Multisig wallets can keep your coins safer (if you use them correctly)

In traditional business, “key person risk” refers to when a company relies too much on one individual to be successful. Cryptocurrency companies are prone to a very literal version of this risk when managing funds. The most infamous example may be QuadrigaCX, whose customers have waited nearly 3 years to recover $ 115 million in deposits since the death of founder Gerald Cotten, the sole holder of the cryptographic keys in the exchange’s wallet.

Fortunately, multisignature cryptocurrency wallets offer an integrated way to manage this type of risk.

Multisignature (or multisig, for short) wallets are cryptocurrency wallets that require two or more private keys to sign and send a transaction. The storage method requires multiple cryptographic signatures (the unique fingerprint of a private key) to access the wallet.

Of course, multisig isn’t a panacea, as OKEx clients learned last month when the exchange suspended withdrawals, explaining (somewhat cryptically) that one of its key holders was partnering with a investigation and had fallen “out of contact”. Without the authorization of the key holder, OKEx was unable to return the money to customers.

However, when used correctly, multisig can mitigate the risks associated with managing digital bearer resources where transactions are irreversible. The following is an explanation of how mutisig works, why someone might want to use it, how it can go wrong, and more.

Imagine a bank vault that requires more than one key to open – it’s kind of the way multi-signature cryptocurrency wallets work (and why multi-signature wallets are generally called vault).

You can choose how many keys are allowed to open the vault and the minimum number of keys needed to unlock it (for example, you might have a 2-of-3 multisig where you need two private keys assigned out of three, 3- of 5, 5 of 7, etc.).

It works like this: Justin, Vittie, and Craig set up a multisignature crypto wallet where each contains a key and two of the three keys must be present to send a transaction. To make a payment, Justin created a transaction and signed it with his key; he would then send this transaction to Vittie, who would sign it with his key. From here, Vittie can either send it back to Justin to finalize the transaction or send it to Craig for him to sign too (although this last step isn’t necessary, considering only two of the three keys are needed to unlock the wallet).

Typically, hardware wallets (i.e. Trezor, Coldcard, and Ledger) are the ideal option for using a multisig setup as they are the safest way to store a private key. Once these wallets are combined into a multisig configuration, they create a completely new multisignature address that is independent of each individual hardware wallet.

For retail investors, multisignature wallets are commonly used to protect bitcoin, but you can also use them for Ether and other cryptocurrencies.

In particular, cryptocurrency exchanges, brokers / OTCs, investment funds, and other cryptocurrency companies use multisignature storage to protect their cold storage funds. Exchanges, brokers and the like distribute administration keys for their funds in order to spread the risk; if a hacker wants to access their reserves, they will need several keys to do so. Likewise, multisig ensures that no person in the company is able to unilaterally withdraw funds from the account. The more signatures that are required to perform a transaction, the more distributed the decision making can be.

Other specific use cases may involve creating a shared account between family members (for, for example, a trust or property) or an escrow account (for, for example, a bet or sale of property). Relatively speaking, multisig is still a niche custody practice among cryptocurrency holders. However, that doesn’t mean your typical crypto user doesn’t use it to store their coins.

Multisig provides an extra layer of protection for cryptocurrency holdings, but it’s not without risk.

For Bitcoin, multisignature wallet software has come a long way since the early days of Electrum (one of the first Bitcoin software wallets that was also one of the first to support multisig), but it’s still a complex process for less technically savvy users. The upcoming Taproot update, which will enrich Bitcoin’s scripting language to simplify coding of smart contracts, is likely to improve consumer-grade multisig software.

Each single signature wallet has an associated seed phrase that allows a user to backup and recover their wallet. A multisig wallet, however, does not have this backup mechanism; this is part of its design. So, if you lose most of the wallets in a multisig and the basic phrases for these wallets, then you lose access to the entire deposit (of course, the same could be said for the loss of the device and the seed phrase for a wallet. single signature).

Proponents of multiple signing argue that multiple signing is the safest and most foolproof way to store cryptocurrency. Even if a thief gets their hands on one of your wallets, for example, they will still not be able to access your account without the keys of the other wallets in the setup.

However, there are others who argue that the user experience with multiple signatures isn’t streamlined enough for average users, so only those who really know what they’re doing should care.

Historically, multisignature wallets have been the domain of developers or hardcore Bitcoiners as they are difficult to set up from scratch. Fortunately, today’s tenderfoot multisignature users have it easier than pioneers of the past. Nowadays, there are software wallets that simplify the multisig setup process, as well as services that provide customer support and key management services (for example, if an unwitting customer loses a hardware wallet due to ether, the service has a key as a backup).

For Bitcoin custody specifically, some popular multisig service providers with key management services include Blockstream, Casa, and Unchained Capital. Other DIY open-source multisig software include Caravan, Electrum, Lily, Nunchuck, and Specter, among others.