Custody in a Decentralized World: From Legal Protection to smart contracts Innovation

In business transactions, when large amounts 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? This is where the escrow mechanism comes into play - a neutral third party holds the funds or assets and only releases them after both parties fulfill their contractual obligations. The application of the custody 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. With a neutral and secure way of custodial management of funds or assets, the custody mechanism effectively reduces the probability of fraud, minimizes transaction disputes, and provides reliable protection for transactions that are difficult to conduct solely based on trust. How does the custody mechanism work?

1. Reach Terms Agreement - The buyer and seller negotiate and mutually confirm the terms and conditions of the transaction.
2. Sign the custody agreement - Both parties formally sign a legally binding custody agreement, designating a neutral custodian.
3. Funds/Assets Deposited into the Accomplice Account - The buyer will deposit the agreed amount or assets into a secure accomplice account, ensuring that the seller cannot withdraw the funds before the obligations defined in the agreement are fulfilled.
4. Fulfillment of Obligations - The seller shall provide goods or services as agreed, and the buyer shall accept and confirm whether they meet the terms.
5. Completion of transaction and release of funds/assets - Once the conditions are confirmed to be met, the accomplice will release the funds or assets to the seller according to the agreement. The broad applicability of the custody mechanism Accomplice custody is not limited to cash; it can also apply to any identifiable and transferable assets, such as: Real estate property certificates, stocks, bonds, and other financial instruments, intellectual property (such as software source code), digital assets (cryptocurrencies, NFTs), patents, legal documents such as contracts, and high-value physical assets (art, jewelry, luxury cars, etc.) These assets must meet the conditions of being identifiable and transferable so that the custodian can accurately execute the release action after the verification conditions are met. The legal risks and complexities of custodial agreements Although the custody mechanism can provide protection for transactions, if the structural design is not rigorous or supervision is insufficient, it may pose serious legal and financial risks. Common risks include:
6. Legal application is vague Accomplice transactions often involve parties from different jurisdictions, such as a buyer in the United States, a seller in Singapore, and an escrow agent registered in the Cayman Islands, where the definitions and enforcement mechanisms of contract law vary across regions. If the applicable law is not clearly specified in the agreement, legal conflicts may arise. The enforcement of cross-border court rulings may be restricted; for example, a judgment from a Hong Kong court may not be directly enforceable in the United States. It is advisable to specify a neutral applicable law (such as English law or New York law) in the agreement and to choose an arbitration mechanism to reduce the risk of disputes. For example, if a custody contract does not specify the applicable law, a Singapore custodian involved in a transaction dispute between a Chinese buyer and a German seller may face conflicts of procedural rules, high costs of cross-border legal consultation, and uncertain arbitration outcomes.
7. Illegal or unlicensed institutions Not all institutions claiming to provide custody services are legitimate and regulated. Especially in the cryptocurrency asset market or cross-border transactions, some fraudsters may impersonate legitimate platforms. In Hong Kong, custody services can only be provided by authorized banks, Hong Kong law firms, or specific trust/company service providers (TCSP); custody activities provided by non-mentioned institutions are illegal. In Singapore, custodial services are typically carried out by banks, trust companies, or compliant law firms regulated by the MAS; informal platforms that do not have a payment license or trust authorization cannot legally provide custody. In the United States, state laws strictly require that custodial services must be performed by state-licensed custodial companies, regulated insurance/title agencies, or attorneys who adhere to professional ethics, and the funds involved may also need to be registered as money transmission businesses. Using unauthorized accomplice services may lead to: the custody agreement not being legally protected, clients being defrauded without regulatory bodies to turn to, assets being lost and unrecoverable, and parties participating in transactions with knowledge of violations may bear civil or criminal liability. The New Era of Decentralized Accomplice Custody: On-chain Smart Contract Mechanism Traditional custody systems rely on intermediaries such as banks and law firms to execute custody and release, but blockchain technology has brought revolutionary changes - on-chain custody utilizes smart contracts to achieve automatic execution without the need for centralized intermediaries. Smart contracts are self-executing code deployed on a blockchain network that can lock, release, or refund assets based on preset conditions. These codes are publicly transparent and immutable, allowing both parties in a transaction to verify in advance whether the logic complies with the agreement, and execution fees are typically lower than traditional custody. For example: The buyer transfers 1 ETH into the smart contract; the contract stipulates: 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 custody 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 mechanisms. Therefore, it is essential to carefully review the contract code and platform reputation before use. Case Study: Hodl Hodl's Peer-to-Peer Accomplice Model Hodl Hodl is a platform that allows users to conduct peer-to-peer trading of Bitcoin or stablecoins. Its design highlight lies in the fact that it does not custody user funds but relies on an on-chain multi-signature mechanism to ensure trading security. The operating 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 uses a 2-of-3 multisignature structure: A private key is held by the seller, while a third party held by Hodl Hodl is held by the buyer as needed according to the contract type. When a normal transaction is completed, both the seller and Hodl Hodl need to sign the contract to release the assets. In case of disputes, Hodl Hodl will choose to sign the transaction with either the buyer or the seller based on the ruling to determine the ownership of the funds. Even if the Hodl Hodl platform is shut down or encounters problems, the seller can still retrieve the funds under specific conditions due to holding their own private key. This model effectively reduces the risk of custody and, combined with a structured dispute resolution mechanism, ensures fair transactions. Conclusion When custodial arrangements are properly designed and executed, they can transform trust into certainty—providing clear and reliable protection for both parties in situations where transactions may be fraught with risk. Whether in high-value real estate transactions, cross-border commercial dealings, or decentralized cryptocurrency platform trades, the custodial mechanism is the core foundation for constructing secure transaction pathways. To truly leverage the utility of custody, merely understanding its operational procedures is far from sufficient; all parties involved in the transaction also need to: Strictly review whether the custody service provider is licensed and meets regulatory requirements, clarify the applicable laws of the agreement and the dispute resolution mechanism, prevent ambiguous release conditions, thus avoiding delays or ambiguities.

