Ripple, is it just another new cryptocurrency riding on this big, fat Bitcoin speculation rollercoaster? For those who skim the crypto news outlets, this may seem to be the case. But the truth is, Ripple is fundamentally different from Bitcoin, Ethereum, Litecoin, and the many other members of the large coin family. You could even say that Ripple is not really a coin at all.
- 1 What is Ripple?
- 2 XRP, the coin
- 3 Ripple, the company, and the centralization issue
- 4 Ripple’s products and services
- 5 What problem is Ripple trying to solve?
- 6 How can you make money with Ripple?
What is Ripple?
Is Ripple a coin or not?
If Ripple is not a coin, then what is the XRP cryptocurrency that is currently so hot on the exchanges? XRP, or Ripples, is indeed a coin, but it is the native coin of the XRP ledger, not the Ripple itself, which is actually: A network.
The Ripple network, or RippleNet for short, is an open-source protocol developed and published in 2012 by Chris Larsen, Ryan Fugger, and Jeb McCaleb.
Their purpose in creating RippleNet was not to introduce another cryptocoin to the market – a means of payment between individuals, mostly – but to construct a payment network for use between financial institutions such as banks.
For global finance and everyday life, it is of the utmost importance that the transfer of funds cannot only be processed within a bank, e.g., remittances between customers of the same bank, or between banks such as interbank loans or currency exchanges. For these purposes, the vast majority of institutions still use the SWIFT (Society for Worldwide Interbank Financial Telecommunication) system that was introduced in 1973, a system with grave inefficiencies and a large overhead.
Ripple, the payment system and protocol
In spite of its name, SWIFT is actually a pretty slow system for cross-border accounting between banks due to the number of intermediaries that are involved. A transaction usually takes in the range of one to several working days! The cost of SWIFT transactions depends on the banks involved and their respective locations, but the cost is usually in the range of 5 to 50 EUR (or its equivalent in other currencies) per transaction, and fees are often incurred both by the sender and the receiver of the money. The Ripple network promises to replace this system with a universally compatible, real-time enabled system.
Ripple vs. SWIFT
Cross-border, there is less trust between institutions than within a country, and this makes international transactions especially cumbersome because oftentimes trusted third parties need to be involved, the so-called correspondent banks.
This has three major drawbacks:
- First, the more parties that are involved, the higher the fees for the clients are; correspondent banks want their share of the funds as well.
- Second, the system is not automated. Often, it is the individual who wants to send the money that needs to find out the details of the correspondent bank. That means: If you want to transfer money for your new car over to your car dealer who is across the border, first you have to research the correspondent bank that stands between your bank and the merchant’s bank. Some banks will do this work for you, but other shun the additional responsibility. Thus, you need to research information that you will probably not use more than once in your life, just for an everyday transaction.
- Also, SWIFT transactions are not transparent in real-time: You order a remittance and then don’t see what happens, except that the money is withdrawn from their account. Has it arrived at the car merchant’s account? How many fees have been deducted along the way? What if the car merchant says he got too little money? You can trace all of this back, but only with a lot of paperwork.
Ripple, IOUs, and rippling
However, in spite of all these disadvantages, the basic idea of SWIFT is not at all bad. Instead of physically transferring assets across a border, such as mailing your car merchant an envelope full of cash or a suitcase of gold, you rely on the trust relationship between intermediaries that owe each other through this transaction. If you ask your bank to send your money to the car merchant’s bank, this generates an “I owe you” (IOU) relationship between the two banks. The car merchant’s bank pays money to the car merchant, and your bank promises to compensate. Because you are not the only one in the world who wants to send money to a different country, transactions go both ways. Perhaps next time the car merchant wants to buy a yacht from a yacht dealer who has an account at your bank. Then, the car merchant’s bank doesn’t need to send money to your bank – both banks can just agree that both debts balance each other out:
Rome Bank (your bank) owes 10,000 EUR to Paris Bank (your car merchant’s bank) because Paris Bank paid 10,000 EUR on your behalf to the car merchant.
