Inside Ripple’s plan to make money move as fast as information

By American Banker

When Brad Garlinghouse, the CEO of Ripple, has to explain to his mother, who lives in Kansas, what his company does, he says, “Mom, it’s pretty simple. We sell software to banks.”

But it isn’t quite that simple. Most fintech startups fall into one of two camps: those that want to compete with banks and those that want to save banks from themselves. Ripple is the rare exception that wants to do both.

The San Francisco startup, which began years ago by launching a cryptocurrency but has since turned its attention to business applications for blockchain technology, can easily prove its bona fides in the second camp. The fact that 60 banks are now in the process of commercially deploying Ripple’s enterprise software—among them Santander, Royal Bank of Canada and Mitsubishi UFJ Financial Group—reflects the company’s incumbent-friendly approach.

“We’re not the disruptors, we’re not the guys who come in and tear everything down,” said Stefan Thomas, Ripple’s chief technology officer.

And yet the company’s larger vision—to build an “internet of value,” a global inter-networking system for money—would be tremendously disruptive to the status quo of international banking. In this system, monetary value could flow seamlessly from a bank ledger to a public blockchain to a mobile money system—all interoperable and working together to move money from one side of the globe to the other. In the more distant future, says Thomas, such a system could expand beyond money to any form of value whatsoever.

Ripple CEO Brad Garlinghouse.

“This is not a science experiment,” says CEO Brad Garlinghouse of Ripple’s technology. “This is real production systems moving real value,”

In other words, Ripple doesn’t just want to help banks make cross-border payments. It wants to make the world’s assets liquid. If Ripple has its way, it will do more than knock out Swift; it will have found a way to make money move like information.

Overcoming an identity crisis
Before it can conquer the world, though, Ripple will have to sort out its branding. It is practically the only blockchain startup selling enterprise software to major banks while funding development costs with its own cryptocurrency. That more serious attention has not been paid to Ripple even by many cryptocurrency enthusiasts—and that it hasn’t garnered headlines the way bitcoin and Ethereum have—may be due in part to poor nomenclature. Another reason, undoubtedly, is the series of pivots Ripple has undergone.

“They’ve had something of an identity crisis about who their customer is, and what problem they are trying to solve,” said John Light, who has consulted for startups working with Ripple’s technology.

Ripple’s initial plan was to “build a better bitcoin,” Garlinghouse said. Its leaders were prescient regarding issues with bitcoin’s software that have now come to the fore, such as its ability to process only seven transactions per second. Ripple wanted to be able to handle transaction volume on the scale of Visa.

They also decided that so-called “bitcoin maximalists” were wrong about being able to replace incumbent banks, much less government currencies, with digital cash. Rather than rail against the status quo, they decided to work with banks to improve it.

But Ripple’s cryptocurrency, XRP, hasn’t gone away, which tends to muddy the picture.

“It is confusing as hell,” admitted Miguel Vias, Ripple’s head of XRP markets.

Vias knows from experience. After being hired last December, he made a point of going to bitcoin meetups to spread the word about Ripple and XRP. People were surprised to hear that XRP was still around, he says.

Miguel Vias of Ripple

“We got 12 banks to hold a digital asset for the first time ever,” says Miguel Vias, head of XRP markets at Ripple. “I think it was a real show of faith from them.”

It takes a while to sort through Ripple’s offerings. There is the Ripple consensus ledger, a public blockchain network tied to XRP (confusingly also called Ripple). There is an enterprise software solution that has nothing to do with digital currency but which purportedly allows banks to send cross-border payments more quickly, transparently and cheaply. (To get the full benefit, though, the banks on either side of a transaction both have to be running the software.) And there is the Interledger Protocol, which works in tandem with the enterprise software and connects ledgers of different types—a private bank ledger and a public blockchain, say—for the purpose of settling payments between them.

Gradually, Ripple is incorporating this array of products and services—formerly a public-relations liability—into a singular vision.

“They’re slowly coalescing around some of these various solutions,” Light said.

‘A better Swift’
When approaching banks, Ripple leads with its enterprise software—”a better Swift,” according to Vias—along with the Interledger Protocol. Ripple executives talk a good game about how blockchain technology disrupts the “correspondent banking paradigm,” in which banks with no direct relationship rely on intermediaries in order to send payments to each other. But Ripple’s current software still depends on a global network of correspondent banks.

