Cryptocurrency communities have long been known for being passionate about their favorite tokens and projects. One longstanding debate in the crypto community that has been known to cause friction even among specific communities: hot versus cold crypto storage.
For the hot storage camp, the convenience and low costs makes hot storage by far the most favorable. Cold storage supporters, on the other hand, will rally about their method’s security using the old adage: “not your keys, not your crypto.” While cold storage offers increased security from traditional hot storage wallets, there's often a legitimate need to keep your crypto online. Further, “not your keys, not your crypto” solutions can get difficult when it’s not a single person’s crypto that needs to be safely stored, but a business or group that needs to keep crypto assets safe.
See Also: How Do Hardware Wallets Keep Your Crypto Safe?
In this article, we’ll take a look at an effective way of increasing asset security without using cold storage with multisignature (multisig) wallets, including how they work and why they’ve become a popular tool for institutions and decentralized autonomous organizations (DAO).
Multisig basics
Multisig wallets, also sometimes called multisig vaults or safes, are a type of crypto wallet that requires two or more private keys to perform certain tasks. This is done to increase the security of the funds stored in the wallet by requiring multiple parties to sign off before sending any transactions. The process of a multisig wallet works by requiring multiple signatures from a set of predetermined addresses, and if any one of these signatures is missing, the transaction will not be able to go through. Think of it as a safe with unique keys that must be used together to open it.
While there are many different types of multisig wallets, there are two top-level types: the first type requires all parties to attest or sign to a transaction, most commonly three-key wallets, and the second type requires a certain number out of the total pool to participate for a transaction to process, for example, two of three or three of five.
The process of signing transactions on multisig wallets differs from traditional wallets due to a key design difference. Traditional wallets are known as externally owned accounts (EOA), meaning they are generated by users and controlled by private keys. EOAs are generally considered to be “user accounts,” meaning they are created for members of the general public to interact with blockchains.
Multisig wallets, on the other hand, are smart contract-based wallets. Rather than being endpoints controlled by a user, these smart wallets are controlled by code and governed on-chain by their owners. Because of this setup, multisig wallets are considered a “seedless” form of self-custody.
Benefits of using a multisig wallet
In addition to increased security and multi-party participation, there are several other benefits for using a multisig wallet. Particularly for institutions and DAOs, the structure of multisig wallets provides a significantly better experience compared to using traditional hot or cold wallets.
No 'key person' risk
First, the design structure of multisig wallets eliminates traditional "key person" risk. Key person risk refers to when a company relies almost entirely on a single individual to succeed. This risk is all too common in crypto, particularly in instances where one individual is in control of a wallet’s seed phrase. One of the most infamous examples of this is in the case of crypto exchange QuadrigaCX. After the sudden death of its founder, it turned out he was the sole key holder for the exchange’s cold storage, which allegedly held $190 million worth of customer deposits that was inaccessible.
Because multisig wallets require multiple signatures from a number of participants in order to complete a transaction, they are able to eliminate key person risk and mitigate any single point of failure. Implementations like the two-of-three multisig can further ensure that essential transactions can go through despite one key party being absent at the time of the transaction.
Greater transparency
Multisig wallets provide increased transparency compared with other types of wallets. Transaction policies, signers and actual transactions are all made publicly available on chain or in the code. This allows for a clear picture of the rules for transactions and accountability of those who participate in directing funds.
Further, the open-source nature of multisig wallets allows anyone to view the code that governs them. Through clear, open development, anyone is able to audit the wallets and ensure that funds remain safe and secure.
Buildable
Due to a multisig’s position as a smart wallet, it can be easily adjusted or upgraded to fit the needs of an institution or DAO. Building on top of the wallet, developers can create protocols and models that can allow for more complex actions including DAO voting or asset management services. Platforms such as Juicebox have enabled groups of people to develop community-owned, programmable wallets that enjoy the power of multisigs.
See Also: Custodial vs. Non-Custodial Crypto Exchanges: What You Need to Know
This article was originally published on
Dec 14, 2022 at 10:00 p.m. UTC
