Bitcoin, Ripple and the Future of Open Money

Up until now Bitcoin has been, by far, the most powerful contender in the crypto-currency market. Other alternative coins, such as Namecoin, Solidcoin and Litecoin, have arisen to offer various modifications on the core Bitcoin concept but none have achieved anything close to Bitcoin’s level of success. Litecoin is perhaps the most prominent out of all the alternatives, rumor has it that Litecoin will be tradable on Mt.Gox soon but so far the overwhelming majority of merchants – and merchant platforms, for that matter – have seen no reason to pay attention to them. Now, that may finally change with decentralized cryptocurrency’s new kid on the block: Ripple.

The Ripple project is actually older than Bitcoin itself. The original implementation was created by Ryan Fugger in 2004, the intent being to create a monetary system that was decentralized and could effectively empower individuals and communities to create their own money. All money in Ripple is explicitly represented as debt, with transactions simply consisting of balances being shifted on a series of imaginary credit lines from the payer to the receiver. In order to explain how this works in practice, consider a simple example:

Normally, if your friend Alice owed you $10, she would have to pay you back before you could make any use of that debt. If you were creative, however, you might be able to pass the debt on to someone else who knew and trusted Alice, in exchange for something you wanted. For example, you might be able to get a book you want from Bob, who also knows Alice, in exchange for letting Alice know that she now owes Bob $10. Instead of money, you used Alice’s IOU to pay Bob. Alice acts as an intermediary between you and Bob.

Ripple does the same thing, only it takes the idea one step further. What happens if you want to get a haircut from Carol, who doesn’t know Alice at all? Your $10 IOU from Alice isn’t useful because Carol being owed money by Alice doesn’t mean anything to Carol. But suppose you had a way to find out that Bob, who knows Alice, also knows Carol. You could talk to Bob and arrange for him to take Alice’s IOU in exchange for giving his own IOU for $10 to Carol. Since Alice owes him exactly what he owes Carol, Bob is even on the deal. Both Alice and Bob act as intermediaries between you and Carol.

And that’s how it works, Ripple turns simple obligation between friends in to money. You create a profile on the system and indicate who you know and how much you trust them by connecting to people by email address and giving them credit limits. Then whenever you want to make a payment to another Ripple user using only friendly obligations, the system finds a chain of intermediaries connecting you to the person you want to pay, and records the payment in each intermediary’s account all the way down the chain. You end up owing one of your “neighbors” on the system, and the payment recipient ends up being owed by one of her neighbors.

Ripple: Solving the Shortcoming of Bitcoin

Bitcoin is clearly not an effective store of wealth — just look at how quickly that wealth can be evaporated with the recent market crash/correction. Neither is it a useful payments mechanism, given how fast its value can fluctuate. Currently, it can take an hour for a bitcoin transaction to clear, which means that the value of the transaction when it clears can be radically different from its value at inception. Bitcoin only works for payments if you can be reasonably sure that its value will remain reasonably steady for at least the next hour or so.

Seeing the problems and prospects of Bitcoin, a company named OpenCoin started developing the Ripple protocol. Ripple is a distributed open source payments system and its native math-based virtual currency is called ripples (XRP). Ripple enables free payments to merchants, consumers and developers; the ability to pay in any currency; no chargebacks; and instant global payments. Ripple can accommodate any currency, including dollars, yen, euros, and even bitcoin, making it the world’s first distributed currency exchange.

logo_medialogOpenCoin is led by financial technology pioneer Chris Larsen (E-LOAN, Prosper) and veteran developer Jed McCaleb (eDonkey, Bitcoin Exchange Mt. Gox) along with a team of well-known developers, advisors and investors behind some of the world’s leading technology companies. Ripple, the first cryptocurrency that truly has a shot at competing with Bitcoin. Up until this point, all other decentralized digital currencies which tried to compete were essentially cheap knockoffs of Bitcoin. Ripple is the first true innovation in decentralized cryptocurrencies since Satoshi Nakamoto released Bitcoin.

Ripple has no blockchain, no mining, and no hard limit on number of transactions per second. Because of this, its transactions can be completely confirmed within seconds rather than hours. Since there is no mining, there is no 51% attack, which in Bitcoin allows someone who invests enough money to either double spend or shut down the entire network. It also makes Ripple a “greener” cryptocurrency as no “pointless” computation has to go into confirming its transactions.

