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“Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers.” Satoshi Nakamoto describing some of the desirable security requirements for Bitcoin in his seminal whitepaper.

One of the biggest drawbacks of cryptocurrency is that it enables two parties anywhere in the world to electronically send and receive value securely, in a matter of minutes and without the need for expensive, error-prone intermediaries.

But what happens when you want to purchase physical goods using your cryptocurrency? Or perhaps you want to buy some cryptocurrency from a local seller (i.e. off-exchange). How can a buyer wishing to execute such a transaction be completely confident that the seller will fulfil her obligations of the transaction, and vice versa?

That’s where escrow services play an important role. As a reminder, escrow is the facility that legally enables a third party to temporarily hold an asset or funds on behalf of two other parties that are in the process of executing a transaction.

Normally once the transaction is completed, the assets/funds being held by the escrow party will be released, as per the instructions stipulated in the contract. Or, if there’s a dispute, the escrow agent can intervene, review the case and make a decision in favor of one party — either refunding the assets to the buyer, or releasing them to the seller.

By guaranteeing that the buyer has the necessary funds, and that the seller can deliver the product as promised, escrow adds a layer of trust to many types of transactions, and also helps to prevent potential scams.

Escrow has long been used in the real estate and stock markets. And now it is becoming an increasingly important security mechanism in the crypto world. Different types of escrow services have emerged to cater to the different preferences of the transacting parties. We take a look at some of the most popular.

Cryptocurrency Marketplaces

At crypto marketplaces such as Localbitcoins.com, people from all over the world can buy Bitcoin with their local fiat currency using various payment methods such as bank transfers, cash deposits and PayPal.

In such a scenario, the buyer has to trust that the seller will release the bitcoins upon payment, while the seller has to ensure that the funds sent from the buyer will be received.

With that in mind, marketplaces will invariably offer a built-in escrow service to ensure all their online trades are protected. When a buyer opens a trade with a seller, the total amount of Bitcoin is taken from the seller’s wallet and put into escrow automatically. Once the seller can confirm that payment has been received, the seller can then release the Bitcoins from escrow, usually to the buyer’s marketplace wallet.

Arguably, Bitify has the most comprehensive escrow service of all major crypto marketplaces, and offers a detailed description of how the service works.

Escrow Agents

But perhaps you’re not convinced that a marketplace in-house escrow system can be trusted. After all, you don’t know who the other party in your proposed transaction is – perhaps it’s someone operating in close co-ordination with the marketplace itself. And that could mean that the escrow service may end up being compromised.

Another option, therefore, is to choose a standalone escrow agent. But again, the biggest challenge to both parties when using this option is to choose a sufficiently reputable/reliable service.

Escrow agents often advertise their services online; indeed, a popular method to find a trusted Escrow Agent is through the BitcoinTalk forum. Again, however, you should ideally be confident that the escrow company you choose is not scamming you. Even some of the oldest Bitcoin escrow services such as BTCrow, which was established in 2011, has had its fair share of problems.

So, choose wisely, otherwise go for a safer option such as…

Multi-Signature Escrow

With multi-sig crypto wallets already proving a popular solution for storing crypto holdings, whereby more than one user is needed to access the wallet and sign off on a transaction, this technology is now being increasingly applied to escrow services.

Instead of having to rely on a single entity to oversee the process, at least two parties must sign off on the transaction to facilitate the release of the funds to the seller. For instance, if the address can be accessed by three separate parties – the buyer, the seller, and a neutral trust agent – the money can be released if two of those three provide authorisation (and is therefore known as a “2-of-3 service”).

Multi-sig escrow wallets provide extra security to both transacting parties by reducing the need to solely rely on the integrity of the third party. And given that this solution requires at least two signatures for authorisation, the likelihood of both authorising parties being compromised is much smaller.

Bitrated offers such a service. Both parties agree on a contract for the transaction and nominate an agent prior to the transaction taking place. The buyer then sends payment to a multi-sig address where it stays locked.

Once the buyer creates a new trade, all three parties – the buyer, the seller and the agent – must review and authorise their participation in the trade before the buyer makes the payment into the multi-sig address. And after the seller verifies that the payment is in the wallet, she can provide the goods to the buyer. Upon completion of the trade, two of the three parties then must agree to release payment from the multi-sig address.

Technically, multi-sig wallets are not the same as holding the funds in escrow. The trust agent does not receive funds at any point; rather, this agent is given voting power to influence the final outcome, in favour of one party. The agent does not operate an escrow account, therefore, but instead operates as an arbiter for the transaction. 

Escrow My Bits is another standalone escrow platform, and offers four different tailored services for users:

  1. Regular Escrow
  2. A Regular Escrow that is fixed to a fiat value (such as the US dollar)
  3. Multi-Signature Escrow
  4. Multi-Signature Escrow fixed to a fiat value

There company charges 1% of the transaction cost to use these services.

Decentralised Escrow Services

Looking forward, the future of escrow for cryptocurrency may well consist of more services like EscrowMyEther, an open source, decentralised app that enables the use of smart contracts on the Ethereum blockchain.

The application allows the two transacting parties to choose an escrow agent agreeable to both of them. The buyer’s ETH is first locked in a smart contract. Then, once the buyer confirms the seller’s obligations are fulfilled, the buyer releases the funds to the seller. The chosen escrow agent oversees the transaction, and can intervene to resolve disputes, refund the buyer or release funds to the seller as appropriate:

Source

A third-party escrow agent is still required to be chosen. But while other, non-decentralised solutions may fail to provide irrefutable proof that the transaction ever took place, EscrowMyEther enables funds to be held on the blockchain, which means there will be clear proof of what is happening in real-time. And again, the escrow agent never has direct access to the funds.

Better still, smart contract solutions are now emerging that in some scenarios eliminate the need to depend on a middleman altogether. Instead, such contracts can be programmed to move funds into escrow and then only proceed with a certain action upon a change in external events, such as an arbitration decision.

For instance, the San Francisco-based global real estate marketplace Propy is using smart contracts to facilitate real estate transactions across international jurisdictions. Last October, the company announced the first real estate transaction to be completed on the blockchain – a $60,000 flat in Kiev, Ukraine, that was purchased requiring the buyer to even set foot in the country.

Instead, the transaction took place via smart contracts on Ethereum, with the buyer sending 212.5 ETH ($60k, the cost of the flat), along with 100 PROs (Propy’s own crypto token) to a smart contract address at the moment of the sale. As explained by Propy CEO Natalia Karayaneva this allowed the smart contract “to play a role of the Escrow Agent.” It held the funds securely in a similar manner to an external escrow agent.

But as the Propy whitepaper suggests, a ‘smart’ escrow contract for real estate can allow for ‘a verified Escrow Agent to lock and release payment’ if required.

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Dr Justin Chan co-founded OCIM and serves as Chief Investment Officer for its fund management platform. Within OCIM, He co-manages OC Horizon Fintech, where he translates real applications and future-awareness into investment performance. He also oversees a number of important tech projects in the fintech and data science space. Prior to co-founding OCIM, he worked as a senior quantitative strategist at GMO and developed in-house trading strategies. An expert in microstructure, market liquidity and behavioral finance, Dr Chan holds a doctoral degree from UCLA, and once served as assistant finance professor at Singapore Management University. He can be reached at justinchan@datadriveninvestor.com.

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