12 October 2017

Escrow agreement for ICO: indications for use

According to statistics, 10% of all investments in ICO has ended up in the hands of criminals. The number of investors who lost 100% of funds invested in ICO (more than 225 million dollars) over the past year amounted to 19,000 people compared to 11,000 in 2016. Officially, the funds collected during the ICO are most often lost due to hacker attacks and phishing, however, it is increasingly suspected that often the “designers” of these attacks are the members of the ICO team themselves. For example, in July 2017, the Veritaseum project announced the breaking of its wallet and the theft of its VERI tokens for a total of 8 million dollars. In the same article from the resource coindesk.com, the founder’s failure to participate in the hacking is questioned. This example is far from the only one, however, as a practicing lawyer, I, referring to the presumption of innocence, refrain from loud statements before the publication of the first court decisions.

Nevertheless, it’s not a secret for anyone that many projects begin to collect funds for the ICO just to make hit and run. You can find articles that, albeit in a joke form, but still explain how to create SCAM ICO. For truepenny it’s a joke, but for someone it’s, quite, a guide to action.
In fact, the market already now has a request for investment protection tools that will help, if not to eliminate the risk of losing funds invested in ICO, then significantly reduce their possible size.

How Escrow works
To date, escrow, in relation to ICO, operates through the use of multisig wallets managed by attorneys-escrow agents. Investors send funds not directly to the ICO project, but to a pre-established wallet, the smart contract of which is prescribed in such a way that financing of each stage of the project (milestone) is carried out only with the consent of the third party — escrow agent (s).

The main question for the team planning to use escrow and for the investor, who is going to entrust his funds to escrow agent — who will this agent be? A simple research of icoalert.com shows that at the current time the choice of an escrow agent does not meet the very goal of involving an independent person. Teams declare as an EA (escrow agent) friends, colleagues or “experts” with incomprehensible competence and portfolio from a distant country — senior lawyer of major law firm in USA, member of commerce chamber of Togo and so on. Teams offer investors to entrust funds to the hands of “experts” with an incomprehensible reputation and competence, and in some cases even fictional characters. The extreme method is the so-called bogus escrow, in which the project states that it is attracting an escrow agent and will use a multisig wallet with three signatures and the rule “2 out of 3 signatures for approval of the transaction”, while leaving the ICO project with 2 signatures. In other words: there is an escrow agent, but the decision to write off the funds from the wallet still remains with the team. Nevertheless, there are several projects that attract as escrow agents of people with a clean reputation on profile resources such as bitcointalk.org, however, there are few such examples (just as independent experts who will not risk their reputation for a chance to hit and run, so the projects that are ready to involve them).

The lack of a business culture of using escrow and an understandable mechanism for its implementation is detrimental to the development of the ICO market, as the increasing number of SCAM projects:

  • discourages existing investors and dilutes the prospect of attracting new ones who are not used to invest in projects at the risk of losing 100% of investments due to bad faith of team members
  • gives more and more grounds for the regulator to restrict or prohibit the attraction of financing through the cryptocurrency

How Escrow should work
The response to the market’s request is the appearance of an independent service that will select escrow agents relevant to the project theme. In this case, the company involved will act as a guarantor of the lack of affiliation of escrow agents with respect to the project, which excludes the possibility of becoming a victim of bogus escrow. Also, professional service is necessary to increase the transparency and reliability of Escrow agreements. Investors, like the ICO team, must have properly answered the following questions before the fundraising begins:
What are the stages of the financing?
What conditions must be met to start each financing phase?
What conditions must be met to freeze funds?
What conditions must be met to start refund?

Despite the obviousness of these questions, not all the teams that decided to use Escrow are ready to answer them (or even ask them). For example, one ICO project as the only condition for starting the return on investment procedure states “if the project founders do not respond to messages and email for more than seven days.”

Problems with the implementation of the agreement may arise even in the absence of malicious intent on the part of team members or agents. Escrow agreement is a complex contract, the purpose, the mechanism of work and the legislative requirements for the content make it a compilation of a similar writing of the program and if the consequences of the refusal of the professional programming services for the project founders are obvious, then, unfortunately, everything is not the case with reluctance to call in a qualified lawyer.

Summing up, it should be noted that the practice of escrow agreements for ICO projects is a sign of the maturing market, the market where the founders of the project perceive ICO as a tool designed to allow the idea to be realised, to create a product and build a company, rather than chance to buy “Lamborghini”. The risk of a rupture of the ICO bubble will inevitably lead to the fact that the expressed reluctance of the project to use the phased financing will be identical to the public recognition of the creation SCAM project, which ultimately will not allow the implementation of the purest intentions.