This article is reprinted with permission from Mankun Blockchain Law, authors: Jen Bai, Evan Lee, copyright belongs to the original authors.

In business transactions, when large sums of money or valuable assets are involved, trust is both important and rare. How can buyers be assured that they will receive what was promised? How can sellers ensure they will receive payment after delivery? This is where the escrow mechanism comes into play—holding funds or assets through a neutral third party, which are only released once both parties fulfill their contractual obligations.

The application of the escrow mechanism goes far beyond simple fund storage services. It is a key risk management tool across various industries, covering real estate, corporate mergers and acquisitions, e-commerce platforms, and even the highly volatile cryptocurrency trading sector. By utilizing a neutral and secure method of holding funds or assets, the escrow mechanism effectively reduces the likelihood of fraud, minimizes transaction disputes, and provides reliable protection for transactions that are difficult to conduct based solely on trust.

1. Agreement on Terms - The buyer and seller negotiate and mutually confirm the terms and conditions of the transaction.

2. Signing the Escrow Agreement - Both parties formally sign a legally binding escrow agreement, designating a neutral escrow agent.

3. Deposit of Funds/Assets into Escrow Account - The buyer deposits the agreed amount or asset into a secure escrow account, ensuring that the seller cannot access the funds before the contractual obligations are fulfilled.

4. Fulfillment of Obligations - The seller provides the goods or services as agreed, and the buyer inspects and confirms whether they meet the terms.

5. Completion of Transaction and Release of Funds/Assets - Once the conditions are confirmed to be met, the escrow agent will release the funds or assets to the seller according to the agreement.

Escrow is not limited to cash; it can also apply to any identifiable and transferable assets, such as:

• Real estate title certificates
• Financial instruments like stocks and bonds
• Intellectual property (e.g., software source code)
• Digital assets (cryptocurrencies, NFTs)
• Legal documents (patents, contracts)
• High-value physical items (art, jewelry, luxury cars)

These assets must meet the criteria of being identifiable and transferable so that the escrow agent can accurately execute the release action after verifying that the conditions have been met.

While the escrow mechanism can provide protection for transactions, if the structure is not rigorously designed or if there is insufficient regulation, it may pose serious legal and financial risks. Common risks include:

Escrow transactions often involve parties from different jurisdictions, such as a buyer in the U.S., a seller in Singapore, and an escrow agent registered in the Cayman Islands, with each region having different definitions and enforcement mechanisms for contract law.

If the applicable law is not clearly specified in the agreement, legal conflicts may arise. The enforcement of cross-border court judgments may be limited; for example, a judgment from a Hong Kong court may not be directly enforceable in the U.S. It is advisable to specify a neutral applicable law (such as UK law or New York law) in the agreement and to choose an arbitration mechanism to reduce the risk of disputes.

For instance, if an escrow contract does not specify the applicable law, a Singapore escrow agent may face procedural rule conflicts, high costs for cross-border legal consultations, and uncertain outcomes when dealing with a transaction dispute between a Chinese buyer and a German seller.

Not all institutions claiming to provide escrow services are legitimate or 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 (TCSPs); any escrow activities conducted by non-authorized entities are illegal.

In Singapore, escrow services are typically executed by banks, trust companies, or compliant law firms regulated by MAS; informal platforms that do not have payment licenses or trust authorizations cannot legally provide escrow services.

In the U.S., state laws strictly require that escrow services must be performed by state-licensed escrow companies, regulated insurance/title agencies, or attorneys 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:

• The escrow agreement not being legally protected
• Clients having no regulatory body to turn to in case of fraud
• Loss of assets with no means of recovery
• Parties participating in transactions with knowledge of violations may incur civil or criminal liability

The traditional escrow system relies on intermediaries like banks and law firms to execute the holding and release, but blockchain technology has brought revolutionary changes—on-chain escrow utilizes smart contracts to achieve automatic execution without the need for centralized intermediaries.

Smart contracts are self-executing codes deployed on a blockchain network that can lock, release, or refund assets based on preset conditions.

These codes are transparent and immutable, allowing both parties to verify in advance whether the logic meets the agreement, and the execution costs are usually lower than traditional escrow.

For example:

• The buyer transfers 1 ETH into a smart contract;
• The contract stipulates that ETH will only be released when 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 costs, it also carries technical risks, such as smart contract vulnerabilities and a lack of effective dispute resolution mechanisms, so it is essential to carefully review the contract code and platform reputation before use.

Hodl Hodl is a platform that allows users to conduct peer-to-peer trading of Bitcoin or stablecoins, with a design highlight of not holding user funds but relying on an on-chain multi-signature mechanism to ensure transaction security.

The operational principle is as follows:

• After a transaction is initiated, the seller's cryptocurrency is locked in a multi-signature smart contract on the Bitcoin or Liquid network;
• The contract uses a 2-of-3 multi-signature structure:
• One private key is held by the seller
• One is held by Hodl Hodl
• The third is held by the buyer as needed based on the contract type
• For a normal transaction to be completed, both the seller and Hodl Hodl must sign the contract to release the asset. 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 the funds. Even if the Hodl Hodl platform ceases operations or encounters issues, the seller can still retrieve the funds under certain conditions due to holding their own private key. This model effectively reduces escrow risks while incorporating a structured dispute resolution mechanism to ensure fair transactions.

When escrow arrangements are properly designed and executed, they can transform trust into certainty—providing clear and reliable protection for both parties in transactions that may be fraught with risks. Whether in high-value real estate transactions, cross-border business dealings, or decentralized cryptocurrency platform trades, the escrow mechanism is a core foundation for building secure transaction pathways.

To truly leverage the benefits of escrow, it is not enough to simply understand its operational processes; all parties involved in the transaction must:

• Rigorously verify whether the escrow service provider is licensed and meets regulatory requirements
• Clearly specify the applicable law and dispute resolution mechanism in the agreement
• Prevent ambiguous release conditions to avoid delays or misunderstandings

Related: Hong Kong issues the strictest stablecoin regulations, the first RWA industry white paper has been released.

Original text: “Escrow in the Decentralized World: From Legal Safeguards to Smart Contract Innovation”

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