Then, Paris Bank owes 20,000 EUR to Rome Bank (both your bank and the yacht dealer’s bank) because Rome Bank paid 20,000 EUR on the car merchant’s behalf to the yacht dealer. (Yes, the yacht was very small.)
The current balance is now 10,000 EUR in favor of Rome Bank.
Then, you decide to buy a high-end stereo set for your car from the same merchant. This stereo costs 5,000 EUR. Rome Bank now owes 5,000 EUR to Paris Bank for this transaction.
Now, the current balance is 5,000 EUR in favour of Rome Bank. In other words, intangible assets are exchanged between the banks (they don’t send each other physical goods like envelopes of cash), but they send so-called IOUs. For example, in the first transaction Rome Bank would send an IOU of 10,000 EUR to Paris Bank. This can be an electronically signed document.
Now let’s say that the yacht dealer wants to buy a Siemens dishwasher for his daughter’s apartment. The dishwasher dealer has an account at Berlin Bank. The dishwasher costs 1,000 EUR. Thus, Rome Bank now owes 1,000 EUR to Berlin Bank. Rome Bank and Berlin Bank haven’t made any deals together previously, so they don’t trust each other. But both trust Paris Bank and Berlin Bank currently owes Paris Bank 2,000 EUR. In summary, the situation right now is:
- Paris Bank owes Rome Bank 5,000 EUR and
- Berlin Bank owes Paris Bank 2,000 EUR and
- Rome Bank owes Berlin Bank 1,000 EUR.
As you can see, these debts can partially cancel each other out when the dishwasher transaction (the last one) comes in: The IOU between Berlin and Paris is diminished by 1,000 EUR because having 1,000 EUR less in debt is just as good for Berlin Bank as is receiving 1,000 EUR in cash. But why should Paris Bank pay for the dishwasher? This is the job of Rome Bank. Thus, the IOU of Paris Bank at Rome Bank (the debt of Paris Bank) is also diminished by 1,000 EUR. Now, the balances are settled (until the next transaction comes in).
This way, an IOU ripples through the network of banks. This is why Ripple is called Ripple: Ripple’s IOUs ripple in the same way through the Ripple network. Thus, you could say that IOUs are also a currency.
The important difference between the example above and Ripple is that with Ripple, trust relationships are automated on a blockchain that tracks all accounts, balances, and IOUs. This blockchain is the Ripple Ledger. Every participant in the network who can send transactions and/or holds XRP is defined as an account. Every account defines its so-called trust lines: Other accounts that are trusted up to a defined amount of money. For example, in Ripple, Rome Bank could define that it trusts Paris Bank up to an amount of 50,000 EUR (or 40,000 XRP, or any other currency).
Whenever a transaction is made that involves two entities that are not connected by a trust line, the payment “ripples through” other nodes in the network (except if you explicitly don’t want them to, as described here).
In its documentation, Ripple discourages users from creating new accounts unless absolutely necessary (for reasons of scalability), and institutions are advised to use one or a few accounts for all their customers. Thus, trust lines exist mainly between institutional accounts, but they can also exist between individual accounts (they are technically the same, of course).
You can see why Ripple is called a “currency agnostic” system, that is to say a system that works independent of currency and thus independent of its own cryptocurrency XRP as well: Participants of a trust line can issue each other IOUs of any currency they want. However, XRP itself is still useful for converting between currencies (if account holders can’t do it themselves because they don’t have the required currency), and to prevent spam. The latter is because each transaction requires a tiny amount of XRP that are then forever burned (does that mean that the network will one day run out of XRP? Probably not – we’ll explain why later in this article). This way, sending several useless transactions at once, perhaps in order to disturb the network, becomes too expensive for the spammer.
How does the Ripple consensus algorithm work?
Could you build an efficient SWIFT alternative on top of the Bitcoin blockchain? Probably not. The problem is the inefficiency of Bitcoin’s consensus mechanism, proof-of-work. The average time for confirmation in Bitcoin has varied between 30 minutes and 16 hours in the recent months, with one peak even reaching 48 hours in January 2018, and Bitcoin participants generally expect a transaction to be confirmed 6 times before it is accepted as a valid part of the blockchain. This is not even close to the real-time capability that is needed for a good SWIFT replacement.
