What Are Multisig Wallets?
Hot or cold storage, which one do you prefer?
Many crypto holders swear by hot wallets, as they’re cheap and provide ease of use. On the other hand, cold storage enthusiasts will tell you that these wallets are better as they keep your private keys away from third parties.
However, neither of these offers an ultimate solution to convenience and security. Hot storage solutions are usually custodial, meaning your wallet service provider has control over your private keys. And since they’re also connected to the internet, hot wallets are more prone to security breaches.
Conversely, cold storage solutions provide an extra layer of security to your assets by giving you full control over your keys and storing them in offline storage. But the full ownership of private keys doesn’t mean much when you’re missing a good trading opportunity because you’ve left your wallet at home. God forbid you’re thinking of panic selling your assets with no wallet in sight.
Photo illustration: Freepik
Although utilizing a self-custody cold wallet undeniably enhances security compared to traditional hot wallets, there are situations where not even a cold wallet is considered a reasonable solution to your needs.
For example, if you and your friend decide to start a Web3 business, who will be in charge of your wallet? In this situation, neither conventional hot nor cold wallets make up a viable solution, as they both pose a significant risk of theft or loss. Here’s where multi-signature wallets come to the rescue.
Simply put, a multi-signature (multisig) wallet is a crypto storage solution that requires two or more signatures to execute a transaction instead of just one.
Traditional crypto wallets have only one private key, a lengthy alphanumeric code used to authorize transactions and manage available funds. With multisig wallets, only a fixed number of signatures (doesn’t matter who’s signing as long as the conditions are met) can initiate changes within a wallet.
In other words, each signature in a multisig wallet is associated with a different private key, and a predetermined number of keys must sign a transaction to make it go through. More importantly, any party associated with a multisig wallet can initiate a transaction signed with their unique private key. However, the transaction won’t be processed and “approved” unless other holders sign it.
Types of Multisig Wallets
You can differentiate multisig wallets based on a ratio of the number of signatures needed for a successful transaction to the number of signatures they possess.
- 2-of-2 multisig wallets – These multisig wallets consist of two wallets, usually stored on different devices, with the same set of addresses. Both signatures are needed to complete a transaction, and many crypto holders use it individually to add another layer of security to their assets. However, 2-of-2 multisig wallet users might lose their funds if one of those devices is compromised.
- 1-of-2 multisig wallets – Setting up a 1-of-2 wallet allows you to share custody over your crypto with another user. These multisig wallets require one signature, so if you and your business partner keep your funds in a multisig account, either one of you can initiate transactions without the other’s keys. A 1-of-2 setup is also an excellent alternative to traditional cold wallets, as it still allows you to recover your crypto in case you lose one of the private keys associated with your wallet.
- 2-of-3 multisig wallets – The 2-of-3 signature wallet has three sets of private keys, making it a decent crypto storage solution for crypto projects and organizations where multiple parties are in charge of digital assets. These wallets require two out of three signatures to finalize an initiated transaction.
Of course, other multisig setups exist, including 1/4, 3/5, 1/3, and so on. Multisig wallets can be adjusted to meet the user’s needs, so you don’t necessarily need to adapt to these setups.
Pros and Cons of Multisig Wallets
Compared to traditional crypto wallets, multisig wallets are undoubtedly a better storage solution for individual use. Although they’ve been created to offer better security solutions to users, using a multisig wallet comes with certain risks. That said, beware of the following disadvantages when scouting for a multisig wallet:
- Lack of efficiency: Unless you’re using a 1/X setup, you will likely experience setbacks when initiating transactions. The more signatures are required to approve a particular task within your wallet, the higher the effect on speed and convenience.
- Funds recovery: On some occasions, you will find that recovering funds from a multisig wallet is a mission impossible. If one of the parties is not available or has lost their private keys, you can say goodbye to your precious crypto.
- Ultimate trust: When using a multisig wallet that doesn’t require all parties involved to approve of transactions, you’re putting yourself in a position that makes it easy for some bad actors to steal funds or harm the project and other holders. Just look at what happened to Pepe – malicious project founders stole almost $16 million worth of coins from the project’s multisig wallet.
Photo illustration: Freepik
On the other hand, a multisig wallet benefits include:
- Better security: A wallet with only one private key is more prone to hacking attempts or any other damage. With multisig wallets where the number of necessary signatures is less than that of all holders, a compromised key won’t get in the way of managing and withdrawing funds.
- Distribution of responsibility: If you’re behind an organization that uses crypto, you probably wouldn’t want all your funds to be in the hands of one person. As it’s in your organization’s best interest to distribute responsibility related to fund management to multiple parties, using a multisig wallet will lower the risk fund theft or misuse.
- Adaptability: As stated earlier, users can adjust multisig wallets and adapt them to their needs. However, keep in mind that this requires advanced technical knowledge, so if you want to enter the world of multisig wallets, make sure you learn how to manage and set it up first.
Multisig wallets are a great way to improve security. However, as they are a relatively new technology that still must come a long way before we label it a new security standard, it’s advisable to evaluate the pros and cons before making a decision.