Multisig, stands for multi-signature, is a security protocol which requires two or more signatures for a transaction before it can be executed. Multisig offers higher security compared to single-signature transactions. In terms of digital currencies, the technology was first applied to Bitcoin in 2012, which ultimately led to the formation of multi-signature wallet, a year later.
Note: Multisig wallets are strongly recommended for advanced users.
How Does it Work?
Multisig can be analogized to a lock that only opens with enough keys, out of a set of predefined keys. Let’s say person A, B and C want to open a business together and invest some of their savings. For valid reasons, none of them wants only one individual to have the private key to their money. So, each of them gets one key and use a multisig wallet that demands two out of three of those keys. This way, none of them can run away with the money alone, yet they do not need all three of them to pay expenses.
Essentially, the funds stored in a multi-signature wallet can only be retrieved by using two or more signatures. Thus, it allows users to create an additional layer of security to their funds.
Single-key vs. Multisig
Usually, bitcoin is stored in a standard, single key address, which means that whoever holds the corresponding private key can access the funds – only one key is needed to sign transactions and anyone that has the private key, can transfer the coins without authorization from anybody else.
Meanwhile, managing a single-key address is not the right choice for crypto businesses. Imagine the funds of a big company being stored on a standard address, which has a single corresponding private key. This would imply that the private key would be either entrusted to an individual or to multiple persons at the same time – and that is clearly not the safest way to go.
Due to the aforementioned problems, a multisig wallet can be the potential solution. Unlike single-key, the funds stored on a multisig address can only be moved if multiple signatures are provided (which are generated using different private keys). Notably, multisig doesn’t have to be two out of three – it can be almost any combination, such as 2-of-2, 3-of-3, 3-of-4, etc.
By using a multisig wallet, users can prevent the problems caused by the loss or theft of a private key. So even if one of the keys are compromised, the funds are still safe.
Taking into an example, if Alice creates a 2-of-3 multisig address and then stores each private key into a different place or device, be it a mobile phone, laptop or tablet; even if her device is lost, her funds can’t be accessed using only one out of three keys. Likewise, phishing attacks and malware infections are less likely to succeed because the hacker would most likely have access to a single device and key. If Alice loses one of her private keys, she can still access her funds using the other two keys.
Two-Factor Authentication, or 2FA, is an extra layer of protection used to ensure the security of online accounts beyond just username and password. By creating a multisig wallet that needed two keys, Alice can create 2FA generator to access her funds. She could have one private key stored in her laptop and the other one in her mobile device (or even on a piece of paper). This would ensure that only someone who has access to both keys is able to make a transaction.
One of a multisig wallet advantages is it allows escrow transactions. If someone wants to buy a product from a stranger on the internet but cannot trust him, then the buyer and seller agree on an arbitrator who will help them in case of a dispute. They each get one key out of three, and the buyer sends the money to the multisig address. If the product is delivered and there are no issues, the buyer and seller can use their two keys to release the money to the seller. However, if there is a dispute, the arbitrator can help the buyer to get a refund, or the seller to release the funds.
A board of directors might use a multisig wallet to control access to a company’s funds. For example, by setting up a 4-of-6 wallet where each board member holds one key, no individual board member can mismanage the funds. Therefore, only decisions that are agreed upon by the majority can be executed.
Even though multisig wallets are a good solution for a range of problems, it is important to take into consideration that there are some drawbacks and limitations tangled. Setting up a multisig address needs some technical knowledge, especially if you do not want to rely on third-party providers. Not only that, since blockchain and multisig addresses are both relatively new, it may be hard to seek a legal alternative if error occurred. There is no legal custodian of funds deposited into a shared wallet with multiple keyholders.
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