Taking a Closer Look at the Online Escrow Space

I recently did some research for a friend who was looking at the online escrow space in the world of Financial Technology. There has been much talk about how bitcoin has the potential to ‘decentralize trust’, with implications on services like online escrow. Escrow services are used for a variety of transactions, from domain name purchases to investments. Sites like escrow.com and Agreed exist to facilitate the escrow of online transactions. The transaction fees for such services range from around 1-6%, depending on the amount (source). Escrow fraud — where sellers receive notice of payment from an “escrow service”, which turns out to have never existed at all — is a common form of fraud; online escrow sites have to be licensed, under existing escrow law at the state level.

Naturally, online escrow services have a role in online marketplaces. Interestingly, eBay does not have its own escrow services, but integrates lightly with escrow.com. eBay will forward purchase information to escrow.com, but buyers/sellers have to create an escrow.com account and continue the transaction from there. Other marketplaces, like labor marketplace Elance, appear to offer their own escrow services (i.e. Elance Escrow Payment Protection) where freelancers and clients agree on milestones before work gets done.

The back-end of such marketplaces may be operated by an external party. Some online payment processors, such as BancBox, Balanced, and Braintree, offer built-in escrow as part of their larger payments offering. BancBox positions their escrow services to target crowdfunding websites (i.e. BancBox Invest). By using their services, BancBox claims crowdfunding sites will remain in compliance with FINCEN, FINRA and SEC requirements, specifically Rule 15c2-4 which covers the transmission or maintenance of payments received in connection with underwritings. BancBox charges an escrow fee of 0.5% of the transaction value for successful escrows (min. $250, max. $2,500) (source).

Looking at BancBox’s minimum fee, it seems like escrow services are more suitable for larger purchases. It turns out that the average escrow size on BancBox is $250,000 (source). This would explain why eBay and Stripe (another leading online payments processor) do not offer their own escrow services. Furthermore, for small transactions, consumers already enjoy an escrow-like benefit in the form of credit card chargebacks.

The potential of bitcoin enforcing digital contracts is an intriguing concept. Services like Reality Keys are already doing something similar by pulling in data from open database Freebase and providing two cryptographic keys, one for if the event happens and another if it doesn’t (more about Reality Keys here). However, the key is in a compelling use case. Considering how escrow services make more sense for large-value transaction, would a high-volume automation be needed? Would users choose an automated system over a human third-party?

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