Ripple Definition

What Is Ripple?

Ripple is a blockchain-based digital payment network and protocol with its own cryptocurrency, XRP. Ripple's main process is a payment settlement asset exchange and remittance system, similar to the SWIFT system for international money and security transfers, which is used by banks and financial middlemen dealing across currencies.

The token used for the cryptocurrency is premined and uses the ticker symbol XRP. Ripple is the name of the company and the network, and XRP is the cryptocurrency token. The purpose of XRP is to serve as an intermediate mechanism of exchange between two currencies or networks—as a sort of temporary settlement layer denomination. Ripple was first released in 2012 and was co-founded by Chris Larsen and Jed McCaleb.

Understanding Ripple

Ripple operates on an open-source and peer-to-peer decentralized platform that allows for a seamless transfer of money in any form, whether it's dollars, yen, euros, or cryptocurrencies, like litecoin or bitcoin. Ripple is a global payments network and counts major banks and financial services institutions among its customers. XRP is used in its products to facilitate quick conversion between different currencies.

Ripple as a Digital Hawala Network

To understand how the system works, consider a money transfer structure where the two parties on either end of the transaction use their preferred middlemen to receive the money. In effect, Ripple functions as a digital hawala service. Hawala is an informal method of transferring money, usually across borders, without any physical money actually moving.

Say that Lawrence needs to send $100 to River, who lives in a different city. Lawrence provides the funds to be sent to River to Lawrence's local agent, Kate. Lawrence also provides a secret password that River is required to answer correctly to receive the funds in their city. Kate alerts River’s agent, Asuka, of the transaction details—recipient, funds to be reimbursed, and the password. If River gives Asuka the right password, Asuka gives them $100.

However, the money comes from Asuka’s account, which means that Kate owes Asuka $100 (which will be settled at a later date). Asuka can either record a journal of all Kate’s debt, which Kate would pay on an agreed day, or make countertransactions that would balance the debt. For example, if Asuka was also Martin’s agent and Martin needed to transfer $100 to Etios, whose agent is Kate, this would balance out the $100 owed to Asuka, because Etios will be paid from Kate’s account.

Although the Ripple network is a little more complex than this example, it demonstrates the basics of how the Ripple system works. From the example above, one can see that trust is required to initiate a transaction—trust between Lawrence and Kate, Kate and Asuka, and River and Asuka.

Ripple uses a medium, known as a gateway, as the link in the trust chain between two parties wanting to make a transaction. The gateway acts as the credit intermediary that receives and sends currencies to public addresses over the Ripple network. Any person or any business can register and open a gateway, which authorizes the registrant to act as the intermediary for exchanging currencies, maintaining liquidity, and transferring payments on the network.

Ripple's Digital Currency XRP

Ripple's digital currency, XRP, acts as a bridge currency to other currencies. It does not discriminate between any fiat/cryptocurrency, which makes it easy for any currency to be exchanged for another. Each currency on the ecosystem has its own gateway—for example, CADBluzelle, BTCbitstamp, and USDsnapswap. If River wanted bitcoins as payment for the services rendered to Lawrence, Lawrence does not necessarily have to be in possession of any bitcoins. He can send the payment to his gateway in Canadian dollars (CAD), and River can receive bitcoins from his gateway. One gateway is not needed to initiate a complete transaction; multiple gateways can be used, forming a chain of trust rippling across the users.

Holding balances with a gateway exposes the user to counterparty risk, a risk that is also present in the traditional banking system. If the gateway does not honor its liability, the user could lose the value of their money held at that gateway. Users that don’t trust a gateway can, therefore, transact with a trusted gateway that in turn deals with the "untrusted" gateway. This way the IOU will be transacted through the trusted, or creditworthy-certified, gateway. Counterparty risk does not apply to bitcoins (and most altcoins) because a user’s bitcoin is not another user’s IOU or liability.

Investors and potential users of Ripple should be aware that it is the target of an ongoing Securities and Exchange Commission (SEC) lawsuit that started in December 2020. The agency is suing the company and two of its top executives for allegedly issuing and selling $1.3 billion in unlicensed securities in the form of the XRP cryptocurrency. The SEC contends that XRP counts as a security and, as such, the SEC is allowed to regulate it. Ripple says that’s not the case, as XRP is instead a medium of exchange, a virtual coin used in order to conduct both international and domestic transactions. The SEC case against Ripple could end in 2023.

How Ripple Works

The Ripple network does not run with a proof-of-work (PoW) system like bitcoin or a proof-of-stake (PoS) system like Nxt. Instead, transactions rely on a consensus protocol in order to validate account balances and transactions on the system. The consensus works to improve the integrity of the system by preventing double-spending.

A Ripple user that initiates a transaction with multiple gateways but attempts to send the same $100 to the gateway systems will have all but the first transaction deleted. Individual distributed nodes decide by consensus which transaction was made first. The confirmations are instant and take roughly five seconds. Because there’s no central authority that decides who can set up a node and confirm transactions, the Ripple platform is described as decentralized.

Ripple keeps track of all IOUs in a given currency for any user or gateway. IOU credits and transaction flows that occur between Ripple wallets are publicly available on the Ripple consensus ledger. But even though financial transaction history is publicly recorded and made available on a blockchain, the data is not linked to the ID or account of any individual or business. However, the public record of all dealings (i.e., the blockchain) makes the information susceptible to de-anonymization measures.

Special Considerations

Ripple improves on some of the drawbacks attributed to traditional banks. Transactions are settled within seconds on the Ripple network (even though the platform handles millions of transactions frequently). This is unlike banks, which could take days or weeks to complete a wire transfer. The fee to conduct transactions on Ripple is also minimal, with the minimum transaction cost required for a standard transaction set at $0.0002 XRP, compared with the large fees charged by banks for conducting cross-border payments.

As May 29, 2023, one XRP is worth around $48.13 cents, and Ripple was the sixth-largest cryptocurrency with a market cap of more than $25 billion.