What is Ripple? A Complete Beginner’s Guide
Last updated: 12/18/18
Ripple and its cryptocurrency XRP have been slowly climbing the cryptocurrency chart until reaching the #2 spot on late 2018. In today’s post I’m going to break down exactly what Ripple, how it’s different from Bitcoin and even touch upon the question “Is it a good investment?”
The banking system today uses slow and outdated systems in order to transfer money (i.e. value) around the world. Ripple aims to create the Internet of value – a set of unified rules helping the financial sector use 21st century solutions for fast and scalable transfer of money. Ripple has two main forms of transferring value – IOUs and XRP (it’s native cryptocurrency).
If you want a deeper explanation about Ripple and XRP keep on reading. Here’s what I’ll cover:
- The problem – Banks are outdated
- The solution – Ripple
- How does Ripple work?
- Ripple currencies
- Ripple mining
- XRP distribution
- Is Ripple centralized?
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Have you ever had occasion where you needed to wire money to someone only to be told it might take several days for that money to appear in their account?
That’s because most major banks are still using systems that were built 40 years ago for this task. Swift, MoneyGram and Western Union are just some examples of slow, expensive and relatively limited systems that financial services use to transfer money.
On top of that, not all of the banks are connected via the same network. So, in many cases, you don’t even have a direct line between two banks when they need to transfer money from one account to the other.
In order for bank A to send money to bank B that it doesn’t have any direct relationship with, more often than not it will have to go through several intermediary banks, searching for common network connections between each other in order to clear a path for the money.
That’s why international wire transfers are so slow and costly; Each bank along the way takes time to process the transaction and a fee for servicing the process.
In some cases, bank transfers must involve currency conversions, which make things even more problematic and expensive. For example, directly transferring currency from Japan to Nicaragua, means turning Yens into Cordobas, which is generally not feasible.
The reason is that Japanese banks don’t usually hold accounts denominated in Cordobas because there’s not a lot of demand for them. However, both Japanese and Nicaraguan banks hold accounts in dollars.
So instead, an individual or bank will usually trade Yens to Dollars and then Dollars to Cordobas. As you can imagine, this process can be costly due to the multiple conversions.
In short, the banking system today doesn’t have a main connecting network with a uniform set of rules. Each time you want to exchange or send money through the banking system, you need to find a path to transfer that money, depending on the circumstances.
Just like the Internet has its own rules, or protocol, to transfer information known as http. RippleNet uses a protocol, known as RTXP, for moving value around the world.
Ripple Labs, the creators of RippleNet, aim to create the “Internet of Value” – a way for money to move as quickly as information does. Through the use of RippleNet, there is no reason to pay a fortune and wait days when transferring money globally.
The idea for Ripple was actually first conceived way back in 2004 by Ryan Fugger and was called RipplePay, but in 2012 was passed to Jed McCaleb and Chris Larsen who founded OpenCoin later to be called Ripple Labs.
Unlike most cryptocurrencies who focus on the individual, Ripple Labs aims to serve banks and payment providers, allowing them to lower transaction costs and expedite settlements.
RippleNet is a network based on a set of rules known as the Ripple Transaction Protocol or RTXP for short. The network consists of computers, known as validators, that are spread around the world and maintain a shared ledger of who owns what.
Validators make sure every transaction sent through the network follows the RTXP rules. Anyone can run a validator and help maintain the Ripple network just like anyone can run a Bitcoin node to maintain the Bitcoin network.
Companies who want access to the Ripple network can use gateways. Gateways, which are usually run by banks, act as entry points to Ripple for people outside the network. It’s the same idea as going to a bank or a credit company to gain access to the banking system.
So Ripple basically offers businesses an alternative to the banking system in the form of an Internet of value called RippleNet. Ripple products like xRapid, xVia and xCurrent are offered to companies in order to optimize their current solutions for transferring money around the world.
It’s worth mentioning that for you, as a customer of a financial service using Ripple, this solution is transparent. If the bank switches to this technology, your bank account balance could be residing on the XRP ledger tomorrow and you would never know it.