Thus, Ripple needed to find a more efficient consensus algorithm. It has found one, and the transaction confirmation time in the Ripple network is now as short as 4 seconds.
Every participant in the network – that is, everyone who wants to initiate a financial transaction – is known as a client. Each client can formulate a transaction. These Ripple transactions are quite similar to Bitcoin transactions, but with some differences. The most important difference is that the Ripple transaction also specifies a path for the changing balances. That means, if your bank wants to send your money transfer to the bank of your car merchant, your bank needs to specify by which gateway (other banks, institutions, or individuals) it is connected in the Ripple network to the car merchant’s bank. This is what we have called a trust line in the section above.
When a client has formulated a transaction, it will send it to a validator. Validators are a subset of all participating servers in the Ripple network. Other servers that do not take part in the validation of transactions are known as tracking nodes – they merely track the current status of the ledger. This is similar to Bitcoin: Not everyone who is running a full Bitcoin wallet is also a miner.
The validator node now follows this algorithm: It takes the transactions it has received itself – the so-called candidate list. In several iterative rounds, it compares the transactions in this candidate list to proposals (other sets of interactions) that it receives from other validators in its UNL. Only those proposals that the majority (more than 50%) of connected nodes agree upon will be sent on to other validator nodes. This process is repeated several times, but with an important change. After a predetermined time interval, the agreement limit is raised from 50% to 60%, then to 70%, and then finally to 80%. When the process has finished with a limit of 80%, all remaining agreed-upon proposals, with their transactions, will finally become part of the ledger.
- Validator nodes collect transactions.
- They turn sets of transactions into proposals.
- They send these proposals out to their fellow validators in their UNL.
- When they receive proposals from other validators, they undergo a voting process: In the first round, only those that get more than 50% consensus are sent further along to other validators. In the next round it is 60%, then 70%, and finally 80%.
- This weeds out all transactions that are somehow doubtful or clearly wrong, such as instances of double spending.
The main purpose of this protocol is to avoid double spending. If the same amount is spent on two different transactions, both of them would not be agreed upon by the majority of validator nodes.
This is a probabilistic voting protocol, meaning that 100% certainty about the validity of a transaction is neither realized nor is this even the intention of the protocol. But the probability that validated transactions are actually valid is high enough for practical purposes, at about 98.889%.
XRP, the coin
XRP, or Ripples, were created before the company was founded and the only relation between Ripple, the company and XRP is that a certain percentage of the coins have been gifted to the company after incorporation. This is part of the final supply of 100 billion – no additional XRP will ever be mined, in contrast to other currencies such as Bitcoin, which is still being mined currently until the limit of 21 million is reached. To be exact, there is no mining at all in Ripple because Ripple does not use a proof-of-work algorithm for consensus, as we have discussed previously.
The current market value of all XRP is about 130 billion USD. Therefore, Ripple Labs’ current market value is at about 80 billion USD. Of course, monetizing all of these XRP funds at once would lead to a drastic decrease in value for XRP, but it seems that Ripple Labs has excluded any big sells for the future anyway. They stated that they had put 55 billion XRP in a cryptographically secure escrow fund out of which only 1 billion XRP per month can be released. Still, at the current XRP rate, pretty good pocket change.
Contrary to what people unfamiliar with Ripple may assume, XRP is, again, not used in the Ripple network to settle balances between participating institutions or individuals. Rather, this role is filled by IOUs that represent the balance between two participants of the network. These IOUs can be in any currency that the two transaction partners have agreed upon; they are not limited to XRP.
XRP within the Ripple network is merely used to impose a small transaction fee that is supposed to deter spammers. This is the same reason why time and again some people argue to impose a tiny fee for each email that is sent on the internet. If you are a reasonable email user (or of Ripple), you send maybe 50 emails (or 5,000 Ripple transactions) per day, and the small transaction fee will not cost you a lot of money in total. If, however, you send a million emails per day, or you try to DDoS the Ripple network with millions of senseless transactions, this will get expensive for you very quickly.
