XRP is hovering near the top of the cryptocurrency chart. Ripple, a creator of XRP, is perused as a company trying to leverage blockchain based technology to solve real world problem. However, Ripple’s blockchain technology is controversial and debatable.

Proponents of blockchain technology may argue that the true blockchain technology should possess following three main characteristics.

Decentralized governance — Network is governed by itself and there is no single authority.

Immutable ledger — Changes made to the state of network is not reversible by any means.

Transferable digital assets — Allowing assets to move freely between participants of network.

As with any other idealistic technology, blockchain technology variations may be required to solve real world problems. Ripple is building one such variation.

So, what problem is Ripple trying to solve?

Ripple is building real-time gross settlement system (RTGS) for cross border currency transactions and remittance that promises faster settlements, reduce cost and liquidity requirements.

To understand how Ripple is solving problem, we need to understand how cross border funds moves in today’s world and what are the major challenges.

Let’s take a very simple scenario. GTBank in Nigeria receives lot of remittance from customers in US. Since GTBank has no physical presence in US, it enters into an agreement with Citibank where GTBank has account opened with Citibank in US dollar. This way, US customers sending money to GTBank account holders in Nigeria will be deposited in the account that GTBank has with Citibank. Citibank would then send message via SWIFT system to GTBank. Once GTBank receives fund credit message, it will deposit corresponding amount in local currency to the local accounts of the recipients.

From GTBank’s perspective, its US dollar account with Citibank is a Nostro account. From Citibank’s perspective, it is holding a Vostro account for GTBank in US dollars. This arrangement is also called correspondent banking.

When GTBank wants to allow fund transfer out of Nigeria to US, they might chose a different correspondent bank based on various requirements and charges.

In another example of a cross-border payment, a U.S. bank is sending a payment to a Japanese bank. The U.S. bank makes RTGS transfer to a local correspondent bank. The U.S. correspondent bank holds a Nostro account with a Japanese correspondent, and provides FX for the transaction. The Japanese correspondent debits the U.S. correspondent bank’s Nostro account and credits the receiving bank through RTGS.

Paper money never moves across countries, just account entries in correspondent bank’s records gets adjusted.

Although fund transfer through correspondent banking is working fine, it has two major problems –

Too many correspondent banking arrangements — Every major bank is required to maintain Nostro account in every major country and pre-fund with local currency. Pre-funding is required to provide liquidity to remittance or fund transfer request. This fund is lying idle and is an opportunity cost to the bank. It is said that trillions of dollars are trapped under such arrangements.

Costly settlement process -Often funds moves from one country to another through chain of correspondent banking. Each bank may have different clearing and settlement process based on technology, time zone, risk management procedures, central bank regulations, reconciliation process etc. This causes uncertainty in transaction cost and settlement delay. Do you remember last time you remit the funds? When you initiate remittance, you only get approximate conversion rate and tentative time to credit your recipient’s account.

To manage their positions more efficiently, financial institutions need near real-time settlements and intraday visibility of their liquidity position on Nostro accounts to manage fund transfer cost effectively.

How Ripple is solving inefficiencies in cross border fund transfer?

Ripple believes that blockchain based consensus ledger “XRP-Ledger” can enable financial institutions to gross settle their accounts in real time. Also, XRP as a bridge currency can release large funds trapped in Nostro accounts by eliminating needs of Nostro account altogether.

Ripple has developed few products to solve some of the problems in cross border fund transfer.

RippleNet — RippleNet is a single, global network of financial institutions that send and receive payments via Ripple’s distributed technology. RippleNet is based on an agreement between Ripple and network participants, all of which utilize the same technology and adhere to a consistent set of payment rules and standards.

xCurrent — xCurrent is the global real-time gross settlement (RTGS) system that enables banks to message, clear and settle their transactions with increased speed, transparency and efficiency across RippleNet’s global footprint of banks and payment providers. Using Ripple, institutions can realize 33 percent cost savings.

xCurrent is group of several modules together, each one has a specific role to eliminate inefficiency in current payment system.

Interledger Protocol (ILP) — xCurrent system uses Interledger Protocol (ILP) that enables interoperation between different ledgers and payments networks. It is designed to comply with each bank’s risk, privacy and compliance requirements. This ledger integrates with banks current ledgers and keeps track of the credits, debits and liquidity across all parties, in real time. ILP is also referred as XRP Ledger.

