What Is a Multisig Wallet?
|— A multi-signature (multisig) wallet is a cryptocurrency wallet that requires multiple signatures to authorize transactions.
— Multisig wallets are popular in DAOs and Web3 corporations to simplify treasury management.
— Multisig wallets bring security and transparency to the Web3 ecosystem, but require some technical knowledge to set-up.
Web3 often involves collaborating with large groups of anonymous strangers across the internet. For instance, blockchain networks require the participation of computers across the world to function properly. Similarly, decentralized autonomous organizations, or DAOs use governance tokens to allow a large number of community members to vote on major protocol decisions.
So who manages the keys for a shared crypto wallet, if the organization has no clear leader? For example, what if a CFO goes rogue, or your accountant decides to leave on an endless round-the-world trip? In these situations, having one entity or person coordinate assets raises trust issues and defeats the purpose of decentralization.
That’s where multisig wallets come in. Multisig wallets provide a secure, transparent, and decentralized approach to managing shared funds.
But what exactly is a multisignature wallet, and how does it work?
Let’s dive in.
What is a Multisig Wallet?
A multisig wallet is a smart contract-based wallet that requires two or more digital signatures to agree on the validity and execution of transactions. Instead of relying on a single private key like in a traditional wallet, multisig wallets involve creating multiple private keys held by different individuals or entities.
However, for the purposes of this article, you need to know that traditional wallets work in public-private key pairs, allowing users to transact and manage their cryptocurrencies through them. Simply put, these wallets have private keys that allow you to sign transactions without any middlemen.
However, in traditional wallets, the owner of the private key is solely responsible for the assets in the wallet. If your private key is stolen or lost, an attacker will have everything they need to access your funds.
On the other hand, multisig wallets use code to distribute the control of the wallet among multiple participants via a smart contract. This way, every participant must approve each transaction.
The number of signatures required to sign a transaction depends on the specific configuration and use case of the wallet. Of course, this varies from one multisig wallet to another. For instance, a “3-4” wallet implies the multisig wallet is shared by four signatories, requiring three out of four participants to sign for each transaction. Similarly, a “2 of 2” wallet requires both signatories.
Due to this robust security mechanism, multisig wallets minimize the risk of unauthorized or fraudulent use of community funds.
What is a Multisig Wallet For?
Multisignature wallets provide a practical way to distribute control and ensure consensus when managing and long-term storage of shared funds in various contexts.
In Web3 communities, multisig wallets help communities manage funds in decentralized autonomous organizations (DAOs). These Web3 communities rely on shared resources and funds to drive their initiatives. Thus, multisig wallets exist to protect their funds from malicious actors.
Decentralized communities can elect community representatives that act as the governing body of the wallet. Every transaction goes through this set of people, making the process more fair and secure.
Apart from communities, multisig wallets are also popular with businesses. One of the core use cases of Multisig wallets is fund dispersion. To explain, to make a third-party invoice payment, Finance teams will process multiple approvals via email. This is slow, and ineffective. Instead, Multisig wallets could streamline and secure this process by giving shared access to funds and record signatures on the blockchain.
How Does a MultiSig Wallet Work?
Multisig wallets rely on having multiple private keys and signing parties. Think of it as a joint bank account where all bank account holders need to approve any transfer of funds.
Participants, known as copayers, set up their own wallets and generate their cryptographic key pairs. When a multisig wallet transaction is initiated, each copayer must sign it independently using their private key. The wallet verifies the validity of the signatures. Then, once it has enough signatures to reach the approval threshold, it’s authorized. Subsequently, the transaction is broadcast to the blockchain network.
To explain, let’s take the example of a hypothetical Web3 DAO which has five key members, Alice, Bob, Charlie, David, and Emily. To understand more about DAOs and how they work, you can read our article on what a DAO is.
These 5 DAO members operate a multisig wallet for managing the DAO’s treasury. The multisig wallet has a 3-of-5 setup, requiring at least three members’ approval for transactions.
When the DAO receives funds, Alice, the treasury manager, proposes a transaction to allocate funds for a community project. She creates a transaction proposal on the DAO’s governance forum, outlining the project details.
The other four members: Bob, Charlie, David, and Emily. They review the proposal and vote through the DAO’s governance platform. To approve this proposal, at least three members must vote in favor.
