing large sums of cryptocurrencies. Having multiple authorized signatories not only increases security but also promotes collaboration and reduces friction within the organization.
- Customizability: At its core, multisig wallets are smart contracts. The use of smart contract technology allows multisig wallets to become programmable. For example, users can configure a multisig wallet to require only two-of-three signatures to approve transactions. A multisig wallet can also be modified to add new authorized signatories or to remove old ones.
- Community use: Multisig wallets are useful in community projects. Most crypto projects have community funds that are put to use for development and investments. In such cases, the use of multisig wallets will decentralize power across multiple project leaders and community representatives.
Disadvantages of Multisig Wallets
- Not user-friendly: Multisig wallets are more complex to use than traditional single-signature wallets. Users will need technical expertise to set up, configure, and manage multisig smart contracts. More importantly, If smart contract parameters are not configured correctly, it can lead to unintended consequences, such as inaccessible funds. Furthermore, coordination between authorized signatories can also be cumbersome.
- Expenses: Because multisig wallets are smart contracts that are deployed on the blockchain, users have to pay gas fees to set up and make changes to the smart contract.
- Slower transaction times: The drawback of having multiple authorized signatories is that it slows down transaction approval. This problem is exacerbated when signatories are spread across different time zones. The unavailability of signatories can delay transactions which can be a significant operational risk for organizations.
- Limited adoption: Multisig wallets are not as popular as traditional single-signature wallets. This means that not all cryptocurrency platforms and services support multisig transactions, potentially limiting the usability of multisig wallets in certain situations.
Examples of Multisignature Use
Here are some examples of multisig wallet use cases:
- Cryptocurrency exchanges: Many cryptocurrency exchanges use multisig wallets to enhance the security of customer funds. Enhanced security and elimination of a single point of failure make multisig wallets ideal for cryptocurrency exchange use.
- Escrow services: Multisig wallets offer a secure and transparent way to escrow assets. A third-party mediator can be added as an authorized signatory who releases the funds held in the wallet only when certain conditions are met.
- Custody services: Similarly, custodians use multisig wallets that require multiple authorizations for withdrawals or asset transfers to safeguard customer funds.
- Decentralized autonomous organizations (DAO): Crypto DAOs are responsible for managing funds required for the development of their projects. Using a multisig wallet ensures that a centralized entity is not in control of the community funds.
Multisig wallets have become popular tools within crypto organizations due to their higher level of security and customizability.
In a crypto world riddled with hacks and scams, multisig wallets provide that extra layer of protection that the industry participants look for.