Ripple & XRP Explained

Who are Ripple? What is XRP? More importantly, why the hell should you care?

In this post, I begin by outlining what Ripple and XRP are all about. In the second part, I address some of the possible reasons for and against ‘investment’ into XRP.

I’ve tried to keep it as balanced and factual as possible, but my scepticism does seep through.

Remember: I’m not a financial advisor. Find my disclaimer here.

The Basics

Ripple vs XRP

Let’s clear this up immediately, as it (understandably) causes some confusion.

Ripple refers to Ripple Labs, the company that packages up and sell the Ripple protocol/network to financial institutions.

XRP is the digital currency which is used to open a wallet and send transactions on the Ripple network. Although XRP is the native asset of the Ripple network, you can send non-XRP assets over the Ripple network. You’ll always need a small amount of XRP to use the network, but financial institutions wouldn’t be locked-in to using XRP as the method of value transfer.

Confusingly, you might read or hear XRP referred to as ‘ripple(s)’ (there’s an excellent explanation of what that’s the case here). They’re interwoven terms, but it’s useful to consider them as different things.

XRP

Basics

Market capitalisation

At the time of writing (11/05/2018), XRP has a market capitalisation of nearly $27bn ($0.69 per coin). This is based on a circulating supply of about 39bn XRP. From its all-time high of $3.84 per coin, it is currently down 82.3%. For context, the overall cryptocurrency market capitalisation has declined about 50% since it peaked in January 2018 ($830bn to $400bn’ish). XRP’s dominance in the cryptocurrency market capitalisation sits between 7-8%. It’s available to buy on 50 exchanges worldwide.

Critics of XRP’s Calculated Market Capitalisation

Some critics argue that this is a disingenuous calculation, as the total supply of XRP which exists sits at 99.99bn XRP. Excluding XRP which are held but not actively circulating is the equivalent of ignoring the BTC held in Satoshi’s wallets. It still exists, even if it currently sits dormant. Adjusting for this, the market capitalisation of XRP would be about $69bn. This would put it slightly ahead of Ethereum at the time of writing.

Ripple

Who are Ripple?

Ripple Labs is the company that created XRP. Originally named Opencoin in 2012, they changed their name to Ripple Labs in 2013 (and are now just known as Ripple). They have offices in San Francisco, New York, London, Sydney, India, Singapore, and Luxembourg. Across their offices, Ripple Labs has over 250 employees and numerous open positions. Brad Garlinghouse is the current CEO.

What’s the problem being solved?

Ripple’s vision is to, essentially, move money around the world just like information. With current systems, cross-border payments are terrible. They’re slow (3-5 days), expensive, and have an error rate of about 3-5%. Ripple is aiming to resolve this real (annoying) inefficiency faced by financial institutions with their three products: xCurrent, xRapid, and xVia.

High volume and efficient corridors (e.g., USD to EUR) aren’t being targeted. Instead, they’re looking to improve upon inefficient medium and high volume corridors (e.g., EUR to INR).

Products

As noted above, Ripple sells three products: xCurrent, xRapid, and xVia.

xCurrent

This is essentially a replacement for SWIFT’s messaging system which allows messaging between banks with “increased speed, transparency, and efficiency”. With xCurrent, banks are able to:

  • Message each other in real-time (two-way protocol).
  • Confirm details of the transaction prior to initiating it (e.g., confirm costs).
  • Confirm delivery.

This appears to be Ripple’s flagship product. While it might not be immediately clear to some, xCurrent does not leverage XRP. Further, it only works well when there’s an existing bilateral arrangement between banks.

xRapid

xRapid allows “access to an on-demand liquidity pool of digital assets which eliminates the need to hold nostro accounts in destination currencies”.

Let’s translate that: making payments into some countries requires pre-funded accounts denominated in the local currency (i.e., nostro). Since the introduction of Basil 3 (brief explanation here), the opportunity cost of supporting such cross-border payments has increased. With xRapid, banks will be able to use XRP to enable payments into and out of countries without holding nostro accounts in those countries. This would free up about $27tn which is sitting idle in nostro accounts.

Unlike xCurrent, xRapid does require the use of XRP. It entered into beta late Q3 2017, with pilots announcing in Q4 2017 and Q1 2018. These pilot customers were reported in the Q1 2018 XRP market report:

  • Western Union
  • Cambridge Global Payments
  • MercuryFX
  • IDT
  • MoneyGram

xVia

This is a web services layer which is intended to optimise the payments experience by providing a standardized interface.