英文版 English version When doing business, trust is both essential and elusive, especially when large sums of money or valuable assets change hands. How can a buyer be sure they’ll receive what they paid for? How can a seller guarantee they’ll get paid once they deliver? Enter escrow, the financial safeguard that acts as a neutral third party, ensuring both sides fulfill their obligations before funds or assets are released. The use of escrow extends far beyond simple money-holding services. It serves as a fundamental risk management tool across various industries, including real estate, corporate mergers and acquisitions, e-commerce platforms, and even the volatile world of cryptocurrency trading. By creating a secure, impartial holding mechanism, escrow arrangements effectively minimize fraud, reduce disputes, and provide much-needed assurance in situations where relying solely on trust between parties would be impractical or risky. How Escrow Works 1.Agreement on Terms – The buyer and seller negotiate and mutually agree upon the terms and conditions of the transaction. 2.Escrow Agreement Execution – Both parties formalize the arrangement by entering into a legally binding escrow agreement, designating a neutral third-party escrow agent. 3.Funds Deposit – The buyer deposits the agreed-upon funds into the secured escrow account, ensuring payment protection until all contractual obligations are met. 4.Fulfilment of Obligations – The seller delivers the goods or services as specified, while the buyer verifies compliance with the agreed terms. 5.Disbursement of Funds – Upon confirmation that all conditions are satisfied, the escrow agent releases the funds to the seller in accordance with the executed agreement. Versatility of Escrow While cash deposits represent the most frequent use of escrow services, the system can safeguard nearly any verifiable and transferable asset. This includes: physical property titles, financial instruments like stocks and bonds, intellectual property rights, digital assets such as cryptocurrencies and NFTs, legal documents including patents and contracts, high-value physical goods like fine art, jewelry, and vehicles The critical factor is that the asset must be clearly identifiable and capable of being transferred to ensure the escrow agent can properly verify fulfillment of conditions before releasing holdings. Legal Risks and Complexities in Escrow Agreements While escrow offers an important layer of protection in transactions, poorly structured or inadequately regulated arrangements can introduce serious legal and financial risks. Common complications include the following:

