Currency on hand vs IOUs

There is growing interest in the Ripple network interest but a lot off confusion about how to use the two wallet types on the premier Ripple Gateway/Exchange GateHub.net. Much of the confusion comes from the fact that newcomers to cryptocurrency don't distinguish between money that is under their control (currency on hand) and money that is under someone else's control (an IOU).

Currency on hand is fiat that you have in your possession and that is under your complete control. This is similar to cash that you might store in a vault in your office or under the mattress in your bedroom. IOUs are promissory notes that give you the legal right to redeem that document for an equivalent amount of fiat currency upon request. This is akin to holding your money in a bank. When you deposit your money in a bank, the IOU is your account balance. When you withdraw cash from the ATM you redeem an IOU (by literally lowering your account balance) and the ATM dispenses fiat currency that you can put into your wallet, your office vault, or under your mattress. Note that the ATM/bank can for any number of reasons decide NOT to honor your IOU and deny your withdrawal (government freeze, insolvency, etc).

Hosted vs. Ripple Wallets

Hosted Wallets

We can use these concepts to distinguish between your Ripple wallet (which is similar to a personal vault to which only you have the key) and GateHub's hosted wallet which holds IOUs for you. You can see your account balance (the amount of IOUs they owe you) by logging into GateHub and opening your hosted wallet but you cannot see your GateHub hosted wallet on the Ripple network. Holding your XRP in GateHub's hosted wallet is like holding your money in a bank account. They have physical custody of your funds and have promised to give them back to you upon your request, therefore you only have XRP IOUs. They may, however, decide not honor your XRP IOUs for some of the reasons listed above. In fact, the Ripple platform allows gateways like GateHub to freeze other assets that they have issued on the network.

GateHub's hosted wallet is effectively an air-gapped cold wallet which makes it relatively secure. You cannot trade XRP using the hosted wallet (cold wallet) because it is not diretly connected to the internet. You can, however, send XRP from your hosted wallet to other GateHub.net users because it only requires an update to GateHub's internal ledger. This is why there are no trading fees, the transaction is only on the GateHub ledger but is not submitted to the Ripple network.

Ripple Wallets

Holding your money in your Ripple wallet on GateHub is similar to holding it in a vault with some exceptions. In this instance, GateHub acts as an interface to your personal vault but they do not have the ability to withdraw your funds or prevent you from withdrawing your funds. This is because only you have the secret key. If GateHub closes your account you can access your Ripple wallet through other platforms or a desktop client using your secret key. GateHub does, however, hold an encrypted version of your secret key so if they are somehow compromised a hacker may be able to steal your funds. This is one of the reasons why it is so critical to use a strong password and two-factor authentication to log in to GateHub.

You can trust other Ripple wallet holders and trade your XRP for their assets. For example XRP for USD. Note though, that XRP is a native asset of the Ripple protocol that does not exist in physical terms. When you have XRP in a Ripple wallet it is YOUR XRP. If you trade XRP for an asset like BTC or USD then you have traded your XRP for an IOU of BTC or IOU of USD, that is you are TRUSTING another entity to give you custody of the BTC or USD if you ask for it. This is why you must extend a trust line to another account if you want to trade with that account. GateHub won't do it for you, you must do your due diligence and decide whether you trust the account holder issuing the IOUs.

Destination Tags

Hopefully this makes sense and you should be able to guess why some transactions require destination tags. If you're sending XRP to your hosted wallet then you're sending XRP to GateHub's wallet and they need to know who those XRP belong to. The destination tag effectively points to the cell in their ledger that reflects your account balance. So, even though your XRP are being lumped into one wallet with everyone else's, they know how much they owe you. If you send XRP to your Ripple wallet then you're sending it to your personal address and there is no need for a destination tag.

This is just a start but post questions or point out errors that you've identified in anything I've written and I'll answer them or edit the post. Let me know if you'd like a post on another Ripple-related topic.