Rather than total disruption, what it promises are faster settlements with more transparent fees.

International banking today, said Garlinghouse, has “a speed problem, a cost problem, plus an error rate problem.” As cross-border payments ping-pong among correspondent banks—as many as five for a single payment—each one takes a piece of the action in the form of fees or currency-exchange charges. The initiating bank often doesn’t know ahead of time what the total cost of a payment will be.

International wire transfers between banks cost from $5 to more than $50, plus foreign-exchange charges of 0.25% to 3% and “landing fees” of as much as $20. And the error rate for wire transfers is between 3% and 5%, Thomas said.

Where Swift, the Society for Worldwide Interbank Financial Telecommunication, provides a one-way messaging service, Ripple provides a two-way protocol. This allows for greater transparency: Banks can exchange information and find out ahead of time what the fees and foreign-exchange rates will be, along with the expected date of delivery for the funds. If any of the information is wrong or missing, both banks will find out before the payment is sent, which should keep transfers from getting stuck in the pipes. Once the sending bank has initiated a transaction, Ripple uses the Interledger Protocol to settle the funds and notify everyone of its successful conclusion.

“This is not a science experiment,” Garlinghouse said. “This is real production systems moving real value, and we’re the only player in the industry that can say that.”

In April, Spanish bank BBVA completed a series of international money transfers between Spain and Mexico using Ripple’s distributed ledger technology. The transfers took mere seconds, BBVA said, as opposed to the four days it normally takes for such international transfers to clear. After the trial, Alicia Pertusa, the bank’s head of digital transformation in investment banking, called it “a clear demonstration of how payment processes can be vastly improved through the implementation of emerging technologies.”

This is perhaps a more diplomatic way of saying what Garlinghouse has said before, that Ripple’s technology represents a race car compared to the horse and buggy of the current system.

Naturally, Swift begs to differ. For about four decades, the nonprofit consortium has had a vise grip on international bank transfers. Swift doubts that its 11,000 members are yet ready to entrust big cross-border payments to a blockchain.

The collective recently launched a service called Global Payments Innovation to clear away some of the murk in the correspondent banking system. GPI enables banks to track a payment’s status in real time, just as consumers can check on their UPS or FedEx packages.

Banks are enthusiastic about GPI, and to some it may seem like a sufficient improvement over the old system. Since February, about 100 banks have signed up for GPI, and 12 of them have already used the service to send hundreds of thousands of cross-border payments around the world, according to Swift.

‘Nothing happens quickly in banking’
Another criticism of distributed ledgers is that they won’t catch on in the corporate world without a set of transaction rules and other standards, ala Swift, to govern activity on the network. Ripple agrees. Last September, it formed the Global Payments Steering Group, an interbank consortium of which Bank of America Merrill Lynch, Santander and Royal Bank of Canada were among the founding members. Its express purpose is to establish a clear framework of rights and obligations for banks using Ripple’s technology.

One member of the group, MUFG, says the expansion of the network is among Ripple’s biggest challenges. Ripple’s 75 customers are nothing compared to Swift’s 11,000. And it is harder for some banks to join up than others. CBW Bank, a small Kansas institution that has managed to become a fintech hub, wants to use Ripple’s technology but is still working through the compliance requirements.

“Nothing happens quickly in banking. There are tens of thousands of banks. There is no easy way that we can connect to every one of them,” said Suresh Ramamurthi, the bank’s chairman and CTO. “It takes a long time to build a global network.”

But there are signs of progress. In March, Ripple announced that a consortium of 47 Japanese banks had successfully completed a pilot with its enterprise software. Twelve more banks have since joined the consortium, and they are planning to deploy a commercial version of the blockchain solution at scale in October 2017. Ripple’s software is now touching 40% of customer banking accounts in Japan, Garlinghouse said.

Although Ripple is signing up as many banks as it can for its messaging software—its customers include the largest bank in Turkey and the national bank of Abu Dhabi—it is emphatically not trying to persuade them to entrust all of their payments to Ripple’s own ledger. To do so would lead to a “Mexican standoff,” said Thomas, because nobody wants to give up their preferred ledger.