With every transaction on the Ripple network, a tiny fraction of XRP is destroyed forever. Thus, XRP is not inflationary – on the contrary, it is even a deflationary currency because its amount is designed to decrease in the future.
The current transaction cost is about 0.00001 XRP. When the network load is very heavy, occasionally this may rise a bit higher. However, with all transactions that have been performed to date, not a single whole XRP has been burned yet. The Ripple documentation states that in time, transaction fees will be adapted to the XRP supply.
That means that when there is fewer XRP, the value of 1 XRP will be higher, and transaction costs would therefore lower to less than 0.00001 XRP:
- If 1 XRP today has a value of 1 USD, the transaction cost is 0.00001 XRP (that would be 0.00001 USD).
- Fast forward 100 years: A bit more XRP has been burned, which means that there is less supply of XRP, which in turn means that 1 XRP becomes more valuable (today’s XRP value is 2 USD)n
- Thus, Ripple will change the transaction cost from 0.00001 XRP to half of it, 0.000005. XRP in a voting process as described above (back to 0.00001 USD as 100 years ago).
This way, Ripple expects that they will never run out of XRP to cover transaction costs.
Please note that USD was just used as an example to define the value of XRP; the transaction costs are not tied to the XRP-USD rate. You can find more information about this process in the documentation.
Ripple, the company, and the centralization issue
Ripple today is not represented by its original developers Larsen, Fugger, and McCaleb, but by the company Ripple Labs Inc., headquartered in San Francisco with Brad Garlinghouse as CEO. Ripple Labs have created all the Ripples (XRP) that will ever come into existence – XRP is not mined. Besides, Ripple offers a range of products geared mostly towards institutional clients and businesses. Consequentially, Ripple Labs calls the RippleNet “The world’s only enterprise blockchain solution for global payments.” This illustrates one of the major differences between Ripple and conventional cryptocurrencies such as Bitcoin and Ether: Most cryptocurrencies are developed either by an informal congregation of voluntary developers, such as Bitcoin, by individual hobbyists such as Dogecoin, or by a nonprofit foundation such as Ethereum and Litecoin. Their blockchains are permissionless blockchains. On the other hand, blockchains in industry applications such as Hyperledger are usually permissioned: Only members of the consortium that is running the blockchain are allowed to read, write, and validate. The Ripple network is something in between a public and private blockchain; a permissioned-on-permissionless blockchain. The Ripple developers themselves say:
“The Ripple network is an open network. No one, including Ripple Labs, can prevent others from using or building on the Ripple protocol as they desire. However, when Ripple Labs provides software, such as the Ripple Trade client, Ripples Labs may impose additional requirements for the use of the software. As such, Ripple Labs will require identification of Ripple Trade account holders.”
Because Ripple Labs is a financial services provider, they are required by law to ask all of their clients (account holders) to give their personal information in order to comply with know-your-customer (KYC) laws. Thus, these accounts are processed centrally, and Ripple Labs can change and cancel the accounts at any time. Although at first you are free to join the network, it is not the same permissionless concept as is the case with Bitcoin, Ethereum, and several others. You can find more details about these requirements in the Ripple Gateway Guide.
In regards to validator nodes (which are not equivalent, but independent from client accounts), Ripple Labs states that, “[A] formal validator onboarding process is not compatible with Ripple, as it is a system with no central authority.” Thus, anyone can run a server in the Ripple network, and any server can become a validator.
The traditional crypto community in general watches jealously over the concept of decentralization, and tends to reject any concept in which the power is held not by the individuals who are equal to one another, but by centralized institutions such as conventional banks and governments (which cryptocurrencies have been promising to replace from the very beginning), or in the case of Ripple, by a dominant corporation (of course, properly decentralized currencies such as Bitcoin and Ethereum also suffer from a tendency towards centralization, which is especially obvious in the Bitcoin mining farms that have replaced the early day mining on personal devices. The communities of different cryptocurrencies, however, have been working against that trend by discussing and introducing alternatives to Proof of Work).
