Ripple explained: What is Ripple? Why banks want to be a part of it?

The recent growing interest in ripple has got cryptocurrency enthusiasts excited about the Ripple’s native currency XRP. Recently ripple has been on the news with banks accepting the new technology and using it for services.

The sparked interest has left many perplexed as to what exactly is ripple ?  is it just a digital currency ? or a payments network? well, its both. A good parallel example would be  Hawala network – a traditional way of transferring funds without a bank. Let’s explore how this medieval banking system relates to Ripple’s payments network.

The Hawala way of funds transfer :

Hawala is a way of funds transfer where money is transferred without money movement. Let’s consider that Alex wants to send money offshore to Bob. This is how the transaction will proceed.

  1. Alex will go to a hawala agent A and give him the amount to be transferred and a password.
  2. Agent A will then contact his offshore trusted Agent B and tell him to release the funds to Bob with the password. Agent A will also meet an agreement for IOU(I Owe you) ie. A owes B x amount of money.
  3. Bob will contact agent B give him the password and take the money.

 Just like the IOU from agent A to B there are transactions from agent B to A. Similarly agent B gives IOU to agent A and the amount is balanced. the IOU’s are important here there is no physical movement of cash but the transfer of IOU’s.

Ripple’s way of funds transfer 

Similarly just like the Havala agents now we have a website that transfers IOU electronically instead of agents phoning each other.

Alex logs on to Ripple gateway,  deposits money and instructs them to release it to Bob’s account through his gateway. Bob withdraws his funds and he is happy!

So we saw how cash can be transferred but imagine a system that can transfer anything from physical gold to just about any commodity. The transfer system will work in a similar way to transfer anything as long as the payment gateway allows it. Now, these transactions can be interchangeable from cash to gold or gold to cash as long as the gateway allows it. Gold traders or other such merchants ‘Market Maker’ as ripple calls it can execute such transactions.

The chain of trust

 

In our above example what if there is no trust relationship between Alex’s agent and Bob’s agent. in order to fulfill the transaction there will be a third agent who has trust relationship between both the agents, so the IOU will flow from agent A to new agent C to agent B.at this point agent C will facilitate the transaction between agent A and B. Coming back to Ripple’s network, as long as there are intermediary gateways  to establish trust network the transaction will be honored.  The ripple algorithm tries to find the shortest possible link of trust between the gateways.

The role of ripples(XRP) explained

If there is no chain of trust between gateways of the network, how will the goods or commodity be transferred? this is where ‘ripples’ XRP come in. XRP is the currency of last resort for the ripple network.

now all gateways provide a value for whatever they trade in for example 50 XRP’s for 1 USD or 100,000 XRP  for 1 oz of gold. so you will convert anything you want to trade to its corresponding amount in XRP and transfer it on the trust network, it will again be converted back at the end gateway. This is how global financial settlement across the border will be executed. According to the Ripple company banks can save 30% on the cost of settlement by enabling banks to transact directly and around 40% by using XRP as a medium of settlement.

Ripple,  the rising tide

For the sake of cross border payments industries and banks currently rely on Nostro Accounts where large capital is tied up in these accounts, approximately $27 trillion is sitting idle in these accounts. ripple assures to free up this capital by using its global exchange and payment gateway.

The Ripple Consensus Ledger can execute 1000 transaction per second and is scalable to tens of thousands of transactions every second bringing it at the same level as Visa. The global foreign exchange market processes about $5.7 trillion every single day. The ripple technology is all set to capture the market by providing an alternative way to process cross border payments and settlements. Until now more than 100 banks have partnered and even more are thinking of implementing this new promising technology that Ripple has pioneered.