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Ripple’s XRP crypto coin went all the way up to $3.50 this January thus achieving its historic peak value propelled by rumors of an imminent Coinbase listing. That brought it a lot of attention (CNBC even published an investor guide for acquiring XRP), but it also created controversy about the corporation, its marketing strategy, the token, and its real-world usefulness.
What does Ripple mean, anyway?
Ripple is not a monolithic notion. It actually encompasses three different entities that, while closely linked to each other, are quite different, and if we’re going to understand Ripple’s current situation we need to know what the differences are. First of all, there’s Ripple Inc., based in California. This is the corporation that is behind all the technology and the coin.
Then there’s the Ripple Protocol which is a blockchain based technology designed for inter-bank transfers and communications. The third concept related to Ripple is its coin, called XRP. That’s the company’s cryptocurrency.
The thing to keep in mind here is that Ripple’s banking platform does not require for its users to adopt the XRP coin in transfers, as it works using other currencies as well. But if they do adopt Ripple’s coin, things run faster and cheaper.
XRP is needed to pay the Ripple Protocol’s fees or as a bridge currency between different banks or within the same bank doing an international transaction.
The Ripple Protocol is sound and could really supplant the traditional way in which inter-bank operations work, which would have a substantial economic impact on the world. But that’s all about the protocol, not the coin. It remains unclear how big a role the XRP will play on this if any at all.
How banks do the trick
Let’s have a look at the Ripple Protocol. To understand it, we need to know how banks work in the 21st century. Let’s say I go to Banco Santander, which for example is my personal bank, and I deposit $10 into my savings account. By doing this, I am loaning $10 to Santander with the understanding that I will be repaid any time I ask. So Santander adds a $10 entry to their liabilities.
Let’s say I transfer that same money to a friend who also does his business at Santander. The bank’s balance doesn’t change, all that happens is that the same liability is now owed to him instead of me. The bank, of course, keeps an internal ledger that records all these debts to its clients.
If I want to send money to somebody who banks with a different institution, things get a bit more complicated because both banks need to keep their ledgers up to date and, at some point, my bank is going to have to make an actual payment to his bank.
Every country’s big players usually know each other well and trust each other (or at least work together all the time), so they are willing to make things faster for clients by accepting to issue IOUs and settling them at a future date.
That is possible as long as the banks trust each other, but they don’t always do. In that case, clients must wait for money to change hands among them or to be routed by a third party that is trusted by both banks. This takes time.
Now let’s say that I want to send funds to a friend who lives in Taiwan and our banks do not trust each other. Maybe they’ve never even heard about each other. This is the most frequent scenario in international transactions. In this case, the money will follow a difficult route that will include several other institutions; it’s expensive, slow, error-prone.
It also needs for my bank to have my friend’s currency in reserve and for my friend’s bank to have my currency in reserve too. This increases both banks working capital needs, which is not great news for either bank because this kind of reserves are useless to them until somebody asks for a transaction between them which could be not a very frequent event.
The Ripple Protocol in a nutshell
In the Ripple Protocol, all participating banks are included in a single ledger (the Ripple Ledger). This makes things considerably faster and also means that these banks don’t need that frozen working capital anymore.
The network finds the shortest possible path for the money to follow by determining trust lines between the network. Because it’s based on a blockchain, it creates a distributed ledger globally that keeps the record of every transaction.
In these way, the decentralized ledgers allow banks to exchange IOUs to be settled in the future, and they can do it using fiat money, XRP, or any other digital asset.
While XRP doesn’t necessarily need to be the means of exchange, it’s still required to pay the network’s fees, and every user must keep at least 20 XRP tokens in their digital wallets if they want to transact.
So what’s the point in keeping XRP tokens?
So once you’ve understood the protocol you must have realized this: however widely adopted the Ripple Protocol becomes, that doesn’t mean that XRP’s value will grow proportionally, which is why it’s so important to understand that coin and protocol are different animals.
XRP’s value will go up as its demand grows. That demand would come as banks use it as a bridge asset within the Ripple network to settle their business. But because XRP has shown some volatility, participants are not that sure they want that additional risk.
