A cryptocurrency transaction is executed only when it is signed by the owner of the wallet. Usually, a wallet had a single signer who used his private key to sign the transaction, until the introduction of a multi signature wallet.
Multi signature, also referred to as multisig, requires two or more signatures for the execution of a transaction. Although the use of multiple signatures to execute a transaction is a long-established practice, it has been recently implemented in the cryptocurrency industry to fortify the security paradigm. Multisig offers more security than single-signature transactions.
M-of-N Transactions: What are these?
Multisig transactions are also known as M-of-N transactions. M refers to the number of signatures or keys and N refers to the total number of signatures or keys involved in a transaction. M-of-N transactions are of different types, including:
1-of-2: John and Michael have a joint cryptocurrency address; the signature of either of them is sufficient to execute the transaction.
2-of-2: John and Michael have a joint cryptocurrency address; the signatures of both of them are required to execute the transaction.
2-of-3: Used as a 2-of-3 Escrow service between a buyer and a seller. We will discuss this in a later section of this blog.
Multi-signature technology provides an additional layer of security to cryptocurrency transactions. The additional signature(s) ensures that the transaction is fully executed only when both the parties sign the transaction.
Multi signature also eliminates a single point of failure by ensuring that the keys required for a multi signature cryptocurrency address are generated and stored on different devices. One key can be generated on John’s smartphone while another one can be generated on his laptop. Even if the hackers are successful to hack John’s laptop, his funds would be safe as the hackers would also need the key stored on John’s smartphone to execute the transaction and steal the funds.
Basic Functionality of a Multi Signature Wallet
When creating a multi signature wallet, you can decide upon the total number of signatures that your wallet should have and how many of these signatures should be required to execute a transaction.
The most common type of wallet is a 2-of-3 wallet. It has 3 signatures in total, out of which 2 are required to execute a transaction.
The functionality of a multi signature wallet is akin to a bank account that requires multiple signatories. However, as Blockchain is based on cryptography and consensus, and not trust, no third party can seize your funds or cheat.
The Use of a Multi Signature Wallet
Here are the 4 instances when 2-of-3 multi signature wallet can be used.
1. Using Multi Signature Wallet as Two-Factor Authentication
Although two-factor authentication (2FA) is not common for Bitcoin wallets, it is recommended for online accounts. A multi signature wallet allows two-factor authentication for Bitcoin wallets.
Wallet 1: Your laptop
Wallet 2: The online 2FA service
Wallet 3: Paper wallet stored in your safe
How does it work?
Each time you initiate a transaction on your laptop or phone, it has to be signed by the online service. But before they sign the transaction, you will be required to enter the two-factor authentication code.
The two-factor authentication code can be generated on your phone or sent to you via a text message. They can also set transaction limits on your account or require different levels of authentication for different crypto transfers.
2. Using Multi Signature Wallet for Better Security
You can use a 2-of-3 multi signature wallet to augment the security and safeguard your funds against any hacks.
Wallet 1: Wallet on your laptop
Wallet 2: Wallet on your phone
Wallet 3: Paper wallet in a different location
How does it work?
To execute a transaction, you will have to initiate the transaction on one device (for example, by scanning the QR code on your phone) and then confirm the transaction from another device.
It is impossible to execute a transaction using only one device, so if your laptop or phone is hacked, you would not lose your crypto assets. You still have another wallet with yourself on the other device.
3. Using Multi Signature Wallet as an Escrow Service
As aforementioned, we’ll discuss the use of 2-of-3 multi signature wallet in this section.
Imagine John wants to buy a camera from Michael over the internet, but since John does not know Michael, he is unsure if he can trust Michael and vice versa. Consequently, John does not want to send the money first and Michael does not want to send the camera first. To get over this situation, John and Michael can create a multisig wallet with a third party Escrow, Alice.
Wallet 1: With John on his phone or laptop
Wallet 2: With Michael on his phone or laptop
Wallet 3: With Alice on her phone or laptop
How does it work?
Alice could be an individual or a company. John and Michael need not trust Alice with their money and camera respectively. They simply need to trust that Alice would not conspire with other participants.
All three — John, Michael and Alice — create a multisig wallet and John sends the money to the address that has been newly created. Michael finds out that John has sent the money and he cannot take the money back once the camera has been shipped because John has only one of the three signatures required for the transaction. Michael sends the camera to John. If everything goes well, Alice’s signature won’t be required as John’s and Michael’s signatures are sufficient to sign the transaction.
However, in case of any dispute, Alice steps in and makes a judgment. Alice cannot take the funds herself as she needs either John’s or Michael’s signature to make the transaction.
4. Using Multi Signature Wallet to Secure Company Funds
A company using Bitcoin is more likely to face challenges securing their funds using a single-signature wallet. The company cannot trust a single person to control all of the Bitcoins.
The replication of keys between authorized signers can increase the chances of the key getting hacked or stolen. Thus, the solution — a multi signature wallet.
Wallet 1: With the CEO
Wallet 2: With the Accountant
Wallet 3: Paper wallet held by the board
How does it work?
In this scenario, neither the CEO nor the Accountant can steal the company’s funds. The Accountant can prepare, sign and forward the payments to the CEO, who can review and confirm the transaction by using his signature. If either the Accountant or CEO runs away with the wallet or loses their device, the other individual can regain access to the company’s funds through the paper wallet.
Multi signature wallets are a perfect solution to ensure secure and authenticated transactions. With various use-cases of a multi signature wallet, it would not be wrong to say that they are a must-have for anyone dealing with cryptocurrencies. After all, you would not want to lose your crypto assets to any hacks or theft.
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