Ripple’s products and services
As we have discussed above, Ripple Labs the company running the Ripple network, and it is not a nonprofit organization such as the Ethereum Foundation- it wants to make money. In order to do so, it has to offer products and/or services. While Ripple Labs is providing the Ripple network to its users for free (except for a tiny XRP fee to prevent spam) as a service, they are also offering a suite of profit-oriented products.
xCurrent is Ripple’s corporate solution for banks and other financial institutions. It interfaces with the traditional SWIFT protocol and other legacy procedures, but transmits the information in real time, and it is more transparent than other systems, using Ripple’s so-called Interledger Protocol (ITL) that interfaces with different types of bank ledgers, independent of country and currency. Ripple Labs say that they don’t expect everyone to adopt the Ripple Ledger, and thus they want interoperability with other ledgers. All transactions are performed according to a rulebook developed by the legal experts at Ripple Labs in order to make sure that the transactions conform to certain rules such as know-your-customer (KYC) and other legal requirements that banks must abide by.
xRapid is a solution geared towards payment providers and banks. In order to fulfil all of their customers’ requests, and at the same time avoid having too much liquid money “lying around” (which is not bringing any profits while it’s not invested), businesses have to find cheap sources of liquidity in the exact currency that is needed at the moment.
Liquid funds are funds that are readily available for spending or lending. If you have a suitcase full of cash under your bed, that is liquid money. The money in your checking account is liquid money as long as you are in good standing with your bank and your bank is healthy – if they freeze your account because you are suspected of money laundering, or because your bank is going bankrupt, liquid money suddenly becomes illiquid money. If you have no money at all, but your bank allows you to overdraw your account by 500 USD, you still have 500 USD liquid money.
That means, when transactions require more liquid funds than an entity has, they need to find ways to borrow it cheaply. xRapid is such a solution that gives them access to liquid funds that is about 30% cheaper than traditional sources, i.e. other banks.
To achieve this, xRapid is based on XRP currency that acts as a “bridge” currency so that businesses (i.e. payment provider, bank, corporation) can send cross border payments quickly to a financial institution in a different country without the need of liquid funds. There is not a direct exchange of XRP between the two institutions, but instead XRP acts as the bridge from one currency (from one country) to another currency (in another country.)
In contrast to the other two products mentioned before, xVia is a solution not only for financial service providers, but for regular businesses as well. It simply uses the Ripple network to send and receive payments to and from banks, businesses, and individuals. In addition, it offers features that small and medium sized businesses need, such as invoicing, tracking of deliveries, and payment tracking, all aimed at replacing the whole financial process for these individuals.
All of these products are still in their beta stages, if not earlier. You can try to register as an early user on the Ripple website, but no independent reports about these products are available yet.
Ripple Payment Channels
This is not a Ripple product per se, but another service that Ripple is offering inside the Ripple network. Payment Channels are Ripple’s off-chain solution, just as Lightning Network is Bitcoin’s off-chain solution. Payment Channels are designed for settling transactions even faster.
In order to avoid having to go through the consensus process for each and every transaction, only the summary of several transactions is validated on the blockchain. The intermediate transactions are conducted outside of the Ripple Ledger, off-chain. Ripple Labs has said that with Payment Channels (introduced in summer 2017), several thousand transactions per second can be processed. This number is approaching the transaction capacity of the VISA network. Because of the increased efficiency, Payment Channels are a feasible micro-payment alternative. You can find more details about Payment Channels here in the Ripple documentation.
What problem is Ripple trying to solve?
The goal of Ripple is to make bank transactions more efficient and transparent – especially cross-border, inter-currency payments.
This would have the following advantages:
- On the blockchain (Ripple Ledger), intermediaries are only involved electronically, no actual work is performed. Thus, intermediaries such as correspondent banks don’t need to deduct fees from the funds that they are processing. This makes payments much cheaper.
