How Does Bitcoin Escrow Work? An Easy Guide.

It can be hard to conduct a transaction with an unknown or untrusted party. After all, nobody wants to see their money go into the pocket of a scammer.

To handle these situations, an escrow service is often used. While banks and other financial institutions handle traditional escrow services, internet-based providers now exist on the digital currency front as well. 

Escrow services were designed to protect buyers from fraudulent sellers, such as in the case of those selling bitcoin for a gift card.

Another common example is hiring a freelancer or contractor to do work for you. Without personal familiarity with this person, there is no way to gauge their trustworthiness, and there is no way for the contractor to guarantee they will get paid.

To mitigate these risks, a bitcoin escrow service mandates that bitcoin be deposited upfront before any funds exchange hands. 

Bitcoin escrow explained

The word escrow itself is derived from the Old French word, escroue. Escroue refers to the piece of scrap paper that indicated a deed or asset would be held by a third-party until a transaction was completed.

The only difference between this form of escrow and a bitcoin escrow service is that bitcoin is being exchanged. Escrow services are often used to ensure that large payments are processed in a timely manner and in accordance with the pre-agreed terms.

In the event that a dispute arises between the two parties, a mediator steps in to help determine how the funds should be allocated.

Bitcoin escrow services can take a few different forms. Aside from peer-to-peer exchanges that use an escrow service, there are dedicated bitcoin escrow service providers and multi-sig escrow options.

Third-Party Escrow Service

In contrast, a third-party bitcoin escrow service is an independent third party that keeps the payment secure on behalf of the transacting parties. Between these two options, it is typically a third-party escrow that is more commonly used and can be seen on P2P Bitcoin exchanges like LocalBitcoins or LocalCoinSwap.

In these cases, a buyer finds a seller with which they would like to enter a trade. The bitcoin seller’s holdings are then held in escrow by the exchange platform until the buyer has sent over the equivalent funds outlined in the agreement.

Once the terms of the agreement have been met, the funds will be released from escrow.

Bitcoin escrow platforms

Currently, the options for bitcoin escrow services are limited. However, there are a few platforms that might be worth checking out.

• Bitrated: an Israel-based payment platform that enables cryptocurrency users to conduct a multi-sig bitcoin transaction using a smart contract.

• Escaroo: a platform launched in 2019 that leverages a non-custodial smart contract to secure payments by temporarily holding funds in escrow for a 1.5 percent flat fee.

• Cryptoexchange.com: a cryptocurrency specific exchange platform offering bitcoin escrow services and crypto payment options

• itBit escrow: a cryptocurrency escrow service provided by the New York regulated exchange itBit with a minimum transaction of 50,000 USD

• Coinsavr: a Canadian company that charges a one percent flat fee + 2 USD for each escrow transaction conducted on their platform

Multisig escrow

Multisig or multi-signature addresses are those that require one or more signatures to sign a transaction. Likewise, multi-sig escrows work by a user creating a multi-sig address. This address requires signatures from the buyer and the seller in agreement with certain trade details.

The buyer will then send the funds to this multi-sig address, and the seller will ship their product. When the item of trade arrives, the buyer and seller sign the transaction, sending the funds held in the multi-sig address to the seller. 

Although a third-party is not needed in this case, it also provides several failure modes, including extortion and negligence, to protect the parties involved.

Using an escrow service of either form will no doubt come in handy when carrying out large and small transactions alike. However, like any other financial initiative, users must exercise a certain level of caution since a third-party may still need to be trusted with your funds.

Therefore, it is important to stick to regulated services or carefully reference customer reviews beforehand when weighing out escrow providers. This will go a long way in ensuring your transactions go as planned.