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The controversy over Ripple, Its marketing and the usefulness of its token have been widely debated since its price hit an all-time high of over $ 3.50 in early January 2018 after rumors emerged that the coin would be listed Coinbaseand CNBC publication step by step manual for private investors to buy XRP.
What is ripple?
When discussing Ripple, three main definitions need to be made to aid in understanding the solution. Remember that in practice, Ripple offers tailor-made solutions for specific market participants:
- Ripple Inc.: the California-based venture capital company
- Ripple Protocol: Design specifications for interbank communication
- XRP: Currency of the Ripple protocol
The Ripple Protocol is designed to work with existing institutions to facilitate the transaction of assets worldwide at lower costs and faster speeds than today. The protocol is administered and developed by Ripple Inc. which currently has unilateral control over the network.
XRP is used to pay network fees in the Ripple protocol, and can can also be used as a bridge currency between institutions. In theory, the Ripple protocol can displace older interbank networks, which would affect economic activity in the trillions of dollars. However, this shift is unlikely to happen with XRP.
How banks settle their debts
To understand the Ripple Protocol, one has to understand how modern banking systems work. When I deposit $ 10 into my checking account at the Bank of Montreal (BMO), I lend that money to BMO and trust them to repay me. BMO posts a liability of $ 10 on its balance sheet. If I send $ 10 to a friend who also does banking with BMO, the bank has the same balance of liabilities, but the liability is now owed to my friend rather than me. The bank’s internal general ledger tracks these liabilities to customers.
If I want to pay $ 10 to someone who has a bank account with Toronto Dominion (TD) it gets more complicated because each of their internal ledgers needs to be updated and the money actually needs to change hands. Larger institutions within the same country usually have trustworthy relationships with one another, in which they issue bonds without any problems and agree to settle their balances in the future in order to enable their customers to have fast transaction times. This works because of the trustworthy relationship between banks. If there is no trustworthy relationship, customers have to wait until the money is actually transferred or the transaction is routed between trusted third parties.
When I want to send money to a friend who lives in Singapore and our banks do not have a trustworthy relationship that is common across borders, the payment is multi-party which is costly, slow, error prone and requires banking institutions to increase the need for working capital, which often remains idle until a transaction with an untrustworthy party needs to be bridged.
A simple explanation of the Ripple Protocol
The Ripple Protocol moves institutions into a single database called Ripple Ledger, which significantly reduces transaction times and frees up working capital for institutions. The network assigns trust lines and optimizes them so that money follows the shortest and fastest path of trusted parties worldwide, and creates a distributed ledger to record all of these transactions.
Banks can exchange IOUs in decentralized ledgers worldwide, but these may have to be settled. These billing can be done in Fiat, XRP or another digital currency. XRP must join the network to pay transaction fees and all participants must have 20 XRP in their wallets. XRP is a deflationary currency that burns transaction fees when paid.
What is the incentive to hold the XRP token?
There is a glaring problem in this model for XRP owners: XRP should not increase in value in proportion to the introduction of the Ripple protocol.
The XRP token should increase in value with increasing demand for the token, which would be due to its use as a bridge currency for the settlement of bonds between banks. Due to the volatility of the XRP token, rational participants of the protocol want to avoid risk and are therefore encouraged to hold tokens for the least amount of time required. If a digital currency is used to pay off this debt, it is likely that it will be a more stable coin.
Therefore, XRP is expected to gain sublinearly in value in relation to transaction throughput and market makers in this market will benefit from it by enabling transactions with a liquidity premium.
Using the Ripple protocol significantly lowers a bank’s cost base without using the XRP token as a bridge currency between assets, and I think it is unlikely that they will use the XRP token to cut settlement times even further.
Since the Ripple Protocol provides the ability to settle debts in fiat or another digital asset, it is likely that debts will be settled in fiat in the medium term and participants could adopt a more stable digital currency in the long term.
XRP: Run Before Walk?
For now, I believe the increased speed in facilitating these transactions is a feature that institutions are currently not interested in. It’s analogous to upgrading a customer from dial-up internet to wireless internet and then trying to sell them to get a higher speed – they probably won’t be interested in the short term. When society upgraded their transportation preferences from horses to steam-powered cars, and there were still some horses on the way, a person with a red flag would walk in front of the cars to make sure they didn’t scare the horses. Banks are likely to go before they run, in which case it would be a common ledger to settle promissory notes using the Ripple protocol
David SchwartzEven Ripple’s chief cryptographer specified Ripple’s protocol can work without XRP and without blockchain technology. He said the protocol improves international payments and that it is a big enough improvement [without involving XRP] On current legacy systems, banks will use the protocol even when money is available [fiat] moves just like it does now. He added that the hard part of getting a bank to adopt a blockchain isn’t the blockchain itself and that it’s governance, compliance, and integration with current banking systems – their software does all of this, so when relaying payments through XRP Instead of Fiat being even a cent cheaper, it makes sense for banks to introduce XRP as a bridge currency.
In his opinion, XRP is an easy upsell, and if this strategy works, it could significantly increase the price of XRP.
What XRP Skeptics Believe
Have skeptics argued in the past there are no good reason that XRP exists in the Ripple protocol except for a means of funding Ripple by selling XRP tokens on the open market and as an incentive for institutional participation, and that Ripple is increasing its financial stats by selling its domestic token.
There are 100 billion XRP tokens, all of which were created before the protocol started. In December 2017, Ripple committed to deposit 55 billion XRP in a cryptographically secured escrow account in order to provide security for the supply of the token. Every month, 1 billion XRP is released from the contract, which Ripple can use at its own discretion. This should serve to motivate market makers and sell to institutional investors.
In the past, Ripple has been a responsible steward in using these funds (selling approximately 30% of those funds monthly), and unused XRP was deposited into a new escrow account every month.
As of now, I believe that inflated price increases on XRP are due to investor speculation that the token will become a global currency to facilitate interbank transactions, and bet that XRP will be the driving currency for disrupting a trillion dollar industry becomes .
This is unlikely to occur because the token is not built in for the Ripple protocol and does not provide the price stability that defines a global digital asset.
I am optimistic about Ripple as a project and I think adoption is a big step in the right direction for the blockchain industry. It’s a perfect use case innovating a lagging industry, but I personally don’t see any benefit or rationalization behind a retail investor’s decision to hold XRP for the long term.
* Disclaimer: I do not own an XRP and these thoughts are my own and do not reflect the values and opinions of Crypto Briefing.
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