What is Escrow?

An escrow is a contractual arrangement in which two people who do not know each other, and therefore cannot trust each other, do business through a third-party who they both trust. This trusted third-party is known as an ‘escrow agent’. Their job is to make sure that neither party tries to cheat the other, and to provide impartial arbitration in the event of any disagreements between the two.

The use of escrow is important in any peer-to-peer market, where it is common for trades to occur between individual users who do not know each other. It is also commonly used by digital currency users, who cannot reverse or ‘charge back’ payments as you can with credit cards and other banking services, to provide a similar level of consumer protection that these reversed transactions offer. Many dark web marketplaces, or ‘dark markets’ use this system, with the website’s administrator providing the escrow service.

A Typical Example of the Escrow Process

Alice would like to buy something from Bob over the internet. She is worried that if she sends Bob a payment for the product or service, he may just ‘take the money and run’. To ensure that Bob provides the product as advertised, she engages John as an escrow agent. Instead of paying Bob directly, Alice sends the payment to John. John tells Bob that the payment has been sent and that he should deliver the product. Once Alice confirms that she has received the product, John makes the payment to Bob – usually after taking a small fee for providing this service.

If Alice never receives the product or service, or if she believes that it does not meet the required standard, she may instruct the escrow agent to return her payment. In this situation the escrow agent must gather whatever information they can in order to assess the situation, and then make a judgement over who should receive the funds. A good agent will have clear policies outlined in advance so that both parties know how a judgement will be reached.

Dangers and Limitations of Using Escrow

It is important when doing business in this way that both parties involved feel comfortable trusting the escrow agent. It is possible for a dishonest escrow agent to collude with one side against the other, to demand a bribe in return for releasing the money (and therefore to make payment to whoever pays the biggest bribe rather than who rightfully deserves to get the payment), or simply to disappear with the funds in what is known as an ‘exit scam’.

In some cases it may also be very difficult for the agent to correctly reach a judgement. For example, if a vendor claims to have posted a package and a buyer claims that they have not received it – unless the buyer paid for a delivery option with parcel tracking there is really no way for the agent to find out who is telling the truth (or whether they both are and the package got lost in the post). In cases such as this the agent is often forced to simply side with whoever has the best reputation and history on the site – which is almost always the vendor.

Alternatives to Traditional or Centralized Escrow

In many peer-to-peer online marketplaces the site’s admin provides an escrow service. Because this involves a single person providing the service to all users, it is sometimes known as a ‘central’ or ‘centralized’ escrow.

Modern digital currency is able to provide an alternative to this kind of traditional centralized escrow through the use of smart contracts. Two of the most popular methods are multi-sig transactions – which use a third-party to arbitrate but make it impossible for them to run away with the money themselves, and double deposit escrow, which does not require a third-party but which does require an additional up-front deposit from both parties.

Finding a Bitcoin Escrow Agent or Becoming One Yourself

Due to the popularity of escrow services amongst users of Bitcoin and other digital currencies, a vibrant market has emerged for agents competing on reputation and cost. One place I recommend for people looking to find the right escrow agent is BitRated, a website which provides an independent trust platform for Bitcoin escrow agents. You can find a wide range of agents with different costs, terms, areas of expertise, and methods for reaching a judgement. You can even sign up to create a profile and start building a reputation yourself!


« Back to Glossary Index