From Bitrated's 2-of-3 multisig to smart-contract escrow: how trustless escrow actually works

In 2014, Bitrated introduced a clever solution for Bitcoin trades between two strangers without either party or the platform holding the funds. This solution, known as a 2-of-3 multisig, used three keys: the buyer, seller and an arbitrator. Any two of the three signatures were able to release the funds, allowing for three possible outcomes: a happy transaction where both parties sign, a buyer winning a dispute where both buyer and arbitrator sign a refund, and a seller winning a dispute where seller and arbitrator sign the release.

However, this model had its limitations. Finding a responsive arbitrator was a challenge as the marketplace shrank, and disputes could be prolonged by price volatility. There was also no built-in time limit for how long a dispute could be pending, and all trades were conducted in Bitcoin, leaving them vulnerable to price swings.

Smart contract escrow aims to address these issues by implementing explicit rules in code. Instead of relying on any two of three keys, a smart contract can define states such as funded, released, refunded, disputed and resolved. These contracts can include timeouts, allowing for automatic release after a certain period. They can also use stablecoins instead of volatile Bitcoin, and the arbitrator can be a decentralized court rather than a single individual.

When evaluating an escrow contract, it's important to ensure it is truly non-custodial, that the source code is verifiable on the blockchain, and that it includes clear rules for resolving disputes and handling timeouts. Stablecoins can provide a safer default for longer trades. Bitrated's innovative model showed that escrow doesn't need a custodian, and smart contracts have built upon this foundation to create more reliable and secure solutions.