Viewpoint: How the Ripple Protocol Could Change Payments

By Gina Knight, Hyperwallet

There was a lot of buzz around an innovative payments protocol named “Ripple” at NACHA’s recent Payments 2015 event in New Orleans. Now, unless you’re a mathematician or a bitcoin fan, trying to understand what Ripple is—and why it’s so revolutionary—requires a bit of research (not to mention a double espresso!). That being said, here at Hyperwallet, we definitely think this new technology is worth investigating. In fact, I’d wager a bet that, within just a few years, Ripple could become as important to the world of payments as the Internet is to the world of information today.

What Is the Ripple Protocol?

The Ripple Protocol is an open payments infrastructure created by San Francisco-based Ripple Labs. It was conceived for the real-time clearing, netting and settlement of all sorts of financial transactions denominated in any currency. Furthermore, the protocol uses a distributed, open-source, consensus ledger and a digital currency called ripples (XRP).

The Trust Factor

With Ripple, users send payments by using cryptographically signed transactions denominated in either real-world currencies, such as U.S. dollars and euros, or in Ripple’s XRP digital currency. For XRP-denominated transactions, Ripple makes use of its internal ledger. For payments denominated in all other currencies, the Ripple ledger only records the amounts owed by one user to another.

Since Ripple only keeps the records in its ledger and has no real-world enforcement power, this requires trust. Users have to specify which other users they trust, to what maximum amount, and in which currency.

Now, things get really interesting when Ripple tries to send payments between users that don’t yet have an established trust relationship. Rather than denying the payment, Ripple takes a six-degrees-of-Kevin-Bacon approach and sends the payment through a trusted path of associates; a process known as rippling. All balances along the path are then adjusted simultaneously and automatically.

Here’s an example. Let’s say that John trusts Mary, Mary trusts Joe, and Joe trusts Jessica. Each party only trusts one other party in the link. Now let’s say that John needs to pay Jessica. They have no direct relationship, but they are able to “ripple” the payment by using the existing trust relationships and balances of Mary and Joe to execute the transaction. It’s the “friend of a friend” approach.

By integrating their shared settlement ledger with a funds exchange mechanism, Ripple is capable of facilitating real-time continuous payments, while simultaneously providing a competitive marketplace for liquidity and foreign exchange. The XRP currency is a nice-to-have add-on to assist with real-world currency conversion and to prevent misuse of the network.

The Current Cross-Border Payment Situation

Some (ahem) mature readers out there might remember the early days of the Internet, back when an AOL user was prohibited from sending an e-mail to a CompuServe user. Back then, separate e-mail systems couldn’t connect and communicate with one another in real time. Simple Mail Transfer Protocol (SMTP) helped solve this issue in the late 1980s through the use of a simple TCP/IP protocol (line-oriented telnet) and a few simple text commands. When it comes to payments, the Ripple Protocol can do the same thing, connecting senders and receivers regardless of their financial provider, currency or location.

Currently, there’s no universal system for settling cross-border interbank payments. This is because the world is missing the underlying rails (i.e., common infrastructure) necessary for this. Because of this missing link, sending money abroad is a costly, clunky, error-prone and opaque process; one that often involves multiple intermediaries. While international wires exist, they’re really only suitable for larger amounts (and even then intermediary or recipient banks are free to dictate the FX rates and restrict visibility into the payment chain). Those with lower value remittance needs are thus forced to swallow excessive fees, many averaging up to 9 to10 percent of the amount sent. In our day and age, this is an absurdly high figure. Ripple’s technology facilitates a more competitive marketplace for FX and liquidity provision, as well as speeds everything up. Not making use of it is like inserting fistfuls of coins in a payphone to make an international phone call when both parties involved could simply fire up Skype and connect for free.

Ripple’s raison d’être? To increase efficiency and transparency while simultaneously improving competition and lowering the costs of cross-border money transfers through an improved protocol. Imagine being able to track your payment at every step of the way—like a FedEx package, for example—and receiving instant confirmation that your funds have been delivered. Wouldn’t that be nice?

The Internet of Payments?

Ripple Labs has taken the best features of existing distributor ledger technologies and adapted them so as to remove many of the limitations and risks of other blockchain technologies, such as bitcoin. Significant work is being done to make the Ripple network suitable for banks and other potential processors, such as Hyperwallet, who wish to exchange value in real-world fiat currencies while remaining compliant with existing anti-money laundering (AML) and know your customer (KYC) rules. This best-of-both-worlds approach enables smaller players to make use of the network without having to redo all of their existing compliance and risk management processes and/or upgrade their legacy systems.

The most exciting features of Ripple include:

• Real-time, 24/7 availability
• A record of balances without a central counterparty (central bank), which  means no restrictions on settlement hours
• Works with any currency or asset (currency agnostic)
• Participants can maintain their unique KYC, AML and other compliance requirements
• Bilateral payments circumvent the need for intermediary banks and smaller players can participate (not just large banks)
• Instead of holding reserves with each correspondent, banks potentially could have to hold only one reserve on Ripple and be able to access all currencies and market makers using the network.
• Doesn’t replace existing networks but does increase efficiency and transparency and connects separate networks
• Designed to be a neutral settlement layer; Ripple cannot “dictate” or control usage
• No single point of failure (the network resides on a distributed collection of servers around the world)

Will it Work?

In theory, Ripple could be the holy grail of international payments. In practice, there are still some key hurdles that need to be overcome before the technology gains traction and attracts a critical mass of mainstream financial institutions and payments players. This includes the need for:

1. A clear definition of the rights and responsibilities of the network members
2. Enforceable network rules
3. General operating protocols for interaction among the various parties
4. Mechanisms to handle exception payments (rejects, returns, unauthorized transactions, etc.)
5. A dispute mediation/arbitration forum
6. A simple method to evaluate gateways and participants when establishing trust lines
7. Filters for the rippling effect to accommodate bank-grade risk management features

Luckily, rumor has it that the Ripple Labs team is working diligently with existing public and private entities to address these outstanding issues and is making significant improvements with each release.

Getting Ready for Ripple

We’re always looking for ways to improve service and expand low-cost payment options for our clients here at Hyperwallet. As such, we’re closely watching the development of Ripple and actively investigating proof-of-concept use cases for the technology—use cases that would enable us to speed up settlement times with our banks and processing partners, which, in turn, would shorten the total payment delivery time for our clients.

As more and more players experiment with the Ripple protocol and join forces, both payers and payees will benefit. Over time, Ripple could become a mechanism that payment providers, like Hyperwallet, use to expand real-time payments coverage to beneficiary bank accounts in key countries and eventually around the world.

Could Ripple be the start of the next payment wave? Only time will tell.

Gina Knight is SVP, treasury and operations, at Hyperwallet Systems Inc., a global payments company that specializes in cross-border payments for corporate clients. She can be reached at [email protected].

In Blogs & Viewpoints, prepaid and emerging payment professionals share their perspectives on the industry. Paybefore endeavors to present many points of view to offer readers new insights and information. The opinions expressed in Viewpoints are not necessarily those of Paybefore.