[Sarien]

In short: The protocol is not even remotely thought through. It is incomplete and cannot work the way it is described.

I wonder if it is theoretically impossible to create a protocol that punishes cheating when the cheating occurs outside the system (when the physical goods change hands).

And even if it isn't you would also somehow have to consider the fact that things get lost or damaged in the mail and assign blame to one party on the protocol level.

[Ntrails]

Paypal has the most experience doing this with Ebay transactions I would think?

[Sarien]

But paypal/ebay is a third party. Something that this system tries to avoid.