But the money burning solution, while great at preventing economically viable fraud, does nothing to prevent revenge and actually makes everyone loose if one side is dishonest. I would certainly not endorse that.
Then you must also be against the common system of payment up front, where the customer loses.
Not at all, satoshi. I do a lot of business in the local auctions and I'm all for paying up front, but only when the feedback mechanism provides me with some insight on the previous trades for the buyer / seller. Failing that, I sell and buy using COD, which is almost like an escrow, except there's no way of asserting the goods are what was previously agreed upon before paying. But I do get the option of putting forward a complaint with witnesses (the post office clerk) which helps somehow.
So, this escrow as I've put it would be someone trusted in the community, effectively removing 75% of the fraud opportunities
a) Say I'll pay but don't
b) Say I'll send but don't and collect money
c) Send some bogus item and collect money
d) Say I've not receive (money / goods) but did
So d) is the one place where the human escrow will need to dig into the trade and assert who's saying the truth. All other are (more or less) easy to prove. The automated escrow service as you describe it would end up in burning money on all 4 situations.
Again, if you are to trust the other party, then cash up front works very well. If you are working under anonymous aliases and there's no previous trade trace, well, I personally prefer to not buy at all, if there's a chance I'll loose both money and goods.