2013-05-14

Bitcoin 2.0: Can Ripple Make Digital Currency Mainstream?

The company is trying to create an online money system that is easy for everyone to use, not just the insiders who feel comfortable trading in Bitcoins. It’s all built on a massive system of personal trust.

It has been a nail-biting year for people who hold Bitcoins, an open-source digital currency that has quickly gained traction in the tech community. Last June, Bitcoins were worth $5. By April 2013, they were up to $266. Then they dropped to $70 in April. They were back up to $108 by May 7. Bitcoin is volatile. We know that much. It’s also vulnerable. Mt. Gox, the biggest Bitcoin exchange (where users go to exchange Bitcoins for other currency)—was recently faced with multiple DDoS attacks , shutting down the site temporarily.

But here’s the thing about open-source currencies: they’re open to improvement. Ripple, a platform that just received funding from Google Ventures, Andreessen Horowitz, Lightspeed Venture Partners, and others, has created both an alternative to Bitcoin and a distributed currency exchange for Bitcoiners (and others) who aren’t comfortable using only Ripple’s currency, known as XRP.

Bitcoiners could have reason to be suspicious of Ripple right off the bat. Whereas Bitcoin was created anonymously and relies on a foundation to standardize and protect the currency, Ripple is the product of OpenCoin, a public-facing company that just raised funding from a number of firms. OpenCoin plans on holding 25% of all the XRP in existence—the idea being that as the currency becomes more valuable, the company will have more resources to fund its operations (and presumably, to make its founders quite wealthy). There’s nothing intrinsically wrong with OpenCoin wanting its currency to rise in value, but the system is dramatically different from Bitcoin.

OpenCoin co-founder Chris Larsen believes that having a central company behind the currency is to its users’ benefit. "Bitcoin does a great job with a group of folks working through a foundation, and ad hoc contributions," he says. "We thought we could get that too, and also get a core group to nurture this thing for a few years."

The Mechanics of Ripple

The Ripple platform serves two purposes: it’s a distributed open-source payment network, and it’s the home of the newly minted XRP currency. As a payment network, Ripple provides free global payments without chargebacks (minus a $0.0001 per transaction network charge, implemented as a security precaution against hackers), the ability to pay in any currency using a distributed currency exchange, and an open protocol that any developer can use. "The Ripple network is a protocol. It’s like HTTP for money. Users, merchants, anyone can use it for free without a license," explains Larsen.

Participants can exchange dollars, yen, Euros, and even completely made-up currencies, all of which are entered into the system via "gateways." Larsen says: "A UI designer and myself can be a gateway to each other. A gateway can be a friend, neighborhood, a group. Most gateways will be larger. It’s like the way Paypal works—you give them $100, they create a $100 balance." The largest Ripple gateway right now is Bitstamp, which is used to buy and sell Bitcoins.

If one gateway is taken out by a hacker, users can move on to the next. And as McCaleb pointed out to The Verge, the Ripple gateways can’t seize or freeze accounts (unlike Bitcoin gateways), so they require less trust to use.

The only currency that doesn’t need to be entered into the Ripple platform from a gateway is XRP. This is an advantage over Bitcoin: Ripple is its own currency exchange—so it doesn’t have to rely on outside exchanges like Mt. Gox (Jed McCaleb, the creator of Mt. Gox, is a co-founder of OpenCoin).

While Bitcoin relies on anonymous exchange, Ripple supports an IOU system. The platform’s website explains it best:

One day your best friend’s sister comes to visit. You, your best friend, and his sister go out to dinner. Your best friend’s sister forgot her wallet, and to be friendly you offer to cover her portion, which comes out to $20. Your best friend’s sister now owes you $20.

Instead of waiting for your best friend’s sister to get to a bank or ATM, you use Ripple. Your best friend’s sister accesses her Ripple wallet on her phone and sends you an IOU for $20.

She can do this because there is a trust path between you in the network, through her brother: you said you were willing to trust her brother (your best friend) up to $100, and he said he was willing to trust her up to $50. So a $20 IOU can get from her to you, by passing through her brother.

The system works because everyone along the path has vouched for the person just directly before him in the pathway. He accepts an IOU from her and then issues an IOU of his own for the same amount to the next person in the path who accepts his. His balance then zeroes out and the IOU has moved along one more link in the pathway.

Distribution

New Bitcoins are created by a process called mining, where network nodes verify transactions by solving math problems. In exchange, the users behind the nodes receive Bitcoins. In contrast, OpenCoin is slowly distributing 100 billion XRP, starting first in the Bitcoin community. No new XRP can ever be created. GigaOm explains:

As this process has nothing to do with mining the virtual currency, there is no need to control the timing of the verification, meaning transactions can happen within seconds rather than in 10 minutes or more it takes with Bitcoin. This is clearly a big advantage, and there are others, such as the ability to create a chain of IOUs, either through people they personally know and trust, or by using ripples.

Larsen thinks that Ripple’s distribution method—giving away XRP—will pump up its appeal to the masses. "It comes down to ease of use, how easy it is to get the currency," he says. "To really get this going, it needs to be in the hands of tens of million on the user side." Getting a hold of Bitcoins, on the other hand, isn’t easy. You have to either buy or mine them—and mining is really only for experts. Bitcoin is expanding, albeit slowly.

Says Larsen: "You give [XRP] away for free, and you give it away in a way that’s super easy to use. Then I think the merchants come with that."

Bringing Bitcoin Users Into The Fold

Ripple isn’t trying to convert all Bitcoin users to dedicated XRP advocates (though that would certainly be nice for OpenCoin). Instead, Larsen sees Ripple as a companion to Bitcoin. "It’s complementary. You can hold your Bitcoin in Ripple. We want to be agnostic to any currency, whether that be a virtual currency, political currencies, or peer to peer currencies," he says.

But Ripple will easily fail if people don’t use it, regardless of whether they hold most of their currency in dollars, Bitcoins, or XRP. Adoption will be key. And judging by conversations on the Bitcoin sub-Reddit, the Bitcoin community is cautiously optimistic. At the moment, that’s the best sign OpenCoin can hope for. The real test will come when Ripple starts moving into the general consumer space—and tries to teach people the somewhat complicated mechanics of the platform.

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