1. Jurisdictional Ambiguity Escrow transactions often involve parties located in different legal jurisdictions—for example, a buyer in the U.S., a seller in Singapore, and an escrow agent incorporated in the Cayman Islands. Each jurisdiction may have its own legal definitions, contract laws, and enforcement mechanisms. Conflict of laws can arise if the governing law is not clearly specified in the escrow agreement. Delays or complications may occur in enforcing court orders across borders ( e.g., a Hong Kong court order may not be directly enforceable in the U.S. without a separate recognition process ). Use of arbitration clauses and designating a neutral governing law is often recommended to reduce litigation risk. Example: If an escrow agreement is silent on governing law, and a dispute arises between a Chinese buyer and a German seller using a Singaporean escrow agent, legal proceedings may involve conflicting procedural rules, costly legal advice across multiple jurisdictions, and uncertainty in outcome.
2. Fraudulent or Unlicensed Providers Not all entities claiming to provide escrow services are legitimate or legally authorized. This is particularly problematic in unregulated digital asset markets or in cross-border transactions, where fraudulent actors may impersonate legitimate institutions. Offering escrow services without the necessary licensing, legal structure, or fiduciary responsibilities may expose clients to misappropriation, lack of recourse, or invalidation of the escrow arrangement itself. For example, in Hong Kong, escrow services are not a general-purpose business activity—they may only be legally provided by: Authorized institutions under the Banking Ordinance ( e.g., licensed banks ) Law firms regulated by the Law Society of Hong Kong Licensed trust or company service providers ( TCSPs ) in specific contexts, provided they do not contravene trust law or banking regulations Risks of Using an Unlicensed Escrow Provider Using an unauthorized or improperly structured escrow provider may result in: No legal enforceability of the escrow contract No consumer protection or access to financial regulators in case of fraud Asset loss with no recovery mechanism, especially in digital asset markets Civil or criminal liability for parties knowingly entering an unlicensed arrangement Developments to Traditional Escrow: On-Chain Escrow While traditional escrow services rely on licensed third parties (like banks or law firms) to hold and release funds based on contractual terms. But blockchain technology enables on-chain escrow, where smart contracts automatically enforce those terms without needing a centralized intermediary. On-chain escrow uses self-executing smart contracts deployed on blockchains to lock, release, or refund assets based on predefined conditions coded into the contract. This offers transparency, automation, and often lower costs. For example: A buyer deposits 1 ETH into a smart contract. The contract is coded to release the ETH only when a specific NFT is transferred to the buyer's wallet. If the NFT isn’t delivered within the deadline, the smart contract automatically refunds the buyer. While on-chain escrow offers compelling benefits, it’s not without risks. Before using an on-chain escrow provider, you will want to ensure proper due diligence has been carried out since any bugs or exploits in the smart contract can lead to loss of funds, and funds locked in a fault smart contract may be unrecoverable. Case Study: Hodl Hodl (P2P Bitcoin and Stablecoin OTC) A strong example of non-custodial escrow in action is Hodl Hodl, a peer-to-peer platform that facilitates direct crypto trades without taking custody of user funds. How It Works: When a trade is initiated, the seller’s cryptocurrency is locked in a multi-signature escrow contract on the Bitcoin ( or Liquid ) network. This escrow is based on a 2-of-3 multisig setup: One key belongs to the seller, One key is held by Hodl Hodl, The third key is optionally assigned to the buyer in certain dispute-enabled contract types. To complete a trade, two of the three parties must sign the release transaction. Normally, this is the seller and Hodl Hodl. If a dispute arises, Hodl Hodl acts as an arbitrator and can co-sign with either party depending on the outcome. Importantly, even if the Hodl Hodl platform goes offline or is compromised, the seller still retains one of the private keys and can reclaim funds under certain conditions. This minimizes custodial risk while still offering structured dispute resolution and user protections. Concluding remarks When structured and executed correctly, escrow arrangements convert trust into certainty — enabling secure transactions in situations that would otherwise be fraught with risk. From high-value real estate deals and international trade to decentralized crypto exchanges, escrow serves as a foundational safeguard that allows parties to do business without relying solely on good faith. To get the full benefit of escrow, it's not enough to understand the mechanics. Transacting parties must: Vet escrow agents for regulatory compliance, especially in financial or cross-border settingsEnsure that the escrow agreement clearly defines governing law and dispute resolution forumsAvoid vague release conditions that could give rise to costly delays or subjective interpretationsBe alert to local licensing restrictions — in many jurisdictions, only specific entities (e.g. law firms or banks) can legally provide escrow services The introduction of on-chain escrow adds further dimension. Platforms like Hodl Hodl show how smart contract-based mechanisms can maintain transactional integrity without ever taking custody of user funds. These systems challenge the traditional idea of what an “escrow agent” is, but also demand a deeper understanding of blockchain architecture, code security, and dispute logic. As escrow continues to evolve across legal and technological domains, it’s important to recognize not just the risks of misuse, but the structural complexity behind what may appear to be a simple trust mechanism. Questions about enforceability, asset freezing by third parties, or the legal recognition of smart contracts are not always immediately visible — but they can define the outcome when things go wrong.

/ END. Original authors: JenBai, Evan Lee