Ripple Definition

What Is Ripple?

Ripple is a blockchain-based digital payment network and protocol that uses its own cryptocurrency, XRP. Ripple's main focus is as a payment settlement asset exchange and remittance system, similar to the SWIFT system for international money and security transfers used by banks and financial intermediaries dealing across currencies.

The token used for the cryptocurrency is premined and uses the ticker symbol XRP. Ripple is the name of the company and the network, and XRP is the cryptocurrency token. The purpose of XRP is to serve as an intermediate mechanism of exchange between two currencies or networks—as a sort of temporary settlement layer denomination. Ripple was first released in 2012 and was co-founded by Chris Larsen and Jed McCaleb.

Understanding Ripple

Ripple operates on an open-source and peer-to-peer decentralized platform that allows for a seamless transfer of money in any form, whether it's dollars, yen, euros, or cryptocurrencies. It is a global payments network and counts major banks and financial services institutions among its customers. XRP is used to facilitate quick conversion between different currencies.

Ripple as a Digital Hawala Network

To understand how the system works, consider a money transfer structure where the two parties on either end of the transaction use their preferred intermediaries to receive the money. In effect, Ripple functions as a digital hawala service. Hawala is an informal method of transferring money, usually across borders, without any physical money actually moving.

For example, imagine Lawrence needs to send $100 to River, who lives in a different city. Lawrence sends the funds to a local agent, Kate, and provides a secret password that River must correctly answer to receive the funds in their city. Kate alerts River's agent, Asuka, of the transaction details—recipient, funds to be reimbursed, and password. If River gives Asuka the right password, Asuka gives them $100.

However, the money comes from Asuka's account, which means that Kate owes Asuka $100 (which will be settled at a later date). Asuka can either record a journal of all Kate's debt, which Kate would pay on an agreed day, or make countertransactions that would balance the debt. This multi-step transaction requires a network of trust, which Ripple bypasses using a blockchain network.

Any person or business can register and open a gateway, which authorizes the registrant to act as the intermediary for exchanging currencies, maintaining liquidity, and transferring payments on the network.

Ripple's Digital Currency XRP

Ripple's digital currency, XRP, acts as a bridge currency to other currencies. It does not discriminate between any fiat/cryptocurrency, which makes it easy for any currency to be exchanged for another. Each currency on the ecosystem has its own gateway—for example, CADBluzelle, BTCbitstamp, and USDsnapswap. If River wanted bitcoins as payment for the services rendered to Lawrence, Lawrence does not necessarily have to be in possession of any bitcoins. He can send the payment to his gateway in Canadian dollars (CAD), and River can receive bitcoins from his gateway. One gateway is not needed to initiate a complete transaction; multiple gateways can be used, forming a chain of trust rippling across the users.

Holding balances with a gateway exposes the user to counterparty risk, which is also present in the traditional banking system. If the gateway does not honor its liability, the user could lose the value of money held at that gateway. Users who don't trust a gateway can, therefore, transact with a trusted gateway that deals with the "untrusted" gateway. This way, the IOU will be transacted through a trusted or creditworthy-certified gateway.

How Ripple Works

The Ripple network does not run with a proof-of-work (PoW) system like Bitcoin or a proof-of-stake (PoS) system like Ethereum. Instead, transactions rely on a consensus protocol to validate account balances and transactions on the system. The consensus works to improve the integrity of the system by preventing double-spending.

A Ripple user that initiates a transaction with multiple gateways but attempts to send the same $100 to the gateway systems will have all but the first transaction deleted. Individual distributed nodes decide by consensus which transaction was made first. The confirmations are instant and take roughly five seconds. Because no central authority decides who can set up a node and confirm transactions, the Ripple platform is described as decentralized.

The XRP Ledger keeps track of all IOUs in a given currency for any user or gateway. IOU credits and transaction flows between wallets are publicly available on the XRP ledger. But even though financial transaction history is publicly recorded and made available on a blockchain, the data is not linked to the ID or account of any individual or business. However, the public record of all dealings (i.e., the blockchain) makes the information susceptible to de-anonymization measures.

Special Considerations

Ripple improves on some of the drawbacks attributed to traditional banks. Transactions are settled within seconds on the Ripple network (even though the platform handles millions of transactions frequently).

This is unlike banks, which could take days or weeks to complete a wire transfer. The fee to conduct transactions on Ripple is also minimal, with the minimum transaction cost required for a standard transaction set at $0.0002 XRP, compared with the hefty fees charged by banks for conducting cross-border payments.

The Bottom Line

Ripple is a decentralized blockchain designed to provide payment services that are faster than existing solutions for institutions globally using its native cryptocurrency, XRP.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read our warranty and liability disclaimer for more info. As of the date this article was written, the author does not own XRP.