Ripple (XRP) Explained: What Is It and How Does It Work?

The existing banking system relies on traditional finance methods, which are often slow, complicated, and expensive. These processes provide the basic framework for transactions for both businesses and individuals. However, the need for innovation is increasingly important. To address this shortcoming, banking institutions are exploring blockchain technology, a faster and more reliable solution. However, most traditional banks are reluctant to adopt the most popular blockchains, such as Bitcoin, due to its decentralized nature. Banks desire more control over their systems than these platforms offer. This is where Ripple comes in. Ripple aims to enhance banking efficiency using blockchain technology while allowing institutions to retain sufficient control over transactions. In this article, we will delve deeper into what Ripple (XRP) is, how it can change global finance, and how it functions. Let’s take a look:

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What Is Ripple (XRP)?

Ripple is a decentralized platform that facilitates the transfer of digital and fiat currencies across international borders in real-time without intermediaries. Ripple is renowned for its digital payment protocol and its native cryptocurrency, XRP.

Ripple Labs developed and promoted the platform, which has two main components: RippleNet and XRP Ledger (XRPL). RippleNet is a network of financial institutions that use Ripple’s technology to enable cross-border transactions. XRP Ledger is a decentralized, open-source blockchain that processes and verifies transactions on the network. XRP, the ledger’s native currency, acts as a bridge currency to increase the speed and reduce the cost of cross-border transactions. Using XRP as a mediator currency eliminates the need for pre-funded accounts, enabling more efficient transactions than traditional financial institutions.

Key Takeaways

• Ripple (XRP) enables quick and low-cost cross-border payments by leveraging its blockchain and native cryptocurrency.
• Ripple’s unique consensus mechanism and trusted validators enhance transaction efficiency compared to traditional blockchains.
• Centralization in Ripple allows for easier transaction adjustments and upgrades, though it sparks decentralization debates.
• Despite facing legal challenges, Ripple shows promise in revolutionizing the global financial system.

How Does Ripple (XRP) Work?

XRP represents an innovative approach to blockchain technology and financial services. Let’s take a closer look at how it functions:

Consensus Algorithm

Unlike many other blockchain networks that use proof-of-work or proof-of-stake, Ripple utilizes an alternative consensus algorithm. Transactions on the Ripple network are validated by a group of trusted validators rather than through mining or staking. These validators reach a consensus on the order and validity of transactions.

Token Issuance

Ripple holds a significant portion of the 100 billion pre-mined XRP tokens in escrow. A small amount of XRP is periodically released to the market to fund network operations and promote liquidity. XRP serves as a liquidity provider in the Ripple network. When two parties want to transact across different fiat currencies, XRP acts as an intermediary, allowing funds to be transferred quickly and efficiently. For instance, if someone wants to send US Dollars to a recipient in Japan who wants to receive Japanese yen, XRP can be used as a bridge currency to facilitate the exchange.

Speed and Cost

Ripple’s design aims to provide cross-border transactions quickly and affordably. The consensus algorithm enables transactions to be settled in seconds, and the use of XRP as a bridge currency reduces transaction costs compared to traditional banking methods. Users must establish trust lines with gateways on the Ripple network to hold and transact XRP.

Trust Lines

Trust lines allow participants to exchange value within the network while maintaining the system’s integrity. Ripple’s network and the XRP ledger are considered more centralized compared to other cryptocurrencies like Bitcoin or Ethereum because Ripple provides a preferred list of validators. This centralization has been a point of controversy and debate within the crypto community.

The Problem Ripple (XRP) Solves

To comprehend why Ripple is important for traditional financial institutions, one must understand the problem the network aims to solve. When users make a cross-border transaction, the funds don’t directly go from their bank to the recipient’s bank. Instead, the transaction goes through several intermediary banks before reaching the destination address. These banks communicate all necessary information and instructions via the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network.

SWIFT’s Shortcomings

SWIFT transactions take days or even weeks because the intermediary banks operate in different time zones and have their own systems and processes. Additionally, the transactions often involve the exchange of currencies in foreign exchange markets, complicating and delaying the process. Each intermediary bank also takes a processing fee, making the transaction more costly.

Ripple’s Solution

Ripple aims to replace SWIFT with a global blockchain ledger system. Ripple offers a superior alternative to SWIFT as it can handle up to 1,500 transactions per second (TPS) and takes only 3-5 seconds to settle a transaction. This efficiency is a significant improvement compared to the usual three days to a week international bank transactions take.

The XRP Token

XRP is Ripple’s native cryptocurrency that runs on the XRP Ledger. Users can buy XRP as an investment, as a crypto to exchange for other cryptocurrencies, or as a way to finance transactions on the Ripple network.