Ripple’s major disadvantage to bitcoin is that it starts out with 100% of Ripple Credits (XRP or ripples) being completely controlled by their originator, a corporation, OpenCoin Inc. In contrast, bitcoins started out not existing at all, but came into existence via mining, a process open to anyone who was so inclined to participate. OpenCoin will over the course of a few years attempt to distribute 80% of all XRP in as fair a way as possible. Whereas most bitcoins were mined by a small amount of individuals early on (for a price much much cheaper than today’s), OpenCoin wants to distribute ripples in a more even fashion between a much larger number of people. So some will say Ripple is more fair because of this, while others will say it’s less fair because a single organization is handling the process rather than a free market mechanism. Other than the distribution mechanism XRP is just the same as BTC, it’s a fixed supply currency enforced by every peer, and once you have them, they are yours. There is no counterparty risk and they will be yours until you choose to send them on to someone else. Ripple’s other obvious disadvantage is that it’s much more alpha than Bitcoin. While Bitcoin is still a very alpha technology as well, it has stood up quite well thus far. It will be years before Ripple can truly claim to be an invulnerable payment processing network.

But none of this matters, Bitcoin and Ripple were made for each other. Ripple is how Bitcoin will scale, in both a technological sense as well as in adoption. Bitcoin has a hard limit on the number and size of transactions it can process per second. While there is much debate in the Bitcoin community about lifting this limit, doing so would be equivalent to creating an entirely new Bitcoin network and migrating everyone onto it. Not an easy task to say the least. Ripple’s two biggest achievements are solving the double spend problem without a blockchain and inventing a decentralized way to send and exchange non Ripple currencies over its network. The latter enables two things which will truly allow Bitcoin to flourish: 1) Most Bitcoin transactions can be done through the Ripple network, only to be settled on the blockchain when absolutely necessary. 2) True decentralized Bitcoin exchanges will now be possible via trading on the Ripple network.

Easy to understand is one of the things Ripple is not.

The first thing to understand is that the Ripple network will have many gateways that will hold the actual currency which is being transacted over Ripple. Anyone can start their own gateway and hold other people’s currencies. So let’s say there are two gateways, gateway A and gateway B. You trust gateway A with your BTC and the merchant you want to pay trusts gateway B with their BTC. This means there are effectively two types of BTC on the Ripple network: BTC/A and BTC/B. Even though they both represent BTC they aren’t equivalent. Since the merchant doesn’t trust gateway A he can’t do anything with BTC/A. This is where the exchange comes in. There are market makers on the Ripple network who will convert to and from any currency pair. So let’s assume someone has an open trade of 1 BTC/A for 1 BTC/B. When you try to send 1 BTC to the merchant, Ripple will see that you have BTC/A, he wants BTC/B, and that a trade between them exist. All in one go it will deduct the BTC from your account, execute the order, converting the BTC/A into BTC/B, and credit it into the merchant’s account. Now the merchant can either hold on to the BTC in the Ripple network or send it to his gateway (gateway B) and withdraw the “real” BTC from them onto the Bitcoin blockchain.

The awesome thing about the above process is that it works for any currency, not just BTC. You can do the exact same thing with dollars, effectively allowing you to transact USD privately outside of the traditional banking system. As stated above you can also convert between USD and any other currency of your choice in a totally decentralized fashion. This opens up a world of possibilities.

Ripple will be much easier to use than Bitcoin, says Chris Larsen, a serial entrepreneur from Silicon Valley and co-founder of OpenCoin, the start-up behind Ripple. Transactions are approved (or not) in a few seconds, compared with the ten minutes a typical Bitcoin trade takes to be confirmed. OpenCoin is expected to start handing out Ripples to the public in May. It has created 100 billion, a number it promises never to increase. To give the new currency momentum, OpenCoin plans eventually to give away 75% of the supply. Anyone opening an OpenCoin account will receive five Ripples; existing Bitcoin users will get more. The 25% retained by OpenCoin will give it a huge incentive to make sure that the Ripple is strong: the higher its value, the bigger the reward for investors. source

The promise of Ripple

It’s very early days yet, but Ripple already has clear advantages over bitcoin, and if various merchants and developers start to converge on the Ripple ecosystem — which, like bitcoin, is all open-source — then I think it could genuinely become the first real way for anybody in the world to pay anybody else in the world, immediately and about as frictionlessly as possible.

