This article is an explanation form of a security, storage, and ownership type solution known as multi-signature. Those factors were fundamental speculation for the past years due to many incidents in the crypto space. Let’s break down the multi-sig method with the types of wallets we have currently.
It’s worth to mention wallets are not storing our assets. They are storing our private keys, which are used to sign transactions on the blockchain. All the assets belong to person who is in control of his/her private keys.
Hot wallet is basically a wallet with a constant internet connection connected to the web server. Usually, it stores our private key for us, which means is custodial (we do not have control over our keys). The best example could be any centralized exchange like Binance, Kucoin, etc.
Cold wallet is disconnected from the internet connection most of the time and only requires doing so when performing signing operations, which still happens physically ex. Ledger Nano/Trezor devices. Cold wallets tend to be non-custodial and this list contains as well paper wallets. To this day cold wallets are the best-known solution for the safe storage of our crypto assets.
A multi-signature wallet in simple terms it’s a wallet that requires a specific amount of signatures from its owners for the outgoing transaction to be sent. During the creation of this type of storage solution, we have to specify the total amount of owners we include (minimum of 2) and how many signatures are needed for transactions to go through. Each user in the wallet has their own set of public and private keys. When a transaction is initiated, it is broadcast to the network and each user is notified. Of course, it doesn’t mean one owner cannot be in possession of two private keys on two separate devices, however, it doesn’t make sense for normal and legit usage.
One of the key differences between a multi-signature and a normal wallet is the process of sighing transactions. Traditional wallets are known as externally owned accounts(EOA) and are possessed by a single entity, controlled by private keys.
On the other hand, true, legit multi-sig wallets are constructed based on the smart contract as they require a specific amount of conditions to be fulfilled in order for transactions to perform.
Where they are being used for? Examples are many. Sometimes they are used for the community pool or other asset sources in many Blockchain ecosystems. In this way, those pools are being used to fund developers, community work, or marketing departments after the positive governance vote.
A similar case could be with big corporations holding their assets in a multi-sig wallet, and releasing them for certain fundings that could be possible after a successful vote of its private key owners and reaching a successful threshold which was initiated at its inception ex. 2 of 3, 3 of 5, 6 0f 10, etc.
Another famous use case for people taking part in Bitcoin is Lightning Network. This Layer 2 requires a multi-signature solution for opening/closing channels and sending/receiving transactions as we are dealing here with a P2P connection.
Since this type of wallet is a smart contract wallet, this can be used to create a subscription service or ensure that funds are released only when certain milestones are met. Conditions for milestones would then be needed by x out of n signers before execution.
Advantages and disadvantages of this solution
Although both sides are valid factors, we have to mention those wallets if appropriately managed can give us extra security from cyber-attacks. Reducing dependence on one device is a great benefit if all the members are participating for a valid reason. Usually, they offer us a bigger transparency due to the governance process. Multi-signature wallets reduce the risk of human error. With a single-signature wallet, a user can accidentally send funds to the wrong address or authorize a transaction they didn’t intend to. With a multi-signature wallet, multiple users must sign off on a transaction, reducing the likelihood of human error.
On the contrary, it can be a disaster if they are not. Another setback could be transaction length. It may take a long time until all the key owners decide to vote for the transaction to go through. The recovery process is not helpful as well as it takes to gather all the seed phrases
Bear in mind, not all the implementation versions are the same. Some of them are open-source and non-custodial and some of them are not. Here is the list of currently most known wallets offering multi-signature solutions in their services for BTC and ETH.
Designed specifically for NFT holders on Ethereum. Still in the process. Not open source however with a big team behind it.