Much of the criticism of Ripple’s rising valuation has focused on XRP, its platform’s native cryptocurrency. Critics say that it hasn’t gained enough traction among businesses to warrant its current valuation. This traction can take the form of its valuation as an asset or as a medium of transaction between banks on Ripple’s platform.
In effect, the role of XRP in Ripple’s ecosystem has become a critical determinant of its overall valuation in the markets. Amid the general brouhaha, however, the mystery of XRP's utility within Ripple’s ecosystem of products still remains. (See also: Is The Rise In Ripple's Prices A Bubble?)
Here is a brief explainer.
What Is The Role Of XRP In Ripple’s Ecosystem?
Current cross-border transactions occur between technology systems that are siloed and are not connected to each other. Ripple uses the Interledger protocol, which enables routing of payments through interconnected ledgers, to connect these systems. Think of it as being similar to TCP/IP, the protocol that underpins Internet systems and enables disparate computers and systems to talk to each other. The ledgers that constitute this protocol can be a part of the financial institution’s own network or they can be trusted nodes in a network that spans multiple entities. The overall system’s technology is designed to increase transaction processing speed for cross-border transactions. (See also: Why Some Claim Ripple Isn't A 'Real' Cryptocurrency).
As clever and future-forward their technology may be, interledgers still do not solve the problem of prefunding fiat currencies in accounts for foreign exchange transfers. Known as nostro and vostro accounts, they are accounts maintained by financial intermediaries, such as banks and money transfer agencies, at either end of a transaction to ensure liquidity for their foreign exchange transactions.
This is where XRP comes into play.
Ripple’s products use XRP to ensure quick liquidity. xRapid, another Ripple product, uses XRP as a “bridge asset” or an asset that businesses and financial institutions can use as a bridge transfer between two different fiat currencies. In such a scenario, the financial institution can simply purchase an equivalent amount of XRP and send it through Ripple’s network. Ripple refers to it as “Third-Party Liquidity Provisioning” and states that it is ideal for banks that do not have a correspondent relationship with each other.
Fancy words apart, this is not a new concept. In fact, XRP’s role can be considered similar to the role that the US dollar plays in international markets. The greenback is the bridge currency used for numerous international trade transactions and currency conversions. It is especially useful for conversions between currencies that are thinly-traded on international markets. For example, a conversion would between, say, Kyrgyzstani som and Japanese yen would be routed through US dollars.
While it can be used in xCurrent and xVia as well, XRP transactions in xRapid have certain advantages. According to Ripple CTO Stefan Thomas, XRP is quicker and cheaper at fractions of a penny and about 3 seconds per transaction as compared to other digital assets. As listed on its website, XRP offers other advantages as well: Using XRP banks can source liquidity on demand in real-time without having to prefund nostro accounts.
But transactions using XRP comes with their own set of risks. For starters, XRPs bridge asset status means that financial institutions are dependent on Ripple to provide liquidity for transfers. Its supply and demand determines transfer value and count as an external risk. That risk is magnified if you consider the inherent dangers of using a cryptocurrency traded in volatile markets. For example, spikes or crashes in XRP’s value could hinder transfers and increase or decrease their value.
According to Ripple, three out of the top five money transfer agencies in the world have expressed interest in using XRP as a liquidity solution to expedite transfers by the end of 2018. Western Union and Moneygram have already started pilot projects for xRapid.
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