Written by: Jen Bai, Evan Lee
In commercial dealings, when large sums of money or valuable assets are involved, trust is both important and rare. How can the buyer be assured that they will receive what was promised? How can the seller ensure they will receive payment after delivery? At this point, the escrow mechanism comes into play—holding funds or assets in a neutral third-party manner, releasing them only after both parties fulfill their obligations.
The application of the escrow mechanism goes far beyond simple fund storage services. It is a key risk management tool in various industries, covering real estate, corporate acquisitions, e-commerce platforms, and even the volatile cryptocurrency trading sector. Through neutral and secure fund or asset escrow methods, the escrow mechanism effectively reduces the probability of fraud, minimizes transaction disputes, and provides reliable protection for transactions that would be difficult to conduct based solely on trust.
How the escrow mechanism operates
1. Reach a terms agreement —— The buyer and seller negotiate and mutually confirm the terms and conditions of the transaction.
2. Sign the escrow agreement —— Both parties formally sign a legally binding escrow agreement, designating a neutral escrow agent.
3. Deposit funds/assets into the escrow account —— The buyer deposits the agreed amount or assets into a secure escrow account, ensuring that the seller cannot withdraw the funds before the agreed obligations are fulfilled.
4. Fulfill obligations —— The seller provides goods or services as agreed, and the buyer confirms whether they meet the terms.
5. Transaction completion and fund/asset release —— Once the conditions are confirmed to be met, the escrow agent will release the funds or assets to the seller according to the agreement.
Wide applicability of the escrow mechanism
Escrow is not limited to cash and can also apply to any identifiable and transferable assets, such as:
Real estate property certificates
Financial instruments such as stocks and bonds
Intellectual property (e.g., software source code)
Digital assets (cryptocurrencies, NFTs)
Legal documents such as patents and contracts
High-value physical items (art, jewelry, luxury cars, etc.)
These assets must meet identifiable and transferable conditions so that the escrow agent can accurately execute the release action after verifying the completion of conditions.
Legal risks and complexities of escrow agreements
Although the escrow mechanism can provide protection for transactions, if the structural design is not rigorous or the supervision is insufficient, it may bring serious legal and financial risks, common risks include:
1. Ambiguous applicable law
Escrow transactions often involve parties from different jurisdictions, such as a buyer from the United States, a seller from Singapore, and an escrow agent registered in the Cayman Islands, each of whose contract law definitions and enforcement mechanisms vary.
If the agreement does not clearly specify the applicable law, legal conflicts may arise. The enforcement of cross-border court rulings may be limited; for example, a Hong Kong court's judgment may not be directly enforceable in the U.S. It is advisable to specify a neutral governing law (such as UK law or New York law) in the agreement and opt for arbitration mechanisms to reduce the risk of disputes.
For example: If an escrow contract does not specify the applicable law, a Singapore escrow agent involved in a transaction dispute between a Chinese buyer and a German seller may face procedural rule conflicts, high costs for cross-border legal advice, and uncertain adjudication outcomes.
2. Illegal or unlicensed institutions
Not all institutions claiming to provide escrow services are legitimate and regulated. Especially in the cryptocurrency market or cross-border transactions, some fraudsters may impersonate legitimate platforms.
In Hong Kong, escrow services can only be provided by **authorized banks, Hong Kong law firms, or specific trust/company service providers (TCSP)**; providing escrow activities by non-listed institutions is illegal.
In Singapore, escrow services are usually executed by banks, trust companies, or compliant law firms regulated by MAS; informal platforms cannot legally provide escrow without payment licenses or trust authorizations.
In the United States, state laws strictly require that escrow services must be executed by state-licensed escrow companies, regulated insurance/title agencies, or lawyers adhering to professional ethics, and the funds involved may also need to be registered as money transmission businesses.
Using unauthorized escrow services may lead to:
Escrow agreements cannot receive legal protection
If the client suffers fraud, there is no regulatory authority to turn to for help
Assets lost and unrecoverable
Parties participating in a transaction knowing it is illegal may bear civil or criminal liability
A new era of decentralized escrow: on-chain smart contract mechanisms
Traditional escrow systems rely on intermediaries such as banks and law firms to execute escrow and release, but blockchain technology has brought revolutionary changes—on-chain escrow uses smart contracts to achieve automatic execution without centralized intermediaries.
Smart contracts are self-executing codes deployed on the blockchain network that can lock, release, or refund assets based on preset conditions.
These codes are open, transparent, and immutable. The parties can verify whether the logic meets the agreement in advance, and the execution costs are usually lower than traditional escrow.
For example:
The buyer transfers 1 ETH into the smart contract;
Contract stipulation: ETH is only released after a certain NFT is transferred to the buyer's wallet;
If the NFT is not delivered within the specified time, the contract automatically refunds the ETH to the buyer.
Although on-chain escrow has advantages such as transparency, automation, and low cost, it also has technical risks, such as smart contract vulnerabilities and lack of effective dispute mechanisms, so contract code and platform credibility must be carefully reviewed before use.
Case study: Hodl Hodl's peer-to-peer escrow model
Hodl Hodl is a platform that allows users to conduct peer-to-peer transactions in Bitcoin or stablecoins, designed to not hold user funds but to rely on on-chain multi-signature mechanisms for transaction security.
The operational principle is as follows:
After the transaction is initiated, the seller's cryptocurrency is locked in a multi-signature smart contract on the Bitcoin or Liquid network;
The contract adopts a 2-of-3 multi-signature structure:
One private key is held by the seller
A holding by Hodl Hodl
The third held by the buyer when needed, according to the contract type
When a normal transaction is completed, both the seller and Hodl Hodl must sign the contract to release the assets. In case of a dispute, Hodl Hodl will choose to co-sign the transaction with either the buyer or the seller based on the ruling, determining the ownership of funds. Even if the Hodl Hodl platform ceases operations or encounters problems, the seller can still retrieve funds under specific conditions because they hold their own private key. This model effectively reduces escrow risks while combining a structured dispute resolution mechanism to ensure fair transactions.
Conclusion
When an escrow arrangement is appropriately designed and executed, it can transform trust into certainty—providing clear and reliable protection for both parties in potentially risky transactions. Whether in high-value real estate trades, cross-border business dealings, or decentralized crypto platform transactions, the escrow mechanism is a core foundation for building secure transaction pathways.
To truly leverage the utility of escrow, merely understanding its operational process is far from enough; all parties involved must also:
Strictly verify whether the escrow service provider is licensed and complies with regulatory requirements
Clarify the applicable law of the agreement and dispute resolution mechanism
Prevent ambiguous release conditions to avoid delays or ambiguities
