Escrow: how a deal with a guarantor works

The classic problem of any deal between strangers: who pays first? If the buyer pays upfront, the seller can disappear. If the seller ships first, the buyer may not pay. Escrow solves this with a neutral third party.

The idea of escrow

The essence is simple: the buyer's money neither goes to the seller at once nor stays with the buyer, but goes into conditional custody with a neutral holder. The seller sees that payment is secured and calmly does the work. The buyer sees the money will not go until they receive what was promised. When the obligations are fulfilled the money is released to the seller.

Escrow has long been used in real-estate purchases, on marketplaces and in international trade. The logic is the same everywhere: the money is held by someone with no stake in the outcome.

Classic escrow and its weak spot

In the traditional scheme a middleman holds the money: a bank, a notary, a guarantee company or a private person. The scheme has awkward sides:

• Trust in the middleman. They can go bankrupt, make mistakes, bow to pressure or turn out dishonest. There are many cases of a forum "guarantor" vanishing with the sides' money.
• Opacity. The sides do not see what happens to the money until a report arrives.
• Price and speed. Fees and time depend on the middleman.
• Borders. Bank escrow is hard to use between people in different countries.

Escrow on a smart contract

In the smart-contract version the money is held not by a person but by a program on a blockchain. That brings different properties:

• The money sits in the contract, not with a middleman. The platform physically cannot take or redirect it: the code simply has no such functions.
• The rules are known in advance and the same for everyone. Anyone can read the code and check how money will be distributed.
• The state of the deal is public. Anyone can open the contract address and see where the money is.
• It works at any time, with no days off and no middlemen. No bank, paperwork or international transfers.

Roles in a deal

The buyer puts money into the contract and, after receiving the goods or service, confirms it - then the money goes to the seller.

The seller fulfils the obligations knowing payment is already secured and receives the money after the buyer's confirmation.

The guarantor steps in only in one case - if the sides disagree. They study the positions and decide how to split the money. It is a person or organisation both sides chose in advance. The guarantor has no access to the money: they can only decide how much each side gets.

Why a guarantor is still needed

A program does not know whether the goods arrived and match the description. Code can execute rules but cannot judge the real world. So in deals with the physical world a human is needed to resolve uncertainty - the arbiter. The smart contract in turn ensures two things: the money will not vanish or go astray, and the guarantor's decision will be carried out automatically, with no way to delay or twist it.

How the guarantor's incentives are designed so that they gain nothing by staying silent or taking a side - in the article on arbitration design.

How it looks in practice

1. The sides agree the terms and pick a guarantor.
2. One side creates an offer in the service.
3. The buyer deposits money into the contract - it is locked.
4. The seller fulfils the obligations.
5. The buyer confirms receipt - the money goes to the seller.
6. If a dispute arises, the guarantor steps in and decides who gets how much.
7. If the guarantor is silent for 30 days, the money is split 50/50.

Step-by-step guides for each role are in the Help section.

What escrow does not guarantee

An honest word about the limits. Escrow does not guarantee the quality of goods - it guarantees the money will not be lost and that a dispute will be settled by the appointed guarantor. So two practical tips:

• Fix the terms in writing. The more precisely it is described what is delivered, the easier it is for the guarantor to decide. In our service there is a terms fingerprint for this.
• Choose the guarantor wisely. Everything left uncertain after the terms is decided by them.

What to read next

See where escrow is applied in practice: 10 real scenarios. Want to test yourself against scammers' tricks - read about red flags in P2P deals. And when you move to the next level, start with the deal lifecycle.