That’s where the Interledger Protocol comes in. In May, Ripple completed a test in which the company sent ether—the native coin of the Ethereum network—to the Ripple consensus ledger; the ether was received as XRP in a Ripple wallet. It was therefore “both a cross-ledger and a cross-currency transfer,” Thomas said.

At the Blockchain Expo in Berlin recently, Ripple went even further, presenting a demo of a payment that had crossed seven different ledgers, and held a hackathon in which representatives from Ethereum, the privacy-focused cryptocurrency Zcash and other projects worked to enable Interledger Protocol payments on their ledgers.

“There isn’t going to be one ledger to rule them all,” Garlinghouse said. “It’s about how do you enable interoperability between ledgers.”

A return to cryptocurrency
One of those ledgers, of course, is XRP’s. Even as Ripple has signed up dozens of banks for its enterprise software, it has been working to bring XRP back into the conversation. You could say it is pivoting back to cryptocurrency just as it once pivoted away from it.

XRP is today the world’s third-largest digital currency by market capitalization, and it has delighted speculators in recent weeks. For a long time, two of the biggest concerns about XRP have been the network’s centralization—with Ripple itself being the primary validator of transactions—and the startup’s huge hoard of XRP, basically a mountain of digital gold on which Ripple has crouched, Smaug-like, and which it has sold off piecemeal to finance development. In addition to paying its developers, Ripple doles out XRP as incentives to market makers and sells it to institutional investors.

For the past year and a half, Ripple has sold an average of 300 million XRP each month. But concerns lingered that the company could dump much more, making it a bad bet for investors.

In mid-May, Garlinghouse announced a solution. Ripple, he wrote, was going to place 55 billion of the nearly 62 billion XRP it owns into escrow by the end of the year. Technically, there will be 55 lockup agreements of one billion XRP each; a contract will expire on the first day of every month, providing Ripple with operating funds. Whatever hasn’t been spent at the end of the month will be put into a new escrow account at the back of the queue.

By cryptographically freezing so many of the company’s assets, Ripple will place a hard limit on the number of XRP that can enter the market at any given time.

“The lockup provides a level of predictability about XRP supply that is favorable for market demand,” Spencer Bogart, the head of research at Blockchain Capital, an investor in the company, said in a statement published by Ripple.

The price of XRP had already been climbing before the announcement. The next day, it hit $0.42, about eight times what it had been at the start of the month. (Even after a retrenchment, XRP’s market cap is still about $10 billion, behind only bitcoin’s and Ether’s.)

The price spike has prompted new exchanges to support XRP trading. As Ripple brings them on board, the exchanges tend to become validators on the XRP network, decentralizing a job that Ripple once performed alone.

Vias acknowledges that some of XRP’s recent price increase is due to larger forces. An intense bull market has seen the total value of all cryptocurrencies rise to a level about six times what it was in January 2017.

“But I think the fact that we attacked those two fundamental structural issues allowed XRP to participate in the [broader] rally in a way that it might not have otherwise,” he said.

Teleporting gold
So why should banks care? Because Ripple plans to use XRP to solve their liquidity problems.

As it stands, banks around the world must hold billions of dollars in reserve, waiting to use them for payments. When one bank needs to send money across borders, it uses the dead cash it is holding at the foreign institution to which it is sending funds—either the final recipient or the intermediary correspondent bank. The whole process involves counterparty risk and the expensive vetting procedures that go along with it. This dormant cash is all the more wasteful because, in a world of Basel III, it counts as yet another balance-sheet asset against which a bank has to hold cash to cover its liabilities.

Ripple’s big idea is to use XRP—once its market cap gets high enough and it is being traded heavily enough—to provide banks with liquidity on demand. During a transaction, a fiat currency like the U.S. dollar would be converted by market makers into XRP and almost instantly swapped back into another fiat currency, like British pounds, on the other side.

XRP is perfect for this, company executives say, because the average transaction costs a mere $0.0003, or three one-hundredths of a penny, and is confirmed within two or three seconds. The Ripple ledger can process more than 1,000 transactions per second. There is even a feature that would allow two parties to set up a direct conduit and send money back and forth at much greater speeds—increasing the network’s processing limit to 50,000 transactions per second, Vias said.

