With all the recent hype surrounding Ripple, I thought it would be timely to re-examine the cryptocurrency that’s since pipped Ethereum to be the world’s second largest cryptocurrency by market cap. Our firm has been studying and analyzing Ripple for the better part of its lifespan. In this piece, I will examine some of the challenges facing Ripple, its potential for future expansion and try to sieve out the wheat from the chaff when it comes to the world’s second largest cryptocurrency after Bitcoin.
Every day, companies and consumers send over US$76 billion in payments through a dizzying array of banks and financial intermediaries. From correspondent banks to issuing banks, the financial services which support payment flows are a vast web of nodes and networks, each demanding their own slice of the action as money flows through the veins of global commerce. Without this flow, dockworkers don’t get paid and cargoes don’t get loaded — the letters of credit (instrumental to global commerce — because nobody trusts anyone) which are key to trade flows have ensured that our modern way of life as we know it gets done. Yet for the better part of a decade, Ripple, a San Francisco-based company claimed to one-up this inefficient and sometimes archaic system by leveraging the blockchain technology underpinning Bitcoin to create what it called the “internet of value.” Ripple, in the cryptosphere is a veritable institution in that sense. It has survived numerous cryptocurrency routs and is just slightly younger than Bitcoin itself and far older than Ethereum. From late Fall last year to early January this year, Ripple saw an eye-watering 1,300% jump in the value of its digital token, with many hopping aboard the Ripple train on the basis that unlike other cryptocurrencies, Ripple had a narrowly defined purpose and a clear utility — to help banks move cash from one point to another faster and more cheaply — particularly across borders.
But as anyone who has worked with banks will attest, the pace of change within these institutional behemoths is glacial (in fact thanks to climate change glaciers are likely to change faster these days). According to one senior executive at a large multinational bank who declined to be named,
Representatives from the company (Ripple) came by earlier in the year and while their technology and value proposition was good, we did not get the go ahead for adoption from legal. We did agree to a trial.
But that detail didn’t stop Ripple from subsequently announcing a partnership with the said bank at the time, one which they had to step back from subsequently. Part of the reason for the reluctance for banks to accept Ripple is ironically trust. The blockchain was meant to create a “trustless” ecosystem that would negate the requirement for trusted intermediaries to facilitate transactions. But current and former executives at several global banks, some of which agreed to partner with Ripple to trial the cryptocurrency say that there is little chance they would ever entrust their corporate clients’ payments to a privately-held cryptocurrency. According to Ripple’s website, in January this year, the company held 61 billion of 100 billion available Ripple tokens, with most held in escrow so as not to be sold in excessively large amounts which would tank the value of Ripple. If one of the main arguments against fiat currencies is central bank manipulation, the same argument can be used against Ripple as well. Quite apart from creating a “trustless” ecosystem — the raison d’être of the blockchain — Ripple merely substitutes several trusted intermediaries with a single one — itself.
Then there’s RippleNet, which is targeted at the Brussels-based Society for Worldwide Interbank Financial Telecommunication — better known as SWIFT — a messaging system used for the control of money flows across the planet. SWIFT was famously hacked (several times) and today connects around 11,000 financial companies. RippleNet doesn’t need Ripple’s digital token XRP to work, but it was hoped that XRP would become a key ingredient in the mix. For instance as an intermediary currency akin to the dollar. Today if you want to convert Afghan afghanis to South Korean won, you’d first need to swap out to dollars — the idea being that XRP could serve as that bridge. The value proposition was that instead of tying up money in various different currencies in accounts at other banks, with the attendant hassles and expense, XRP could do the job. But that sort of also misses the point. Now instead of a disparate bunch of currencies (which may or may not have value), banks would essentially be centralizing their currency risk by holding deposits of XRP. But at least the technology underpinning RippleNet seems to be sound (for now). More than a handful of banks have signed up to the network and Ripple has even managed to sell equity stakes in itself to Standard Chartered and Banco Santander. But of the over 100 banks which have signed up, only Swedish bank Skandinaviska Enskilda Banken is moving commercial payments over to RippleNet. Over a year ago, Standard Chartered started a program to allow payments between Singapore (a fintech hub) and India using RippleNet for its corporate clients and Banco Santander’s U.K. division tested an international payment using Ripple’s technology which allowed an international money transfer to be executed in mere seconds. Although neither bank has indicated they will use XRP anytime soon, they remain optimistic about Ripple’s technology and understandably so as they have directly invested in it as well.
But Ripple is far from alone in its innovation. Other companies such as TransferWise are also tackling the issue of global payment networks as is SWIFT itself, which despite the hackings, released its own major upgrade called Global Payments Innovation or GPI which allows corporate clients to make payments in hours as opposed to days and to track the money flows the same way DHL would track a parcel. Add to that SWIFT is already a trusted network used by banks and approved by compliance departments and Ripple has its work cut out for it. GPI already has 36 banks using it to make over US$1 billion in cross-border payments and while Ripple may argue that SWIFT is merely trying to speed up an already slow system, at the very minimum, hours versus minutes starts to matter very little when a ship travels less than 50 miles an hour anyway. Efficiency arguments work — to a point. The reality is that while it may be preferable to have instant cross-border money transfers, there are plenty of counter-examples when you may either not require that level of urgency or perhaps not desire that level of efficiency.
And even if plucky bankers were willing to roll the dice on Ripple, their compliance departments were there to stop the roll. Because Ripple has yet to be approved by regulators (who move at an even more glacial pace) bank compliance departments could never allow them to risk cross-border payments using the digital stuff. And approval is unlikely to be forthcoming for a variety of reasons, chief among which is that approval would be a tacit endorsement of Ripple’s business model and could potentially be perceived as as government-sanctioned currency — something a central bank or regulator would be hard put to do — especially for a private company. Though that’s not to say it’s not been done before. During the Great Financial Crisis of 2008, the government stood behind private companies and stumped up for their debts to preserve the integrity of the entire financial system. But those were dire circumstances, Ripple’s argument is far weaker in comparison. Efficiency is hardly a pressing need.
Finally, there is the age-old (or at least as old as the cryptocurrency industry) problem with the inherent volatility of cryptocurrencies. In January this year, Ripple’s XRP was worth about US$2.92, today it’s worth US$0.35 — hardly the stuff of stability and a far cry from its intended use as a replacement for the dollar for facilitating transactions. And it adds an unnecessary layer of headaches for both compliance departments as well as bankers. That Ripple is the world’s second largest cryptocurrency today by market cap is more a testament to its value as a speculative investment tool, rather than as a serious contender to existing global money network solutions.
And it is in trying to be all things to all people that perhaps is where Ripple’s greatest challenge lies. It is at once both payment network and cryptocurrency, regardless of the internal divorce, the two will be closely associated from an external optics perspective and depending on the state of cryptocurrencies and their legal status, will no doubt weigh on potential adopters considerations. In terms of technology, banks and other financial institutions are already exploring blockchain-driven solutions which do not require a native cryptocurrency. Countries from China to Uruguay are toying with the idea of central bank-issued digital currencies, which would effectively negate the value of a privately held cryptocurrency to facilitate transfers. And finally, Ripple misses the point of decentralization. With its outsize holding of its own digital token, XRP, banks would be derelict in their duty of care to their clients to concentrate risk within a single point of failure. Decentralization itself is a benefit, not a feature. And if the only value to be had from adopting Ripple is re-centralization and efficiency, then the efficiency benefits pale in comparison to the increased risks undertaken.