Unlike other cryptocurrency protocols which support only their own asset, Ripple offers two different types of “currencies”: IOUs and XRP.
IOUs are tokens on the Ripple network that can be stored on any Ripple wallet. Just like we can store a variety of Ethereum tokens on an Ethereum wallet, we can have plenty of tokens coexisting on the same Ripple wallet. But we really should stop the comparison here, since this is as far as the similarities go.
Any participant on the Ripple network can issue an IOU, however an IOU doesn’t represent something you OWN it represents something you OWE. It’s a debt, an obligation to pay back something you got in real life.
When I issue an IOU to someone, it means I owe them something. When I hold an IOU issued by someone else, it means someone owes me something.
Each IOU has a name that is comprised out of who issued it and what it represents. For example, USD.Bitstamp is an IOU issued by Bitstamp promising to pay back USD dollars. An IOU can be issued for any type of real world asset. For example you can have an IOU for dollars, EUROs, gold , oil, airline miles and even cows.
It’s important to note that the IOU itself is not the asset, it’s just a promise by the issuer to give you the asset back in the future. This promise won’t do you any good if the issuer isn’t good for his word. That’s why trust plays an important issue with IOUs.
In order for you to accept an IOU from someone you have to trust that they will be able to pay you back. In RippleNet this is known as a trustline. A Trustline is somewhat similar to a line of credit with the bank. It’s an agreement to trust someone up to a limited amount of money.
For each asset we borrow, we will issue a new IOU. Unlike other forms of debt that can be traded, IOUs for the same asset type are not interchangeable if they were issued by two different people. For example, if I borrow money from you and issue you a 20 USD.99Bitcoins IOU, that IOU can’t be added to a 20 USD.Bitstamp IOU. Since each IOU has a different credit line or trust line you can only redeem the USD.99Bitcoins IOU from 99Bitcoins.
XRP is a currency issued by Ripple Labs to help transfer payments through the Ripple Network. For example, if a bank wants to move large amounts of money, instead of needing to use multiple intermediary banks to transfer the money, it can just convert the money to XRP and send that XRP to the recipient bank.
It’s important to note that two banks don’t have to use XRP to transfer assets between them. Instead, they can choose to keep an ‘open tab’ using IOUs only, without ever closing it. Still, XRP is a form of payment that unlike an IOU is final and is considered a tradable asset by anyone on the network.
Unlike IOUs, XRP is the actual asset so there is no counter-party risk. In other words, once you received payment in XRP, the transaction is made and there’s no fear that the other party will not meet its obligations for payment.
So, if no trust is needed and no trustline needs to be opened when sending XRP to other network participants, why do we even need IOU? The simple answer is that XRP, being a cryptocurrency asset by itself, is relatively volatile and also not respected worldwide. IOUs, on the other hand, are treated and valued as the assets each represent.
XRP has additional advantages as well. It’s fast and scalable. Sending an XRP transaction through the network takes 4 seconds as opposed to Bitcoin’s 10 minute average. Also, XRP can handle 1,500 transactions per second while Bitcoin can handle only 7. So the upside of using XRP as a form of payment is pretty obvious.
One question people ask a lot is “if XRP is a cryptocurrency, can it be mined?”
The answer is – no, it can’t.
Mining in Bitcoin is done in order to confirm and determine the order of transactions on the blockchain. In Ripple transactions are handled through a different process.
When an XRP transaction is broadcast through the network, the validators that maintain the network decide if it’s valid or not through voting. When a validator receives the transaction, it consults with other trusted validators and they vote whether the transaction is valid. If 80% or more vote it “valid” – the transaction is updated in the Ripple ledger. For an in-depth read about Ripple’s consensus algorithm read this.
This list of trusted validators that a validator consults with, is known as a Unique Node List (UNL for short). Each validator has its own UNL. Deciding who will be included in the validaor’s UNL is completely up to the person who runs the validator. However, Ripple offers a default list of trusted validators. Validators don’t get compensated for their work like Bitcoin miners do with new coins.
When Ripple Labs started out they actually issued, or “pre-mined”, a total of 100 billion XRP and according to the Ripple protocol, no more XRP can ever be created.
