Much of the criticism of Ripple’s valuation has focused on XRP, its platform’s native cryptocurrency. Critics say that XRP cryptocurrency has not gained sufficient traction among businesses to warrant its current valuation. XRP's traction can be interpreted as 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 Ripple's overall valuation in the markets. Amid the general brouhaha, however, XRP's utility within Ripple’s ecosystem of products remains somewhat of a mystery.

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 not connected to each other. Ripple uses interledger protocol, which enables the 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 technology is designed to increase transaction processing speed for cross-border transactions.

As clever and future-forward their technology may be, interledgers still do not solve the problem of pre-funding 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 in. 

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 corresponding relationship with each other.

XRP as a Currency

Ripple's solution is not a new concept. In fact, XRP’s role can be considered similar to the role that the U.S. dollar plays in international markets. The greenback, or the U.S. dollar, 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 between, say, Kyrgyzstani som and Japanese yen would be routed through U.S. dollars. 

While it can also be used in xCurrent and xVia, Ripple's other two products, 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 three seconds faster per transaction compared to other digital assets. XRP offers other advantages as well: using XRP, banks can source liquidity on demand in real-time without having to pre-fund nostro accounts.  

But transactions using XRP come 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. 

XRP as a Security

In February 2018, the United States Securities and Exchange Commission (SEC) alleged that Ripple Lab executives Bradley Garlinghouse and Christian Larsen manipulated the XRP price by slowing down or speeding up sales depending on the market. The SEC accused Garlinghouse and Larsen of creating “information asymmetry” that allowed them to continue selling off XRP at a “substantial risk to investors.” The crux of the accusation was whether XRP could be deemed a security offering or not.

In 2020, former Commodity Futures Trading Commission Chair, Chris Giancarlo, argued that XRP should not be deemed a security offering because it did not fit the criteria of the Howey test. However, a potential conflict of interest was apparent because the law firm that Giancarlo represented—Willkie Farr & Gallagher LLP—was also acting as legal counsel to Ripple.

The Bottom Line

The bottom line is that XRP has an underlying role in Ripple's activities and products. Exactly what that role is and the dependencies and influence that may exist between the two are not yet fully understood and may never be as long as cryptocurrencies are unregulated and their definition as a currency or investment is undetermined.

Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns 0.01 bitcoin.