They know that using XRP in this way makes the network work better for them by reducing costs and increasing transaction speeds. But even with those incentives in the mix, it still makes better sense for them to use a more stable cryptocurrency to settle their debts.
As transactions within the net need fees to be paid in XRP, the demand will increase for sure as the protocol’s adoption increases, but this is going to be a very slow process, best case scenario.
As the use of decentralized exchanges becomes more common, it makes it easier to trade in all kinds of tokens quickly and safely, exposure to volatility decreases. This makes XRP something of a third wheel. It just adds friction to the user experience, and you can avoid it but only if you just have the funds, you need to complete the transaction.The Ripple Protocol is actually a good one, so it makes things quicker and cheaper for banks even if they don’t use XRP to transact. Yes, if they do adopt XRP things do improve. But are they so much less expensive and quicker so the additional risk is worth taking?
Ripple allows settling accounts in many different currencies both fiat and digital. So the chances are that some fiat currency will be the main bridge for some time yet and that members will adopt a cryptocurrency (a very stable one) in the long-term.
Don’t try to run before you can walk
As things stand right now, it seems that banks and financial institutions’ current priority is not to have increased transaction speeds.
When you upgrade an internet user from dial-up internet to WiFi, they see the benefits immediately, but it will also make it harder to sell them a much faster service too soon, or at least until they’ve learned to use their new WiFi to its maximum.
Something like that also happened when cars appeared in the market. Horses were still around for a very long time, and one of the priorities back then was to make sure that the new machines did not scare the animals.
Banks are usually very conservative institutions in which inertia and skepticism hold changes back. They will make sure they can walk before they even consider attempting to run. Just adopting the Ripple Protocol (let alone the coin) is already a significant change for them.
Even Ripple’s Chief Cryptographer, David Schwarz, has made it clear that the Ripple Protocol is powerful enough to work without XRP. Even without any blockchain at all. It improves international payments so much over the current legacy systems that banks will adopt it even if, in the end, fiat money keeps moving just as it does right now.
Mr. Schwarz also said that the tricky bit in all this is to get banks to use the blockchain but that it’s not the blockchain per se that makes the network convenient but the integration with current systems, compliance, and governance. And that’s what Ripple does. But if transactions costs go down even by a cent by adopting XRP, it still makes sense to adopt it, according to him.
In his opinion, Ripple’s and XRP advantages speak for themselves. If he’s right, XRP’s value will increase very much very quickly.
XRP: The skeptics
Skeptics think that XRP shouldn’t exist in the Ripple Protocol at all. They just see no reason for that other than to make users buy XRP tokens thus inflating XRP’s price in the open market without really adding any value.There are 100 billion XRP tokens in existence, and they are all already mined and ready to sell as the mining process was completed before the protocol was launched. Last December Ripple committed to storing 55 billion XRP tokens in a crypto-safe escrow account to make everybody know that the token’s supply is not at risk. A billion XRP are released from this vault on a monthly basis for Ripple to use as they deem fit. So far, it’s been mainly to create market incentives and sell to institutional investors.
Ripple has used those funds responsibly so far. They’ve sold about 30% monthly, and any XRP remainings go into a new escrow account.
It currently seems that XRP’s prices are inflated. Investors speculate that XRP will indeed become a global currency that will facilitate transactions between banks. Such event will disrupt a worldwide trillion dollar industry, and XRP would be at the heart of it. This is the belief (or hope) that is driving XRP’s price up.
But this doesn’t need to happen because the Protocol doesn’t really need to use the coin, except for fees, and fees will not create such high demand. Also, banks will not go for XRP until they are sure that it’s a stable asset.
We are quite optimistic about Ripple as a project. Many banks are adopting it, and that’s just a significant step for the whole blockchain industry. It will revitalize an industry that sorely needs it, but that’s the Protocol. On the other hand, to buy and keep XRP tokens as a retail investor, in long-term, doesn’t make much sense as yet. Wait a bit further at this stage, judge, and then invest (if you want to)!
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