What is Ripple? (XRP, IOUs, Gateway and Validators Explained)

What is Ripple? How does it work? Is XRP, Ripple’s cryptocurrency,
a good investment? And what does this all have to do
with the banking system? Well stick around, in this episode
of Crypto Whiteboard Tuesday we’ll answer these questions
and more. Hi, I’m Nate Martin from 99Bitcoins.com and welcome to
Crypto Whiteboard Tuesday where we take complex
cryptocurrency topics, break them down and translate them
into plain English. Before we begin don’t forget to subscribe to the channel and click the bell
so you’ll immediately get notified when a new video comes out. Today’s topic is Ripple and XRP, one of the leading cryptocurrencies around. 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 for 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. That’s exactly what Ripple
is here to change. 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. But how does it all work? 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 to access
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 transfering 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. This all sounds great, but what type of currency
can actually be sent through the Ripple Network? Well, 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. 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.Nate 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.Nate IOU from me. 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 trust line. A trust line 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. Aside from IOUs there is another currency
the Ripple protocol supports – XRP. 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 counterparty risk.

In other words,
once you've 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 trust line 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 us 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. Let me explain: 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 on whether
the transaction is valid. If 80% or more vote it “valid” – the transaction is updated
in the Ripple ledger. This list of trusted validators
that a validator consults with is known as a Unique Node List
or 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. You might be wondering, who owns all of these pre-mined coins? 20 Billion XRP
were given to Ripple founders – Jed Macaleb, Chris Larsen
and Arthur Britto. Ripple Labs holds around 7 billion XRP. 40 billion XRP have been sold
to companies and individuals. The remaining supply
is sealed in a smart contract 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. 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 shooting this video 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. So, is it a good idea to invest in XRP? 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. Before we end this video I want to touch upon one more subject and that’s the 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 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. 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? 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. 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. 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? That’s it for today’s episode of
Crypto Whiteboard Tuesday. 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.

You may still have some questions. If so, just leave them
in the comment section below. And if you’re watching this video
on YouTube, and enjoy what you’ve seen, don’t forget to hit the like button. Then make sure to subscribe
to the channel and click that bell so that you’ll be notified
as soon as we post new episodes. Thanks for joining me
here at the Whiteboard.

For 99Bitcoins.com, I’m Nate Martin,
and I’ll see you… in a bit..

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