September 11, 2023

What Is Escrow and Why Is it So Important to Crypto?

What Is Escrow and Why Is it So Important to Crypto?

Consider this situation… you own a store and are looking to buy a shipment of products from a supplier you’ve found. The problem is, you’ve never dealt with this supplier before and you're understandably a little worried about their trustworthiness.

As for the supplier, they’ve never dealt with you either, and the same concern applies to them. While you may be unwilling to pay for the TVs until you’ve received them and checked their quality, the supplier is equally unwilling to dispatch the goods until they’ve received payment from you. It’s a frustrating situation for both parties that can only be solved by introducing an element of trust.

So how do you introduce trust into a relationship at will? You involve the services of a trusted third party who has no vested interests or connections to either you or your supplier. You can now confidently pay the money for the TVs to this third party, who will hold onto it until the supplier has delivered the goods to you as promised. In the meantime, the supplier is happy to dispatch the goods, as they know this third party will transfer the money to them once the TVs have arrived. It’s an ideal situation for all involved, including the third party, who earns a small fee for the service.

This third-party service is known as escrow, with escrow agents holding money or properties in trust until all parties involved are satisfied that the transaction can be completed.

While escrow services are commonplace in any number of markets — from real estate to eCommerce — they are particularly important when it comes to cryptocurrency transactions.

Escrow in the Crypto Space

For all the advantages that decentralized finance offers its users — increased security, trust, and transparency — blockchain technology has one distinct characteristic that can prove problematic when conducting transactions. That trait is that cryptocurrency transactions can’t be reversed — they can only be refunded by the individual who receives the money, and if the individual isn’t in the mood to do that, there’s not much you can do about it.

Unlike traditional banks, blockchain systems, by their very nature, have no central governing body that you can approach to make a complaint if there are any mistakes or failings in a transaction. Once you’ve paid crypto for something, even if you’ve paid the wrong person in error, that crypto is gone.  

As a result, escrow services are vital to the smooth and reliable running of the blockchain ecosystem.

How Does Decentralized Escrow Work?

When it comes to crypto transactions, whether you are purchasing currency or digital assets like NFTs, the most effective method to provide escrow security is to use a multi-signature escrow wallet — also known as a ‘multisig’.

Although the function of a multisig is the same as a traditional escrow service, the manner in which it achieves this functionality differs in a fundamental way. When using a multisig, no funds are held by a third party. While all the agreed stipulations that define an escrow agreement are still in place, the multisig itself is a smart contract that works as an agreement within the blockchain to perform the escrow service.

What that means in practice is that if you decide, for example, to spend some of your hard-earned Bitcoin to buy an NFT from an unknown seller, the multisig serves as an agreement that the funds will not be transferred until any two of the three parties involved (you, the seller, and the escrow provider) have signed off that the transaction has gone ahead satisfactorily.

Assuming that you received the NFT from the seller as promised, both you and the seller use your own personal crypto ‘keys’ to authorize the transaction. With the ‘two of three’ authorization condition now fulfilled, the payment held in the multisig wallet is released to the seller.

In the event that there are issues with the transaction, such as you claiming that the NFT hasn’t arrived or is a fake, only then does the escrow provider serve as an adjudicator and ‘third vote’ to decide the veracity of the transaction.

The crucial aspect here, of course, is that control over the money is divided between all the participants at all times and expedited by the mutually agreed parameters of a smart contract. With this escrow method operable in pretty much any cryptocurrency on the market — at least, in any that possess even the most basic functionalities — it’s among the most effective and efficient ways to transact digital assets. With smart contracts being essentially code that runs on blockchains, they possess all the security and reliability inherent in the crypto ecosystem.  

What makes the multisig system even more efficient is that unless there’s a dispute over the transaction, the third-party escrow provider doesn’t even need to be involved. In addition to this, at no time does the third party have access to the funds, which makes the chances of them running off with the money virtually zero.  

The Reputation Factor

As simple as blockchain escrow sounds (at least, we hope we’ve made it sound simple), there are still reasons why transaction parties need to take care when dealing with blockchain escrow services.

Firstly, when disputes take place, as they inevitably will over time, the manner in which these disputes are resolved can vary widely, depending on the escrow service provider chosen. With the provider having the final say in the veracity of a translation — subject to court or tribunal appeals — it’s crucial that transaction partners in the crypto space use a reputable and licensed escrow provider. In this respect, blockchain escrows are no different from traditional ones — as automated and safe as the transaction process may be, an escrow provider's reputation still matters.

Another aspect that needs further consideration is the fact that the technology at the heart of blockchain escrow is still relatively new and is therefore in a state of constant development. As a result, many blockchain escrow services come with a long list of disclaimers — from making users aware that the quality of the service ‘may vary’ to warnings that technical flaws may lead to a complete loss of funds. It’s essential, therefore, that you find a blockchain escrow service that is fully licensed in order to protect you and your trading partners from any unfortunate eventualities.

The Zert Solution

Fortunately, or unfortunately, depending on your perspective, the human element remains a central part of even the most digitized of escrow services. It’s therefore crucial that risk mitigation is maximized wherever possible — and it’s here where blockchain escrow services like Zert can make a real difference.

As well as being fully licensed in the US, EU, Canada and UAE, Zert works diligently to ensure that transaction security and reliability are fully maximized in all respects. Employing extensive user verification systems such as KYC, KYB, and AML, Zert ensures that all transactions are fully vetted and compliant.

What’s more, with the platform utilizing everything from institutional-grade vaults that require both a public and a private key to access to MPC wallet technology that allows individuals to evaluate transaction data without having to reveal their data to anyone else, Zert offers escrow payments solutions that are built around security and reliability.

In this respect, payment services like Zert are helping to establish blockchain escrow as the new benchmark for payment security — and it couldn’t have come a day too soon. The inherent lack of trust that has beset marketplaces throughout history has only been exacerbated by the arrival of the digital world in so much as trading partners are increasingly becoming strangers to each other.

The Future of Escrow

With the increasing availability of reliable digital payment services like Zert, the perceived risks regarding reputation — or the lack of it — will hopefully expand the reach of blockchain technology in the mainstream market.

With the rise of cryptocurrencies as a viable financial alternative to centralized systems, blockchain escrow services are, needless to say, ideally suited to the job of securing transactions. While there still may be ground to cover regarding the effective integration of non-digital real-world data into a fully automated blockchain system, the ever-accelerating march of progress in the digital space will no doubt overcome real-world data issues in the not-too-distant future.

In the meantime, however, if you’re considering trading digital assets in the crypto space or simply need to make a payment to someone, services like Zert are not only fit for these purposes but offer a safer and more convenient alternative to traditional methods.

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