What is an escrow? How does it work?

1. What is an escrow?

An escrow is a way to control and protect financial assets.

An escrow is a legal concept where a financial instrument or an asset is held by a third party on behalf of two other parties that are in the process of completing a transaction. In other words, when you use an escrow, a third party acts as a guarantor. The funds or assets are held by an escrow agent. This party controls the whole process and makes sure the commitments are fulfilled. Therefore, nobody can use money on their own without the agreement from other participants.

2. How does it work?

One of the most used concepts is a secret splitting.

It works when you possess important information and share it with people and/or companies you trust. You can share a password, a number of a bank account, an access to securities, and more. No one can get access on their own. The only way to access it is with a mutual agreement.

But it has some weak spots. If one party loses access to the info and has no connection with other parties to make an agreement or compromises themselves and loses trust, there is no way to restore it.

What if you can’t gather or reach all the people involved? What to do? Consider a threshold scheme.

3. What is a threshold scheme?

A threshold scheme is an improved version of secret splitting.

The threshold scheme does not require the agreement of all parties. For example, you share info with five different parties, but any three of them can reconstruct the secret. Two parties are not enough to get access to the info. If you need to exclude someone from your escrow, you can do it without any difficulties. These parties can be divided into some groups, depending on the confidence level. Let’s assume you have six people, you completely trust three of them- group one, and the other three are less credible- group two.

You can make a scheme of data reconstruction, in case something happens. So the access is available to three people from group one and anyone from group two.

Or any two people from group one and three people from group two.

There are no restrictions in the threshold system. They can be as complex and easy as you wish.

4. Is it secure?

Mathematics and cryptography prove the reliability of the escrow.

A lot of mathematicians and cryptologists have worked on the security issue and managed to develop algorithms for safe escrow. A lot of research was made to prove the security. To avoid collusion of some parties a scheme was developed when others are able to cancel the decision of others. If some party tries to cheat, there is a way to destroy its plans. If some party loses its access, there is no need to change the key.

5. If escrow is that good, why does not everybody use it?

Complexity of implementation discourages a lot of people.

The described models are rather complicated and weird. It’s much more difficult to understand it than it might look. You’ll most likely need an individual expert in mathematics and cryptography in the team. Moreover, incorrect implementation can be costly. You may not notice any mistake in the system at first, but it may make it vulnerable or the funds unavailable.

Don’t forget about guarantors. They put their reputation at stake. Certainly, their services will cost a lot. Together with the expert, expenses will significantly increase.

6. How is escrow applied in the Blockchain world?

Escrow is gaining more and more popularity in Blockchain.

A lot of companies understand the importance of guarantees for investors to prevent scams. The team may be unknown to the general public, but the Blockchain world has its authorities which reputation is indisputable. Some companies serve as a third party in different agreements. Some startups already launch their ICOs with escrow. The largest Blockchain platform, Ethereum, has already made an escrow smart contract. Escrow becomes one of the power instruments to show the seriousness of your purposes.