Clients

Ripple’s target market are financial institutions like banks (e.g., Santander) and money transfer processors (e.g., Moneygram). They are over 100 banks “working with Ripple” around the world. This page lists some of their clients. In Q1 2018, they’ve been signing about 1 product contract a week with Brad Garlinghouse (CEO) noting that “you’ll continue to see many financial institutions lean in”.

We should be clear about what “working with Ripple” means. From what I can tell, lots of these clients are testing xCurrent (the Ripple protocol). xCurrent doesn’t involve XRP usage. xRapid – which does use XRP – is being tested by less than 10 clients. This isn’t immediately clear when you read coverage from news sites (e.g., this post) which don’t differentiate these two products. It might also not be clear that the majority of these partnerships seem to be pilots.

Clarifications

Ripple’s ownership of XRP

Ripple Labs owns about 61% of the XRP’s total supply. To assuage concerns about their ability to flood the market with XRP on-demand, Ripple committed the majority of their XRP (55bn) into an escrow account. Every month, 1bn XRP is released for their use. Any XRP which isn’t utilised in that month is then returned to their escrow account (which then adds another month to the contract).

They’ve repeatedly noted that they use their XRP as a “strategic weapon” in an effort to increase XRP market liquidity and drive network effects. Their $300m RippleNet Accelerator Program is an example of this. This consists of two things:

  • Volume rebate program:
    • “…provides license and integration-fee rebates to RippleNet members once they’ve reached integration and volume milestones by certain deadlines.”
    • “…can cover anywhere between 50 to 300 percent of the integration fees and first year’s license fees.”
  •  Adoption market incentive
    • “…will match eligible customers’ marketing spend when they promote Ripple-powered products and services to their end-customers.”

Both incentives are payable in USD or XRP.

Where will financial institutions source XRP?

Banks won’t be sourcing XRP from exchanges that you or I frequent. Instead, they’ll be using liquidity providers (LP). These LPs will stockpile XRP and allow large customers (like banks) to buy and sell without needing to interact with exchanges. If these LPs need more XRP to meet demand, they’ll source this from Ripple or buy from exchanges.

Using XRP with xRapid shifts the burden of nostro accounts from banks to private LP companies. As such, the XRP LPs are pools which would require no direct investment and would free up the $27 trillion which is parked by banks so accommodate cross-border payments. This resolves a significant inefficiency faced by banks, as it sits idle.

In the Q1 2018 XRP market report, they noted that $16m in new XRP loans had been extended to market makers (i.e., LPs) to “tighten spreads” and reduce the burden of XRP sourcing costs (from exchanges).

Arguments (For & Against)

“Brad’s beard is beautiful you dirty straw-hat-wearing peasant!”

xRapid’s Misrepresented Benefit

As noted in this report:

“the most interesting feature of the inter-bank Ripple protocol [xCurrent] is the fact that these transactions do not have to be denominated in the network’s native currency, XRP”

You can transact with anything over the ledger, including IOUs for USD/EUR or any other cryptoasset.

Therefore, while the Ripple protocol is a good application of blockchain technology that might cause trillions of dollars to be more efficiently transacted across borders, the same report notes that it’s “unlikely to be conducted in XRP”. Given that possible reality, XRP’s valuation might be incredibly optimistic.

According to this insight post published by Ripple, using XRP on the Ripple network (i.e., using xRapid) would deliver significant benefits to clients (up to 60%). However, the real benefit of using XRP is somewhat blurred. This is because:

  • It shows the percentage difference for each product/scenario in comparison to the base, not each other.
    • Using Ripple + XRP offers a 14.2% relative improvement over just using the Ripple protocol.
    • Using Ripple + XRP (assuming low volatility) offers a 41.1% relative improvement over just using the Ripple protocol.
  • The Ripple + XRP (with low XRP volatility) is an idealised scenario which distracts from the benefit from using XRP under current market conditions.
    • From my interactions with XRP supporters and reading articles, this is the scenario which is latched onto to make the benefit of XRP seem larger than it appears to really be.