— xCurrent system uses Interledger Protocol (ILP) that enables interoperation between different ledgers and payments networks. It is designed to comply with each bank’s risk, privacy and compliance requirements. This ledger integrates with banks current ledgers and keeps track of the credits, debits and liquidity across all parties, in real time. ILP is also referred as XRP Ledger. Messenger — Messenger is an API-based messaging module that seems to be trying to replace current unidirectional SWIFT protocol messages with bidirectional communication between connected RippleNet banks. It connects to beneficiary bank’s instance of messenger to send payment details and retrieve cost structure for transfer. Once the sender approves the transaction, messenger employs ILP to settle funds and notifies all parties about transaction confirmation.

— Messenger is an API-based messaging module that seems to be trying to replace current unidirectional SWIFT protocol messages with bidirectional communication between connected RippleNet banks. It connects to beneficiary bank’s instance of messenger to send payment details and retrieve cost structure for transfer. Once the sender approves the transaction, messenger employs ILP to settle funds and notifies all parties about transaction confirmation. FX Ticker — FX Ticker is the component of xCurrent that facilitates the exchange between ledgers by enabling liquidity providers to post FX rates. This component provides the exchange rate between any pair of ledgers that it is configured with. During the transaction, it coordinates transfers on ILP Ledgers for settlement, ensures the validity of an FX quote and transfers the payment amount to the beneficiary bank’s ILP Ledger.

— FX Ticker is the component of xCurrent that facilitates the exchange between ledgers by enabling liquidity providers to post FX rates. This component provides the exchange rate between any pair of ledgers that it is configured with. During the transaction, it coordinates transfers on ILP Ledgers for settlement, ensures the validity of an FX quote and transfers the payment amount to the beneficiary bank’s ILP Ledger. Validator — Validator is a component that cryptographically confirms the success or failure of a payment. It coordinates the funds movement across the ledgers of transacting parties in a way that removes all settlement risk and minimizes delays in settlement.

XRP Ledger is a subledger of each transacting bank’s general ledger. This component of xCurrent is utilized to the track the credits, debits and liquidity across the transacting parties. XRP Ledger enables transacting parties to settle funds atomically, which means the entire transaction settles instantly or not at all — no matter how many parties are involved.

Businesses like banks that wants to participate in RippleNet are called Gateways. Gateways provide a way for money and other forms of value to move in and out of the XRP Ledger. Gatways need to install xCurrent application and relevant modules to participate in RippleNet.

All assets in the XRP Ledger, except for XRP, are represented as issuances, which are digital balances that represent currency or assets of value held by an issuer. Within the XRP Ledger, counterparties can send and trade issuances without requiring intervention from the issuer. Typically, a gateway sends issuances to customers when it receives money in systems and ledgers outside the XRP Ledger, and promises to send money to customers in outside systems in exchange for being repaid in issuances in the XRP Ledger. Issuances get their value from a gateway’s agreement to honour the obligation that the issuances represent.

Real world example of issuances are your money deposited in the bank. In the books of bank, your deposit is written as an IOU (“I owe you”), it signifies an outstanding debt. You are actually lending money to bank. Fund transfer from one bank to another is just a movement of IOU in record books.

The XRP Ledger has a system of directional accounting relationships, called trust lines, to make sure that users only hold issuances from counterparties they trust. A “trust line” is link between two addresses in the XRP Ledger. A trust line represents an explicit statement of willingness to hold gateway debt obligations. This issuances can be freely traded among XRP Ledger and converted back into real world asset through issuing gateway. When two banks setup a trust line, they both will be able to send and receive issuances and XRP Ledger will keep track of issuances balance. This eliminates Nostro and Vostro account setup and maintenance.

xRapid — xRapid uses a digital asset, XRP — a native digital currency, to offer banks and payment providers a highly efficient, scalable, reliable liquidity option to service cross-border payments. This module is intended for market makers providing liquidity between XRP and any other currency. Market makers profit from bid and ask spread. Instead of holding local currency in Nostro accounts around the world, banks can now source XRP from market makers in real time and use it for cross border currency transactions. By using XRP as a bridge currency, banks will requires to allocate less total liquidity, in domestic currency only, to service the same volume of global payments.

