What is an escrow?

Since 2011 there has been a total of $1.7 billion worth of cryptocurrencies lost through exchange hacks and other more conventional scams, mostly in the Initial Coin Offering (ICO) market.

For some of you, this may seem paradoxical as one of blockchain’s most lauded benefits is precisely how secure it is. While that’s certainly the case when we’re discussing the technology, the truth is hackers and scammers prey mostly on human error; a backdoor someone forgot to close or a gullible, greedy investor who bites off more than he can chew.

At the moment, the total value of the cryptocurrency market roughly matches the market capitalisation of Apple. The recent boom has made this industry even more exciting, but as we can see, there’s plenty of room to grow.

As cryptocurrencies are more widely used, regulation will undoubtedly follow. However, if you’re planning to use them to pay for goods and services, you’ll want to be protected. You can research the person who’s selling or buying from you, but bear in mind scammers are usually good at tricking people. That’s where an escrow service comes in.

What is it?

Imagine the following simple scenario. James is looking to sell one Bitcoin. Sara wants to buy, and she has the money. James completes the transfer and Sara keeps the cash and the Bitcoin. In a digital setting, Sara could have fooled James with a couple of fake social media profiles and disappeared without a trace.

Scams such as this one are a dime a dozen in an increasingly connected digital world. We used bitcoin in this example, but the same scam could be done with any product or service. In our scenario, an escrow service would have solved this problem before it even arose. Traditionally, it’s an arrangement where a third party holds the funds between a buyer and a seller as they engage in a transaction. The main advantage is that it brings security and peace of mind to both parties.

How does it work?

In the context of cryptocurrencies, an escrow service would work in the same manner, allowing people to trade coins for goods, services, or other cryptos, regardless of whether or not they trust each other.

Going back to the same example, James wants to sell another of his Bitcoins and this time he knows better. Mary wants to buy, and she has the money to pay. James tells her what happened last time and they both agree to use one of the many cryptocurrency escrow services out there. James sends his Bitcoin to the escrow company, Mary sends him the amount they agreed. Once James has the amount in his bank account, he signals the escrow company that they can send Mary her Bitcoin.

A few months later, Mary decides to sell her laptop and finds a buyer who’s willing to pay what she stipulated, but he’s unsure about going ahead with the payment because he doesn’t know or trust Mary. She remembers James’ experience and suggests they use the same crypto escrow service. The buyer sends the agreed amount to the company, and Mary ships off the laptop. Once the buyer receives it, he notifies the escrow company all is in order and they, in turn, release the funds.

However, sometimes agreements aren’t that simple. Let’s imagine James works for a company who’s looking for a developer to build and actively manage a website. The project will take a few months to complete, and there are several milestones along the way, which when successfully reached, trigger a payment to the developer.

James finds an incredible developer who wishes to be paid in crypto. Aware of the importance of getting this right, he agrees with his bosses and the developer to use a crypto escrow service. Once the terms of the arrangement have been finalised, both sides enter a smart contract where any potential disputes are factored into the agreement. The escrow company can mediate it.

The smart contract can reflect the following three dispute scenarios:

James and the developer agree: payment is released or developer reimburses James without the mediator getting involved

The developer and the mediator agree: the milestone is achieved, the developer receives payment

The mediator and James agree: the latter gets his funds back.

How secure is escrow?

If you’re dealing with a credible company, it’s your safest option. These services hold your funds in cold storage – in physical isolation from any IT systems – which means they can’t be hacked. These crypto escrow services run on a blockchain, so you can rest assured your information will also be secure.

As a final thought on security, it’s worth noting that a lot of ICO’s also resort to an escrow service. They do so to improve the project’s reputation, presenting their company as trustworthy which will ultimately attract more investment. In a time of record amounts of stolen funds and hacked crypto exchanges, you can never be too careful.

Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.

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