- The administrative overhead is greatly reduced through automation and transparence; no one has to look up correspondent banks to correctly fill out the form or phone the transaction addressee to find out if the funds had arrived.
- Cheaper liquidity is available for banks (see xRapid), who can then lower their fees for their customers.
Who controls Ripple?
Interestingly, in order to do what xVia promises to do, you basically don’t even need xVia. As the Ripple protocol is open source (Github page), anyone can develop clients or wallets that provides services and access to the Ripple network. An example of this is the Rippex client, which is also open source.
A question that has occasionally come up in online forums: Why are there so few applications for Ripple transfers from individual to individual, or private business to private business? Why has no one built another PayPal based on Ripple yet?
A possible answer to this question may be that Ripple – even though it is an open source protocol – is pretty much in the hands of Ripple Labs. As we have outlined briefly, Ripple works with gateways as a connection between Ripple users and the Ripple network. In theory, every business can become a Ripple gateway, and Ripple outlines the possible sources of revenue that you can have by being a gateway on its website. However, gateways have to comply with a large number of regulations, from KYC to AML to Suspicious Activity Reporting, and several others. Therefore, the hurdles to becoming a gateway are high.
If you are not a gateway, but a regular Ripple user (maybe a small merchant who wants to accept Ripple payments), you have to connect via a gateway. And the gateway now has the freedom to freeze your funds and shut down your account. This exact thing happened to one of the Ripple founders, Jed McCaleb, who wanted to sell his 9 billion XRP when he left Ripple in 2014 (which of course would have ruined the price, at least for a time). Independent of whether or not it was right for him to try and dump all of his funds at once, it clearly shows that users on the Ripple network do not have equal rights, as should be the case in a truly decentralized system. This may be a factor that is deterring individual enterprises from building their businesses on Ripple.
How does Ripple Labs make money?
Currently, Ripple is working hard at onboarding banks for its corporate solutions. Recently, it has started partnerships with several Japanese and South Korean banks for its xCurrency system, and it is going to pilot its xRapid system with the financial service provider MoneyGram (similar to Western Union).
Until these partnerships start paying off, it seems like Ripple Labs can decently fund themselves by cashing in on XRP’s currency gains on the markets; they are still holding onto the majority of the XRP funds that exist, and they further contribute to XRP’s rise with strong marketing measures. The important thing for Ripple Labs is that this strategy holds until the products start bringing in profits.
How can you make money with Ripple?
The current adoption and pilot projects of Ripple look quite promising, as it has many big names on board already; MoneyGram, American Express, Santander Bank, Bank of Tokyo-Mitsubishi UFJ, SEB, and others. Of course, it remains to be seen if Ripple will be adopted long-term after such pilot projects, but it is at least off to a strong start.
First, the demand for developers familiar with Ripple will increase in the banking sector and adjacent industries. Many banking professionals are still working on understanding the blockchain itself, so they will need technical professionals to explain Ripple for them. These experts will also be needed to implement Ripple’s solutions and interfaces with legacy systems.
Second, further currency gains in XRP is possible, but speculative. The higher the industry adoption of XRP, the higher its price will possibly rise. However, the simple fact that Ripple is holding so much of the funds is a source of uncertainty.
Third, can you build a business on Ripple? This too seems risky as Ripple is already highly regulated, more so than other cryptocurrencies. Additionally, it is under the control of a single entity, at least a majority of it. However, it remains that the Ripple protocol is open source, so in principle everyone is free to come up with innovative business models that avoid the cumbersome regulatory aspects.
Incidentally, in 2014, Ripple got a nonprofit sister network: Jed McCaleb (the aberrant Ripple founder mentioned above) created a Ripple fork and called it Stellar. Stellar seems to be less commercially oriented and it has a different consensus mechanism, as well as an inflationary currency that is in contrast to the deflationary XRP. Stellar is worth keeping an eye on – it could very well be a friendlier platform for independent entrepreneurs. We will cover Stellar in a future article.
What do you think about the business models on Ripple?