An incentive program has been designed to stimulate XRP adoption in market making by rebating liquidity providers for quoting against XRP in the immediate term, thereby supporting spread reduction over time against a new asset.

XRP — XRP, a native digital currency, enables the transfer of value anywhere in the world in an entirely frictionless manner. Financial institutions can source XRP from market makers in exchange for fiat currency and transfer it in real time using ILP to beneficiary bank. Beneficiary bank interns may opt to exchange XRP for local currency. This entire operations is performed within few seconds eliminating volatility of XRP price and settlement risk. Since use of XRP by banks is intended for only value transfer, actual cost of XRP is not relevant. XRP being native currency of network, it eliminates counterparty risk too. Using XRP, banks can realize estimated 42% of cost saving on international fund transfers.

XRP can be freely sent and exchanged among XRP Ledger addresses without going through a gateway or liquidity provider. XRP is not tied to an accounting relationship.

There are fixed number, 100 Billion, XRP’s are created. By the end of 2017, the company had plan to put 55 billion of its XRP into escrow and will unleash up to 1 billion into the market every month to maintain liquidity, reward or rebait market maker. XRP also gets consumed and destroyed as a part of transaction process. Unlike bitcoin, there is no reward for mining as there is no mining process at all. XRP is supposed to get valued by genuine demand and supply from financial institutions as a part of cross border transactions. Financial institutions needs to pay charges in XRP to open account with RippleNet.

Issuing gateways do not need to accumulate or exchange XRP. They must only hold a small balance of XRP to send transactions through the network. The XRP equivalent of $10 USD should be enough for at least one year of transaction costs for a busy gateway.

Where is blockchain in RippleNet? What about distributed consensus and transactions immutability?

RippleNet is a blockchain like technology. It consists of many distributed servers, called nodes. Node accept and process transactions. Client applications sign and send transactions to nodes, which relay these candidate transactions throughout the network for processing. Examples of client applications include mobile and web wallets, gateways to financial institutions, and electronic trading platforms.

The nodes may be either tracking nodes or validating nodes. Tracking nodes’ primary functions include distributing transactions from clients and responding to queries about the ledger. Validating nodes perform the same functions as tracking nodes and additionally contribute to validating transactions and creating new ledger version.

While accepting transactions submitted by client applications, each tracking node uses the last validated ledger as a starting point. The accepted transactions are candidates. The nodes relay their candidate transactions to their peers, allowing the candidate transactions to propagate throughout the network. As transactions take time to propagate the nodes may not work with the same set of candidate transactions at all times. To account for this, the XRP Ledger uses a process called consensus to ensure that the same transactions are processed and validated ledgers are consistent across the peer-to-peer XRP Ledger network.

Through the consensus process, validating nodes agree on a specific subset of the candidate transactions to be considered for the next ledger. Consensus is an iterative process in which nodes relay proposals, or sets of candidate transactions. Nodes communicate and update proposals until a supermajority of peers agree on the same set of candidate transactions.

During consensus, each node evaluates proposals from a specific set of peers, called chosen validators. Chosen validators represent a subset of the network which, when taken collectively, is “trusted” not to collude in an attempt to defraud the node evaluating the proposals.

When a round of consensus completes, each node computes a new ledger by applying the candidate transactions in the consensus transaction set to the last validated ledger and advance ledger number by one.

Nodes always trust validation from chosen validators only. This enables banks to deploy and select nodes as per regulatory requirements of the country and same time allow enough decentralization to RippleNet to provide transaction safety. It also enables completion of transaction execution, consensus, and settlement within few seconds in negligible cost.

What is the future of Ripple and XRP?

Ripple as a company has uphill battle to win against established financial industry norms and complicated processes. Ripple definitely has found a problem worth solving and banks across the world are experimenting with Ripple technology. However, Ripples success is depend on network effect that they can create only by on-board large banks around the world in short span of time.

XRP as a currency is designed for RippleNet to function efficiently. As of now, general public has no utility of XRP. One can hold and trade XRP for pure financial gains only.

xCurrent product of Ripple has better chances to succeed as it is trying to help banks to settle transactions faster, cheaper, and within regulatory framework. However, XRapid and XRP itself may not succeed and may become totally redundant in future. For XRP, displacing world’s fiat currency is no small feat to achieve. Political adaption of XRP as global currency is bigger challenge than adaption by financial institutions.

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