What Is a Multi-Sig Wallet?

What Is a Crypto Wallet?

Multi-signature (multi-sig) wallets are essential to blockchain-based organizations, projects, and apps that need to engage in more advanced crypto transactions. To understand the specifics of crypto multi-signature wallets, it's worth examining what makes the technology work: public and private keys. Every crypto wallet has public and private keys, but in the case of multi-sig wallets, they work with more advanced functionality.

Public keys: Public keys are in some ways similar to traditional bank account numbers for routing deposits. A public key is cryptographically paired to a private key. Although anyone can send crypto to a public key, the corresponding private key is necessary to access the funds.

Private keys: Like a bank account personal identification number (PIN), a private key controls access to a crypto wallet and is generally kept secret. There’s no way to send or spend the crypto in a wallet without the private key. Private keys prove crypto ownership, and are also required for all outgoing transactions.

Crypto Custody

Although each crypto wallet utilizes a private and public key pair, the question of who holds the keys determines whether the wallet is custodial or non-custodial. For example, custodial wallet providers hold private keys on your behalf. In contrast, a non-custodial wallet gives you control of the private keys, which generally means funds stored on the wallet are under your sole control and care. Non-custodial wallets let you set up an initial recovery phase, a back-up measure that can be utilized if you lose your wallet and forget your password. The recovery phase can be used to regenerate a new wallet with the same funds. Generally speaking, if a user forgets their recovery phrase and password, a non-custodial wallet and its contents cannot be recovered.

What Is a Multi-Signature Wallet?

Now let’s break down the difference between standard crypto wallets and multi-sig wallets. Conventional non-custodial crypto wallets have one private key that provides access to funds. As a result, only this key needs to sign an outgoing transaction — no further authorization is required.

In contrast, a multi-signature wallet utilizes a unique digital signature that requires more than one private key to sign an outgoing transaction. In some cases, several different keys can generate a signature. Although multi-sig technology existed long before the arrival of crypto, it's most often associated with the advent of Bitcoin. Specifically, multi-sig technology was first applied to the Bitcoin network in 2012, leading to the widespread availability of multi-sig wallets the following year.

Based on how a multi-sig address is configured, there are different key combinations:

• 2-of-3: Only two signatures are required to access a three-signature wallet.

• 2-of-2: Both signatures are required to access a two-signature wallet.

• 3-of-3: All three signatures are required to access a three-signature wallet.

• 3-of-4: Three signatures are required to access a four-signature wallet.

Regardless of the specific combination, all multi-sig wallets aim to enhance security. Below, we break down how this process works.

Why Use a Multi-Sig Wallet?

If the concept of a multi-sig wallet is still unclear, we can use an analogy from everyday life to explain: Let's imagine there's a bank safe with two locks and two keys. Bank employee Jack holds one key, and Jill has the other. In order for them to open the safe, both of them use their keys simultaneously. In this scenario, one wouldn’t be able to open the safe without the consent of the other.

In the same way, funds stored on a multi-sig crypto address can only be moved if multiple parties provide their signature. This additional layer of security is beneficial when managing crypto, given its digital nature. Specifically, funds are more likely to be stolen with only one private key. Further, this can make losing the funds less likely as well, provided you use a combination that doesn’t require all the keys, like a 3-of-5 scheme. Mandating all the signatures (as in a 3-of-3 combination) would actually require even more diligence and trust. The requirement of multiple signatures helps ensure that transactions made to and from that wallet are in accordance with the intentions of those who hold the keys.

Whether two, three, four, or more signatures are needed, a multi-sig wallet is designed to mitigate the possibility of a single point of failure. For this reason, many blockchains, exchanges, and wallet providers enable the creation of some version of a multi-signature wallet to protect user funds. Multi-sig wallets also make sense for businesses involved in the crypto industry. Like traditional companies, these crypto companies need to secure large amounts of money, and only multi-sig wallets can offer the necessary protection.

Advantages of Multi-Sig Wallets

There are several distinct advantages of using a multi-sig wallet:

Increased Security

Multi-sig wallets provide a greater degree of protection than single-signature (single-sig) alternatives. It's much harder for hackers to obtain all the necessary keys to authorize withdrawals from a multi-sig wallet. Just as multi-signature wallets reduce the dependence on a single person, they also reduce the risk of relying on one device. For example, if a broken device holds the only private key, the holder may lose access. However, because you can store multi-sig keys on several devices, there's generally less risk of losing a private key. 

Escrow Transactions

In traditional terms, escrow is a legal arrangement where a third party holds funds until certain conditions are met. A 2-of-3 multi-sig wallet allows third-party participation in escrow transactions between two parties (A and B). In this scenario, the transaction includes a mutually-trusted third party (C) in case anything goes wrong. If there's a dispute, only A or B will authorize the transaction, allowing C to make the final decision.

Two-Factor Authentication (2FA)

Multi-sig can also serve as a form of two-factor authentication (2FA), because users can hold private keys on different devices. However, there are risks associated with using multi-sig technology as 2FA because a device holding one private key can be lost, stolen, or broken. For example, if the wallet signature is set as 2-of-2, losing a key on one device would make it impossible to recover funds.

Decision Making

Similar to the concept of using multi-sig technology for escrow, multi-signature wallets can also control access to joint company funds. For example, if the company sets up a 4-of-6 wallet where each person holds one key, no single individual should be able to gain access and misuse funds. As a result, only agreement among most key holders would be required to grant access to the wallet.

Disadvantages of Multi-Sig Wallets

Despite the advantages of using multi-sig wallets, there are also some potential risks and limitations to be aware of:

Technical Knowledge

The process of setting up a multi-signature wallet address requires a certain level of technical expertise. However, the growing number of multi-sig wallet providers has made this less of a problem in recent years.

Transaction Speed

Multi-sig is often slower than single-sig because it relies on another party, device, or location to access the wallet to authorize a transaction. While this might not be an immediate issue for infrequent use, regularly transacting with a multi-sig wallet may be slower than using a single-sig wallet.

Fund Recovery and Custodian

Another challenge of using a multi-sig wallet is that the recovery process requires importing each recovery phrase on each device. Finally, perhaps the biggest potential disadvantage of multi-sig wallets is the lack of a third-party custodian, making it difficult to seek legal recourse if something goes wrong. Specifically, because multi-sig wallets tend to be non-custodial wallets, a legal custodian doesn't guard the funds for a multi-sig wallet. Instead, the funds are usually just in a shared non-custodial wallet with multiple keyholders.

Despite the potential challenges of using multi-sig wallets, there are also several practical applications. By requiring more than one signature to transfer funds, multi-sig wallets are designed to avoid single sources of failure and enable trustless escrow transactions. Although each person will need to weigh the advantages and disadvantages based on their needs, multi-signature wallets may enhance credibility and security in situations involving large sums of crypto. Further, multi-sig wallets hold the potential to encourage crypto adoption by adding another layer of security for a variety of use cases.