XRP’s blockchain operates differently than most other cryptos. Other cryptocurrencies open their transaction ledgers and verification processes to anyone who can solve complex equations quickly. However, transactions are secure as the majority of ledger holders must agree with the verification before they can be added. XRP’s Ripple network centralizes things slightly and uses a consensus protocol. While anyone can download its validation software, it maintains unique node lists that users can select to verify their transactions based on which participants they think are least likely to defraud them.

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XRP Tokenomics

XRP operates with a fixed supply of 100 billion tokens, distinguishing it as a pre-mined cryptocurrency with no possibility of additional token creation. Despite this predetermined limit, the tokens were not all introduced into circulation simultaneously; only a fraction is actively traded on various exchanges. Additionally, 20 billion tokens went to the founders.

The distribution strategy involves 55 smart contracts, each containing 1 billion XRP tokens. These contracts systematically release 1 billion tokens into the market on a monthly basis, spanning a total period of 55 months. Consequently, the circulating supply experiences a monthly increment of 1 billion tokens. At present, the circulating supply stands at approximately 55.9 billion tokens, while the remaining tokens are securely held in escrow.

Benefits of Ripple (XRP)

Ripple boasts numerous benefits for its users, including:

Flexibility in Transactions

RippleNet’s fewer nodes make transactions more flexible. For example, if there is a mistake in a transaction, RippleNet’s nodes can easily edit it. This flexibility is a significant advantage for banks, which may need to change transactions to catch a criminal or fix a mistake. Ripple’s fewer nodes make the blockchain more editable, which can be a huge benefit.

Speed

Ripple’s use of a Unique Node List (UNL) mechanism means that it is significantly faster than today’s most popular blockchains. A single transaction on the Bitcoin network can take anywhere from a few seconds to an hour, which is inefficient for the banking system. Ripple’s UNL mechanism increases transaction speed, with a single transaction typically executing in less than four seconds.

Scalability

Ripple can handle a massive number of transactions at one time. It can manage up to 1,500 transactions per second, comparable to VISA’s 1,700 transactions per second. This capability is significantly faster than other blockchain networks, such as Ethereum, which can only process 30 transactions per second.

Drawbacks of Ripple (XRP)

While Ripple has many advantages, there are also key risks to consider.

Centralization

Ripple is more centralized than today’s most popular blockchains. It operates using a more permission-based blockchain model. In the most decentralized networks, any participant can become a validator. However, Ripple works differently. Only validators recommended by Ripple via its UNL will verify transactions. While this centralization makes the chain easier to organize and implement upgrades, it also raises concerns about control.

Influence on XRP Price

The allocation of XRP also contributes to centralization. Since the Ripple Foundation owns most of the supply, it can influence the token’s price. This means that if a problem occurs, Ripple can change a transaction. However, it also means that if the CEO goes rogue or a hacker gains control of Ripple, it could wreak havoc on the network.

Validator Collusion

Ripple’s fewer nodes theoretically make it easier for validators to collude than on most networks. Colluding validators could disrupt the consensus process and undermine the network’s integrity, potentially putting funds at risk. To combat this, Ripple verifies all of its validators and evaluates their performance based on various metrics. It then displays all the details on their Validator Registry page, allowing users to select a list of trusted validators to be part of their UNL and conduct transactions securely.

The SEC’s Lawsuit Against Ripple

On December 20, 2023, the SEC alleged that Ripple had violated securities laws with its initial coin offering and subsequent exchange sales of the XRP token. The SEC based this violation on its interpretation of the Howey test for digital assets.

Ripple immediately defended its actions by filing a Wells Submission with the SEC. Ripple also asked on multiple occasions for the SEC’s charges to be dismissed. On July 13, a federal judge ruled in response to Ripple’s motion for summary judgment that Ripple’s XRP offerings were not investment contracts, which was considered a loss for the SEC. However, the judge also ruled that the initial sale of XRP violated federal securities laws, an issue that will be decided in court later. The ruling was seen as a win by crypto enthusiasts, and the price of XRP jumped more than 95% on the news.

Conclusion

Ripple (XRP) presents a unique approach to blockchain technology aimed at improving the efficiency of cross-border transactions. By addressing the limitations of traditional banking systems and offering faster, more affordable transactions, Ripple has positioned itself as a valuable tool for financial institutions. However, its centralization and control by Ripple Labs have sparked debate within the crypto community. Despite these controversies, Ripple’s potential to revolutionize the financial sector remains significant, making it one of the top crypto projects to watch in years to come.

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