Ripple, a privately operated entity, aims to improve the speed and cost of financial transactions globally and its services have already successfully powered cross-border payments and remittances. In fact, many have considered it an alternative—or even competitor—to the SWIFT payment network used by traditional financial institutions since 1977. Ripple also touts the ability to offer crypto liquidity solutions to institutions and build central bank digital currencies.
Ripple’s technology primarily relies on the XRP Ledger (XRPL), an independent distributed ledger technology (DLT) that records and verifies transactions. The XRPL supports XRP as its medium of exchange, and it relies on an approved set of validators to process transactions. Unlike cryptocurrencies like Bitcoin and Ethereum, the XRPL is not reliant on either mining or staking. In fact, there is some debate about whether the XRPL constitutes “blockchain” technology, as it is built differently than most other protocols that use digital assets.
Although XRP is a digital asset not controlled by any one party, Ripple has orchestrated sales of its own holdings to fund the company’s operations. It is also a main contributor to the XRPL’s open-source development and runs some of the XRPL’s validators. This has given some the impression of centralized control of the coin and has drawn scrutiny of regulatory bodies like the Securities and Exchange Commission (SEC). In the wake of SEC’s litigation against Ripple, the company has become a standard-setting focus of the crypto community.
History of Ripple
In 2004, software developer Ryan Fugger created RipplePay, a company that allowed users to “be [their] own banker.” It began as a way to extend lines of credit to friends and family, promising that the credit would become “a fully-functional currency.” However, it was not based on any cryptocurrency at the time.
That would change in 2012, when Mt. Gox founder Jed McCaleb and businessman Chris Larsen took over RipplePay. McCaleb was working with programmers Arthur Britto and David Schwartz (now Ripple’s CTO) throughout 2011 to build a new cryptocurrency architecture like Bitcoin’s—but with faster, cheaper, and more energy-conscious transactions. McCaleb called this “Bitcoin without mining” in a May 2011 forum post.
XRP was formally launched in 2012, at which time it was called “ripples.” The company that created it went through multiple name changes (NewCoin, OpenCoin) before ultimately landing on Ripple.
However, Ripple’s success has been punctuated by legal challenges. In 2015, the company was fined $700,000 by the Financial Crimes Enforcement Network (FinCEN) of the United States for violations of the Bank Secrecy Act. In 2018, a class action lawsuit was filed against Ripple for selling its XRP in a “never-ending [initial coin offering],” and thus violating securities law. Still, these suits were only a preview of larger legal action.
The Securities and Exchange Commission (SEC) sued Ripple, its co-founder Larsen, and its CEO Bradley Garlinghouse in 2020 for $1.3 billion, alleging the sale of unregistered securities (XRP). After a protracted legal battle, a New York court ruled that the sale of XRP was a security in cases when Ripple sold the coin to institutional investors, but XRP was not a security when sold on exchanges and through trading algorithms. This partial victory excited the crypto community, as it was the first time the U.S. court system provided any guidance or clarity around cryptocurrency as a security, commodity, or otherwise.
How do Ripple and the XRP Ledger work?
Although Ripple originally created the XRP Ledger, the latter is open-source and can be used independently of the company. Therefore, it is important to explore both the company’s services and the underlying architecture that powers them.
The XRP Ledger
The XRP Ledger (XRPL) is a type of distributed ledger technology (DLT). DLTs validate and record transactions on a network, so digital assets can be stored and tracked accurately. This is especially useful for the storage and transfer of value, making it a suitable technology for the digitization of the financial world. A familiar type of DLT is the blockchain, used by protocols like Bitcoin and Ethereum.
However, the XRPL does not use a consensus mechanism (e.g. Proof of Work or Proof of Stake) to build blocks of transactions onto a digital chain. In this way, its DLT is different from other, more commonplace cryptocurrency protocols. Instead, the XRPL uses its own, novel consensus mechanism that records transactions on its decentralized ledger.
XRPL’s consensus mechanism
A networks’ consensus mechanism is necessary to ensure that proposed transactions are valid. Briefly, consensus refers to the parties on the network (called nodes or validators) agreeing on a transaction. The XRPL’s consensus algorithm works in rounds which consist of multiple steps:
- A node (or “server”) receives transactions, publicizes them, and then communicates them to the Unique Node List (UNL), which is a trusted subset of other nodes on the network.
- The nodes in the UNL then vote on the validity of transactions in that round. Those that receive the minimum number of “yes” votes are passed onto the next round.
- All transactions that receive 80% “yes” votes are finalized and applied to the ledger.
Ripple maintains a system where, as long as 80% of the UNL’s nodes are honest, fraudulent transactions cannot be validated. Further, there is an overlap of nodes across UNLs, aimed to help maintain agreement across the entire network.
Through this process, Ripple states that transactions can be processed quickly (with consensus occurring every 3-5 seconds), and with minimal use of energy and computing resources.
Ripple uses the XRPL to operate RippleNet, a peer-to-peer application that provides services such as transaction messaging and settlement. These operations are necessary for financial institutions to facilitate transfers of value. By using the XRPL and the XRP digital currency, RippleNet aims to make this process instant and cheap.
RippleNet also uses a solution called On-Demand Liquidity (ODL), which allows for improvements to payment functionality, including real-time settlement of payments and access to global methods of paying out funds. This eliminates the need for “nostro” bank accounts (which hold foreign currency for a bank in another country) for cross-border transactions.
Together, these services have attracted partnerships with institutions like MoneyGram and have also encouraged Ripple to work with governments to develop central bank digital currencies (CBDCs).
How is the XRP token used?
XRP is the currency of the XRP Ledger (XRPL) and is used to exchange value across the network.
A very small amount of XRP is also burned as part of the transaction cost to discourage spam transactions. As of August 2023, around 11.5 million XRP were burned (destroyed) through transactions on the XRP Ledger.
XRP is also used by Ripple to fund its operations. There is a maximum supply of 100 billion XRP, of which 20 billion were allocated to the company’s co-founders and the remaining 80 billion could theoretically be sold by the company to fund its operations.
However, of all XRP that will exist, only a portion is circulating on the market through these sales. This is because Ripple placed 55 billion XRP it held in an escrow account on the XRP Ledger in 2017. The company took this action due to mounting concerns about its ability to flood the market with its large XRP holdings.
The escrow system was designed to release 1 billion XRP into Ripple’s crypto holdings for use every month. Since Ripple does not use all the allocated monthly XRP, some are recycled back into escrow to be released later. Therefore, although the company has historically controlled a relatively low percentage of the circulating XRP—at least since 2017—tranches of the coin are consistently being released for its use.
- Ripple is the company that originated the XRP cryptocurrency, and its underlying distributed ledger technology (DLT) called the XRP Ledger.
- The XRP Ledger’s consensus mechanism doesn’t rely on the same principles as more familiar Proof of Work and Proof of Stake blockchain cryptocurrencies. It uses subsets of nodes with shared trust to validate transactions before finalizing them.
- XRP is used primarily as a store of value as well as a method of digital asset transfers, which includes those that facilitate cross-border payments; Ripple also uses its XRP holdings to raise funds for operating costs.