When preparing to send money, the bank would get a single quote for the foreign-exchange cost. Everything else, the actual sausage-making, would be abstracted away. This, according to Thomas, is the new frontier, “trying to get banks to use digital assets for settlement.”

Stefan Thomas, CTO at Ripple

“We’re not the disruptors, we’re not the guys who come in and tear everything down,” says Stefan Thomas, Ripple’s chief technology officer.

“Ripple is definitely thinking about this the right way,” said Whitman Knapp, chairman of the transaction banking advisory firm GTBInsights, regarding Ripple’s plan to use cryptocurrency for cross-border payments.

While Vias admits he can’t even begin to have this conversation with banks until XRP itself is more liquid, Thomas is already thinking about the end result in magical terms. Banks, he said, will have “gold that you can teleport into any vault in the world instantly.”

One real step toward this payments utopia came last year, when Ripple collaborated with the technology consortium R3 on a project in which 12 banks used XRP to settle transactions with each other in real time. The payments were made in a test environment; it was all house money. But Vias calls it a success.

“We got 12 banks to hold a digital asset for the first time ever,” he said. “I think it was a real show of faith from them.”

Thomas says that Ripple is now seeing a lot of interest from banks in XRP. The next step is to do a real pilot involving XRP settlements, though Thomas said the company has nothing yet to announce on that front.

There are plenty of hurdles left to clear before high finance can ever do away with correspondent banking. Regulators will want to have their say about any new system.

“Digital currency brings a different set of compliance [requirements], and if you’re trying to pioneer that, you’re bearing the brunt of all the questions from the regulators,” said Ramamurthi.

For now, Ripple is trying to play a sort of three-dimensional chess, selling banks on software even while working hard to transcend that software. This type of development goes beyond the iterative process with which Silicon Valley and Wall Street alike have become familiar. That process involves releasing an early version of an app or feature—a so-called “minimum viable product”—and then steadily improving it in later versions. Ripple’s approach looks more like an overlapping chain of innovations.

“In the most elegant end-state of our solution, Ripple, ILP and XRP work seamlessly together,” Vias said.

‘Transformational leaps’
Ripple is not yet a world-beating company, which is to say that most banks, while excited about blockchain technology, haven’t yet decided just whose blockchain, or chains, they are going to use. BBVA, for instance, is engaged in several pilots with the technology, including one involving syndicated loans as a member of R3. It also belongs to the Ethereum Enterprise Alliance and Hyperledger.

An MUFG representative said the Japanese megabank is still pursuing a previously disclosed project with Coinbase, a leading bitcoin startup, to use the cryptocurrency for cross-border payments.

“Our intent is not to compare or have these services ‘compete’ with each other,” the representative said. “Because we do not believe there is a ‘one and only’ payment method, we are reviewing other payment systems. MUFG believes in offering options for our customers, so they can choose.”

As for Ripple’s technology, MUFG has “finished the experimentation phase and [is] moving toward pilot/production testing this year.”

Even Swift is adapting to the new landscape. In April, the cooperative announced that it was developing a blockchain proof of concept for the real-time reconciliation of nostro accounts used in cross-border payments. Wells Fargo, Bank of New York Mellon, BNP Paribas and a number of other financial institutions are taking part. (To build the proof of concept, Swift is relying on Fabric, an open-source blockchain framework incubated by Hyperledger.)

To succeed, Ripple will need “to be laser-focused on what problem they’re solving, because there’s a lot of competition in this space, and you can’t solve all of everybody’s problems,” Light said. “They have competition from R3, from traditional fintech companies, even from some of the bitcoin-based enterprise software companies, so they’re going to need to keep their offering competitive.”

Even in this chaotic space, however, there are some signs that Ripple is emerging as a frontrunner. Seventy-five banks are now Ripple customers. In March, the startup poached a Swift executive. And when Santander dropped out of R3 in November 2016—one of several banks to do so over the past several months—it took care to reaffirm its commitment to a couple of other blockchain projects. One of them was the Global Payments Steering Group.

In recent conversations, Ripple’s leaders were as sanguine about the competition as they were bullish on blockchain technology as a whole.

“I don’t knock bitcoin, I don’t knock Ethereum, I don’t knock anybody,” Vias said. “Everybody is out here trying to make transformational leaps forward, and I think we’re all going to be better off for it.”