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Escrow can be defined as “a financial arrangement where a third party holds and regulates the payment of funds required for two parties involved in a given transaction. While the payment is ‘in escrow’ the transaction can be safely carried out without risk of losing money or merchandise due to fraud.”
This type of service can be very useful in many kinds of situations. As of late, blockchain investments have become a notable case given the impersonal nature these deals tend to have. Escrow services are an important risk reduction tool in this space because they guarantee that the funds in question are not misused or misappropriated anonymously online.
Some of the most common use cases are simple to understand and work like traditional escrows, albeit with some twists.
- Secure Collection
During the ICO process, a trustworthy startup will collect funds through escrow. This is a standard process that safeguards the investor’s funds in case the startup doesn’t reach its proposed goals or other inconveniences occur. Here, the startup doesn’t hold the investor’s funds in the first place and there is no risk of embezzlement.
These services are generally provided through blockchain mechanisms, making use of the technology’s trust-minimization features. In this way, the funds are virtually held in escrow but instead of relying on a trusted third party it is done through a smart contract.
- Delayed Decisions
Escrow also allows investors to reduce the amount of risk they participate in by enabling delayed decisions on capital disbursements. Generally, they will pledge a certain amount to a startup but will retain a significant percentage of it in case they decide to back away from the deal in the future.
For example, Investor A decides pledges $1 million to Startup B, but only 25% will be given away initially. Here, $750,000 are held temporarily from Startup B. This way Investor A has a hedge in case the situation becomes unfavorable.
Large investors such as blockchain investment funds make particular use of this arrangement. However, whether or not these kinds of operations can be handled through escrow will depend on the conditions both parties negotiate. Funds that do employ delayed decisions have what expert Nick Evdokimov calls a “time machine.”
- Staged Investment
Although very similar to delayed decisions, staged investments are a more interesting implementation of escrow services as risk reduction tools. The main difference is that they usually exist in the form of an escrow service that is embedded in the blockchain platform.
This is seen in new initiatives for what are called Serial ICOs. Here, a pool of users can invest in projects that have clear development goals for particular ideas, much like Kickstarter. The funds are held in escrow by the platform and these projects receive a fraction corresponding to what is necessary for each stage of their process. Further funds are only released from escrow gradually, as they reach each milestone.
Staged investments can apply for crowdfunding initiatives around films, music, books, games, or even real estate.
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