Another recent insight published by Ripple reported that trials with:

“…financial institutions using xRapid saw savings of 40-70 percent compared to what they normally pay foreign exchange brokers [in the US to Mexico corridor]”

The post doesn’t provide further details (e.g., mean, median, mode, SD). Additionally, it fails to isolate the benefits of xRapid in comparison to xCurrent. Instead, the benefit is described in relation to traditional money transfer systems.

Why am I paying so much attention to this? Does this really matter? I think so. These blurry comparisons (by Ripple) are making XRP appear more impactful than it probably is. While reading such articles might leave you with the impression that XRP is driving significant improvements (up to 70%), it is likely responsible for less than half of that by itself. Such a misrepresentation may be:

  1. Driving unrealistic valuations of XRP.
  2. Bootstrapping exchange liquidity by on-boarding confused (or misled) speculators.

Being fair though, it’s just clever marketing. Everyone does it.

Network Effects

For consumer remittance providers like MoneyGram and Western Union, a significant competitive advantage might immediately be leveraged by using xRapid (i.e., XRP) to move value across borders. As such businesses would only be using the technology internally, establishing a network effect wouldn’t be required. It’s not surprising that these consumer remittance providers are the first clients looking to utilise xRapid (and, as such, XRP). There are some details in the Q1 2018 XRP market report.

Unlike consumer remittance providers, banks would be more reliant on the establishment of network effects. This is because the bank transferring value using xRapid would require the recipient bank to also be using xRapid.

While it might be unclear to less devout Ripple or XRP fans, the majority of Ripple’s announcements in 2017 concerned tests of xCurrent. As noted previously, this doesn’t use XRP. Now that xRapid is in beta, we’re starting to see financial institutions testing that.

Getting a Foot in the Door

A moderator of Ripple’s discord (Nymdok) raised a great point. xCurrent (which doesn’t use XRP) is the onramp which gets Ripple’s foot in the door. “It’s a digital win for payments, full stop.” Once financial institutions are comfortable with xCurrent, xRapid (and XRP) will have a better chance of being adopted. As noted here, xCurrent and xRapid aren’t mutually exclusive, but “sequential adoptions”. Assuming a bank is using xCurrent, they’d be able to easily test and upgrade to xRapid (and use XRP for settlement).

Will financial institutions use XRP?

Here’s an interesting quote, cited by TwoBitIdiot in this post, from someone with hands-on experience of RippleNet:

“Ripple’s approach with XRP has been to get it listed on a bunch of exchanges and ‘infer’ but never explicitly say that banks are using it for settlement. We (and all the global players that I work with) are not. We wouldn’t touch it.”

Here’s another comment from P4man on CoinDesk:

“…banks currently control Swift. How likely is it they would relinquish control to a small startup and allow themselves to become beholden to its private currency, that they have no need for? I just don’t see that happening.”

It’s a contentious point which I encountered most frequently in my research. There is some strong scepticism that XRP will ever be adopted by banks. Instead, critics argue that banks will use another non-XRP asset which does everything XRP does (and perhaps more). So while praises might be sung for the Ripple protocol, there is less confidence that XRP will become the dominant settlement currency used across the world.

I don’t think we have enough data (right now) to conclusively affirm that XRP will never be used by banks. However, I do think it’d be foolish to not be sceptical until we have more solid information from a range of trials (and decent comparisons against other non-XRP assets).

The Bottom Line

Just like the rest of the cryptocurrency market, XRP’s valuation is based on the positive expectations of speculators. XRP seems to have a mixed relationship with the cryptocurrency community because it’s perceived as being ideologically opposed. Rather than making the bankers obsolete, Ripple is seen as helping them to remain relevant.

The ambiguous distinction between Ripple and XRP doesn’t help. For some, the distinction is irrelevant considering how interwoven they appear to be. While XRP might survive the collapse of Ripple Labs, it’d might then become irrelevant (and collapse in value if the total supply began circulating). While Ripple’s CEO might condemn journalists for their confusion of Ripple Labs and XRP (and the spread of misinformation), I’m not convinced Ripple have helped much.

If it wasn’t obvious, I’m still a sceptic of XRP after putting this post together. Regardless, I am looking forward to seeing more results from trials using XRP through Ripple’s xRapid. It’s still early days – no need for premature conclusions.

One Response

  1. Bitcoin Hyperlord 16th May 2018

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