Ripple was founded by geeks, as a result, right now it has a bit too much functionality with too little ease of use. It supports an effectively infinite number of different currencies, for instance, including bitcoin; and although it’s easier to use than bitcoin, it’s still not particularly user-friendly. But that will come, with time — and in fact I would be happier if the people developing the easy-to-use front ends for Ripple were not OpenCoin. OpenCoin is a for-profit company, which will make good money if Ripple takes off; but it’s very important that a lot of the rest of the Ripple ecosystem not be built by OpenCoin: so long as OpenCoin is the only company to really buy into Ripple, the whole scheme will go nowhere.

Ripple feels like bitcoin in many ways. Users are anonymous (or, technically, pseudonymous), for instance: if you want to send me money via Ripple, right now you have to pay rpU1neb5evF3Dk9CbPahxHoxkXRuiuYC3S rather than just my email address. It’s all open-source, too: OpenCoin has no privileged access to the way in which people pay each other. The fees are de minimis, just enough to prevent DDoS attacks and the like. There’s even a built-in crypto-currency, the Ripple, with a fixed money supply. But the great thing about the Ripple system is that individuals don’t have to pay each other in Ripples. Instead, they can pay each other in pretty much any currency in the world: Ripples, yes, or dollars, or yen, or euros, or even bitcoins.

Here, for instance, is a screenshot of a Ripple wallet: it shows, 3,052 Ripples, 13 dollars, and 0.0284 bitcoins. If the owner, Felix, wanted to send a payment in any one of those three currencies, he can do so pretty much cost-free; if he want to send a payment in some other currency, then the system will select for him the best exchange rate, based on various companies which are offering currency-conversion services on the Ripple platform. Any time you deal in currencies other than Ripples — which, in practice, is going to be all of the time — you have to go through “gateways” to the Ripple system. Eventually, those gateways could be PayPal, or Citibank, or Western Union, but that might take a while; for the time being, they’re smaller institutions, and you probably don’t want to be moving large amounts of money through them.

Everybody using a Ripple account will have some Ripples in their account, just to get them on the system, and there will always be people making a market, converting Ripples to real currency and back again. The good news, however, is that Ripples are not (fingers crossed) going to become speculative investment vehicles, in the way that bitcoins are. That’s because all the Ripples in existence — 100 billion of them — have already been created, and, to a first approximation, they’re all owned by OpenCoin, which is essentially the central bank of the Ripple economy. OpenCoin is going to be giving away billions of Ripples for free, to anybody opening an account, just to get the system seeded and get people transacting with each other. There’s little reason to hoard a few thousand Ripples if there are 100 billion of them just waiting to flood the market at any time.

It’s in OpenCoin’s interest, then, to carefully calibrate the rate at which it’s introducing Ripples into the active money supply, and to keep the value of a Ripple relatively stable. Right now, there are about 750 Ripples to the dollar, which means that theoretically OpenCoin’s 100 billion Ripples are worth something over $100 million. OpenCoin is going to want to see that number rise, slowly, as Ripple becomes more popular — but it doesn’t want to encourage hoarding: quite the opposite. It wants as many transactions to happen over its network as possible, so that it can really become, in Larsen’s words, “http for money”.

Given the Andreessen Horowitz connection, and a lot of shared interests between the two companies, the first place I’ll be looking for third-party ratification of the Ripple idea is the hot payments startup Stripe. I’ve had long conversations with Stripe CEO Patrick Collison about bitcoin and international payments and frictionlessness, and in theory there’s no reason why he shouldn’t build a pay-with-Ripple option into Stripe alongside its more conventional credit-card and debit-card payments.

As with all such things, there’s a first-mover problem here: there’s no point in building Ripple-based infrastructure if no one is using Ripple, and no one’s going to use Ripple if there isn’t any infrastructure. OpenCoin’s solution to the problem, which I like a lot, is to simply give away billions of Ripples for free, all of which are worth real money, thereby giving people an incentive to use it. I hope it works, and I hope that the number of gateways into the system will soon expand from the current list of relatively obscure sites like Bitstamp. Ripple hasn’t succeeded yet. But at least it has a genuine hope of doing so.

About these ads

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s