This year, Bitcoin and digital currencies have been an increasingly popular topic of interest in the financial and tech communities. A broader segment of the world population is beginning to understand the value of virtual currencies (or at least trying to), which has been reflected in higher bitcoin prices. The bitcoin economy is growing quickly, likely faster than any other economy has grown ever before it. However, on the cusp of this cycle are other financial technologies that we see as being equally interesting in their ability to improve the world’s financial markets. One of the more near-term technologies being talked about is Ripple and its embedded virtual currency, XRP. As traders reflect on Bitcoin’s future, we thought it would be interesting to analyze how it compares to other potentially competing virtual currencies. After 30+ hours of research and numerous meetings on the topic, we finally feel we have a strong understanding of Ripple and its place in the financial world versus Bitcoin.
What Is Ripple?
If you’re hearing about Ripple for the first time, Bitcoin Magazine has a great introductory article on it here.
Let’s be honest: trying to understand Ripple is confusing as heck. Is it a currency or a payment network? Why do we need Ripple when we have Bitcoin? Explanations by Ripple’s creators have generally seemed convoluted and have not bred confidence that the Ripple network is something truly needed by society (as opposed to being a scheme to capitalize on Bitcoin’s popularity). Many have pointed out various questionable features of Ripple, including but not limited to:
- What does XRP do and why it is even necessary when we have Bitcoin?
- Why shouldn’t we be concerned that Ripple’s creators kept 20% of the XRPs created for themselves?
- Why is the Ripple system, which is built off of debt-based “IOUs,” desirable?
- Why does the way in which Ripple is being presented just sound evil in general?
These were hard questions for us to get past, but ultimately we did. And now that we have a firm grasp on the topic, we believe Ripple is actually something to be very excited about. If you’re still feeling uncertain about it, we think “misterbigg” from the Bitcointalk forums explains the progression of emotions toward understanding Ripple best:
- Denial: “This can’t possibly work. Who needs it when we have Bitcoin?”
- Anger: “These guys gave themselves all the coins! This is another pre-mine / Ponzi scam.”
- Acceptance: “Ripple solves important problems, and is well designed.”
In the end, we see Ripple and Bitcoin both being valuable, separately, for different end markets. We see Bitcoin as being a better private currency, primarily used by the wealthy around the world to securely store wealth and buy yachts and homes (okay, maybe more than that). For Ripple, one must separate the Ripple protocol from the XRP currency, and we see XRP as becoming a highly used digital currency for everyday transactions and money transfers. Bitcoin will be a commonly known term, and XRP will be used behind the scenes of transactions initiated by financial institutions.
Understanding Ripple: Getting Past the Bad PR Statements
Want to know why you don’t understand Ripple yet? 20% of the reason is because it really is that complicated. However, 80% of the reason why you don’t understand Ripple is that its creators haven’t been completely straight with how they’ve presented Ripple to the public. Our unexpected finding is that the truth is actually quite palatable and much more noble than what OpenCoin’s PR people have been communicating. Let’s begin exploring what Ripple is by saying what it’s not: Ripple is not a postage stamp!
The most important key to understanding Ripple is to first understand that Ripple is actually two things: 1) the Ripple protocol and 2) XRP.
Let’s first start with the Ripple protocol, which creates a distributed exchange network. This facet of Ripple is as world-changing as Bitcoin. Why is a distributed exchange network interesting? To understand its potential, it’s better to think of Ripple as “Kayak for currency exchange.” Ripple will compare various pathways of exchanging one currency to another and find the lowest cost option. Transactions also happen rapidly (in under 5 seconds). The pathway of any transaction is based on trust relationships between gateways, but what happens if there is no trust relationship that enables the transaction to take place, or the transaction is unreasonably expensive? Enter XRP.
Our first roadblock in understanding Ripple was understanding what XRP is. Early statements made about it indicated that it was like a “postage stamp” used to pay for transactions. After learning more about it, we realized that this was legal mumbo-jumbo and wasn’t really true. XRP is a digital currency. More interestingly, it’s a digital currency with an embedded use, which is to pay for Ripple transactions, create Ripple accounts and be a currency of last resort in the Ripple system. For transactions that have inefficient trust relationships, XRP is the currency that lubricates the Ripple system. Although Bitcoin is still a good benchmark currency within the Ripple network, XRP transfers aren’t subject to delayed settlement like Bitcoin transfers within Ripple are by nature. This makes XRP a very interesting currency from a valuation standpoint. Whereas Bitcoin has no inherent use (its demand and use is solely based on people’s interest in Bitcoin), XRP has similarities to government-backed fiat currencies. Like the obligation to pay taxes with fiat currencies, there is a basic reason why someone may need to use XRP, which is to complete Ripple transactions. This could justify XRP having a base value, making it very interesting from a trading and investment perspective.
What Ripple Is Not
While Ripple and XRP are very capable of transforming the banking and payments space, possibly more so than Bitcoin is even, they are not the be-all-end-all Bitcoin killer that many people fear. XRP, in particular, has quite a few useful properties, but it will be used for a completely different type of transaction than Bitcoin. Here are some misconceptions about XRP that we feel traders should know:
- Ripple transactions are not free, or even cheap! This is marketing spin touted by Ripple’s creators that is part of what makes Ripple so hard to understand. Yes, XRP-to-XRP transactions are almost free. But converting money from one currency to another within the Ripple system is just as expensive as any other exchange method, with gateways and other intermediaries setting prices for their services. A gateway is an exchange, and these exchanges charge fees. Ripple should create substantial price competition, but it will not remove fees altogether.
- XRP is not a great base currency for use by real people. XRP should be looked at as a value benchmark used for Ripple transactions. As the Ripple network is used by more and more gateways, XRP stands to grow in value based on its utility as a currency of last resort. However, XRP will never be easy to understand for the average person. Most people can understand the idea that “I can use bitcoins to buy things,” but it would be very difficult for them to understand what XRP is and how to transact with it. As an aside, most Bitcoin transactions should ultimately take place off-chain over the Ripple network.
- XRP is not particularly social or viral. Blame it on Bitcoin being first to market, blame it on the apprehension caused by Ripple’s creators keeping 20% of XRPs for themselves, or blame it on Ripple being a completely confusing concept altogether… XRP does not have the same social roots or potential to allow it to become a viral concept. But that’s okay! The Ripple network and XRP are destined to become a behind-the-scenes payment network that only need to be understood by a small group of people (how many people actually understand how an ACH or wire transfer works?) Lack of virality won’t hold back Ripple’s success, but it will restrict XRP’s potential of becoming a currency used by the masses.
So if Ripple is terrible at all of these things, what is it good for? The answer: any time someone mentions Bitcoin being used to disrupt the payments space, they should actually be talking about Ripple. If a given transaction involves a flow from currency A to Bitcoin to currency C, use Ripple instead. Additionally over the long run, once money is inside the Ripple network, most of it should never have to leave it. But that’s a story for another time…
Ripple’s Place in a Bitcoin World (Or Perhaps Bitcoin’s Place in a Ripple World)
Should Bitcoin believers be worried that Ripple is on its way to crush their dream currency? Absolutely not. Interest in Bitcoin will continue to grow, and separately, interest in Ripple will continue to grow. In fact, the Ripple network should help make bitcoins substantially easier to buy and sell, as well as legitimize them. Our take on it is that XRPs will primarily be held by institutions, while bitcoins will primarily be held by people. On a transactions level, XRPs will primarily be used in money transfers between institutions, while bitcoins will primarily be used to store wealth and buy things. If you’re a trader, you should be long term bullish on both.