- 20 Billion XRP were given to Ripple founders Jed Macaleb, Chris Larsen and Arthur Britto.
- 7 billion XRP is help by Ripple Labs.
- 20 billion XRP have been sold to companies and individuals.
- The remaining supply (around 55 billion) – was sealed in a smart contract as of may 2017 that releases 1 billion XRP into Ripple Labs’ hands each month until all of the 100 billion XRP cap will be reached.
XRP can be divided into 6 decimal points with the smallest unit being known as a drop (0.000001 XRP). If you want to hold XRP you will need a wallet that supports the currency and a minimum deposit of 20 XRP in your account. This is done in order to prevent people from spamming the Ripple Network by opening a large number of accounts.
One last thing to know about XRP is that the XRP supply decreases over time making it, in theory, more valuable as time passes. This is done through destroying the transaction fees attached to each XRP transaction.
For example, at the time of writing we’re down to about 99.99% of the original 100 Billion XRP. The “missing” XRP are transaction fees that have been destroyed and can never be used again.
Is XRP a good investment?
When people invest in XRP they are basically betting that in the future banks and institutions will use XRP to move value and will therefore buy XRP and drive up its price. Of course, banks could always use IOUs instead and that will keep XRP’s price rather stagnant. Therefore, the question of “will XRP rise in value?”, is mainly a question of whether a majority of banks and payment providers choose to utilize it instead of their current infrastructure.
There’s a lot of criticism about Ripple being a centralized platform. There are many arguments for both sides, and while I clearly have my opinion I will try to display some of the main points of debate.
Just like Bitcoin, once Ripple’s protocol is published, Ripple Labs, has no control over it. Validators run the code themselves. This is pretty similar to Bitcoin’s core development team maintaining the Bitcoin protocol but having no real control over the nodes that run it.
But while Ripple Labs doesn’t control the protocol, it does have a lot of influence since it is the organization maintaining it. So, if for some good reason it determined to create more coins, it might succeed. Ripple Labs is sort of a central bank for RippleNet.
The number of Ripple validators today is relatively small, and is a fraction of the number of Bitcoin nodes that maintain the Bitcoin network. Since these relatively few validators are ultimately responsible for maintaining the integrity of the network, this raises the question: how can we know the validators aren’t colluding in order to defraud Ripple’s users?
On the upside, since there’s no such thing as Ripple mining, the network itself is much more energy efficient compared to Bitcoin’s extreme energy consumption.
Another attribute in Ripple that raises concern is that you ultimately have to depend on trust in order to use the IOU tokens.. In contrast, Bitcoin’s entire system is designed to work in a trustless environment.
Additionally, while Bitcoin is free for all and censorship resistant, Ripple is committed to monitoring and reporting any Anti-Money Laundering flags across the network, as well as reporting suspicious activity to relevant authorities.
The Ripple protocol itself is open source, meaning that if Ripple Labs ceases to exist, the validators can still run the network themselves. On the other hand, products the company offers to banks and institutions aren’t open source and are run solely by Ripple Labs.
In the end, there’s no clear answer to whether Ripple is decentralized or not. Personally I think the real question of centralization arises when there’s one key figure or company that has implicit power over what the community thinks. And in this case, Ripple Labs undoubtedly has the most influence on the entire Ripple community, making it much more centralized in nature than Bitcoin.
It’s up to you to decide if you think Ripple is centralized or not, or whether that even matters. Ripple isn’t built on the same ideals as Bitcoin. It’s a ‘for profit’ company, serving the banking system. Perhaps this centralized solution is a more efficient means of international transaction, but is it the right one?
Hopefully by now you understand what Ripple is and how it works – A network designed to move value around the world, mainly aimed at banks and payment providers.
Consistently keeping your place at the top 5 cryptocurrencies is not an easy task and XRP has been doing this pretty successfully. For now, it seems that Ripple Labs are slowly advancing towards their goal to add more and more banks to their system, however this doesn’t necessarily mean that XRP will rise in price.
What are you thoughts about Ripple and XRP? Would you invest in it? Let me know in the comment section below.
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