Bob, Charlie, and David support the proposal and provide their digital signatures using their private keys. Once the multisig wallet verifies the three signatures, the blockchain executes the transaction, allocating the funds as per the proposal.
Single Signature vs Multi-signature wallets
Multisig wallets differ from single-signature wallets on transaction complexity, transparency, and security. Let’s look at the key advantages and disadvantages of using a multisig wallet for your community.
Benefits of Multisig wallets
One of the core promises of a multisig wallet is unbeatable security. Even if one key is compromised, an attacker still needs access to other keys to gain control of the wallet. Therefore, by equally distributing the power between signing authorities, multisig wallets eliminate “key person” risks common with single-signature wallets. This also ensures malicious members within the team cannot run off with the assets.
Think of this as the typical 2-factor authentication you use to sign in to services. You can only access the account with confirmatory codes from multiple devices. Similarly, in multisig wallets, every signature is equally important, removing the single point of failure.
Multisig wallets enable trustless transactions due to their decentralized nature. Community members can track the wallet on block explorers (such as Etherscan), and see precisely when trusted parties move assets. No one can move assets without the permission of all the signing members — so the community can track any suspicious activity in real-time.
Disadvantages of Multisig Wallets
Setting up multisig wallets often involves some technical knowledge due to the number of keys and recovery phrases needed. An alternative is to use a third-party provider to set up a multisig address, but that can also introduce a point of failure.
Since multisig wallets require a confirmation from many parties, transaction speed is often slow. Therefore, multisig wallets are not ideal for communities that need quick or frequent transactions. In such cases, some of the funds could be moved to a hot wallet and the bulk of the funds can be kept in the multisig wallets.
Fund recovery can be challenging in multisig wallets. Since the wallet is tied to many private keys, users must import multiple recovery phrases from different devices. Recovery can be complex if one key holder loses access or becomes unresponsive.
How To Create a Multi-sig Wallet
While using a multisig wallet with a hardware wallet has historically been challenging, Ledger has now successfully integrated multisig capabilities.
Creating a Bitcoin multi-sig wallet
For Bitcoin, you can create a multisig wallet using Ledger and Unchained. Here’s how you can do just that step-by-step:
- Create an Individual account on Unchained and go to the “Keys” tab.
- To create your first key, choose “Ledger” from the options and export your extended public key (xpub) from your Ledger device via the prompt.
- Once done, you’ll see the extended public key on the screen. Click on “Next” to confirm and create your first key. Repeat this process for the number of key holders in your multisig wallet.
- Now, go to the “Vault” tab, choose the keys you’ve added and create your multisig wallet.
To read the complete guide on how Unchained works with Ledger, check out this article.
Creating an Ethereum Compatible Multi-sig wallet
For Ethereum and other EVM chains, you can create a multi-sig wallet using Safe, previously known as Gnosis safe. With Safe wallets, you can set up multiple signatories, with one of them controlled by your Ledger device.
To do so is easy: You can easily connect your Ledger wallet just like you would connect to any other blockchain app or service. Plus, if you want to do more with Safe, you can also connect your Ledger device via Ledger Extension or even with the Safe mobile app and a Ledger Nano. Whichever way you decide to connect you can rest easy that no one can find the private key to a piece of your multi-sig wallet, keeping those treasury funds in an offline environment. To learn more about how to get started, check out the Safe help center.
Manage Your Shared Funds With A Multisig Wallet
Whether you’re starting a DAO, NFT project or a holiday fund with your partner, multisig wallets are a great way to share and manage your funds. As you know, trusting single entities with shared funds can often end in misery. Using Multisig wallets, it’s easier to reduce that direct risk of collaborating with strangers. Plus, you can rest assured that you’re not submitting to centralized methods.
Multisig wallets are key components of effective community security. But what’s the use of multiple signatories if each private key is not secure? Of course, where you store the private keys of the multi-sig wallet matters.
This unique problem highlights why multisig-wallets and Ledger devices make the perfect pair. Using a multisig wallet with a Ledger device only increases its security and decentralization–something at the heart of web3’s ethos. So before you start a new web3 community, consider these tools, as your multisig is only as strong as its private key’s protectors.