Ripple for dumdums - a layman's explanation

[Roborovskii]

I compiled some of my previous replies to create this for those who may be new.

Ripple Consensus Ledger (RCL) basics | [XRP-Ledger]

RCL is a “record book” that keep tabs on Trustlines and IOUs (and more).

** RCL is now being referred to as "XRP-Ledger" by Ripple, while IOUs are now known as "Issuances".

IOUs | [Issuances]

·         Every account on RCL can issue an IOU.

·         IOU = “I owe you” in short. A token representing an amount owed to someone.

·         For example, I can issue USD.roborovskii or EUR.roborovskii or XAU.roborovskii, basically anything except XRP which is the reserved native token.

·         If you have 10 USD.roborovskii in your RCL account. It would mean that I (roborovskii), owe you 10 USD as recorded on RCL.

·         IOUs issued by another person are seen as USD.anotherperson, EUR.anotherperson, XAU.anotherperson, etc.

·         Note that on RCL you may not see USD.anotherperson (the name), but the actual account’s public address (USD.rxxxxxxxxxxxxxxxxxxxxx).

·         IOU tokens issued by different accounts (people or gateways) are treated as different tokens even if their symbols are the same. I.e. USD.roborovskii is different from USD.anotherperson

Trustlines

·         A trustline is simply the amount in which you are willing to trust another party for.

·         E.g. The amount in your bank account can be seen as IOU tokens, and what you have is basically a “trustline” of at least that amount extended to the bank. If you only dare trust your bank for a maximum of 10,000 USD. Then your trustline can be said to be 10,000 USD extended to your bank. And you would never hold more than that in your account.

·         Trustlines on RCL - You make a deposit of 1000 USD to Bitstamp through a bank transfer. You NEED to set a trustline to Bitstamp on RCL for at least 1000 USD, or Bitstamp will not be able to credit 1000 USD.bitstamp (IOUs) to your RCL account.

·         Once you do, Bitstamp would then be able to send 1000 USD.bitstamp to your RCL account.

·         It is a common problem that new users forget (or do not know how) to set the trustlines. They transfer the money to the gateway, and wonder why they are not credited on RCL.

·         E.g. If you do not set a trustline to me, I can never send you any IOUs. If you set a trustline to me for 100 USD, then I can only send you 100 USD.roborovskii maximum and not more than that.

A network of trustlines bridged by orderbooks and market-making

On RCL there are orderbooks where currency (or IOU) pairs are traded by market-makers and traders (examples):

USD.bitstamp : BTC.bitstamp

USD.gatehub : EUR.gatehub

USD.bitstamp : USD.gatehub

Remember that USD.bitstamp and USD.gatehub are treated as different tokens.

(Ideally, tokens with the same name would be valued at 1:1, but in reality, this isn’t so - due to the differentiated number of trust participants and valuation. E.g. 10,000 people trust and use USD.gatewayX, but only 100 people trust and use USD.gatewayZ. The USD token for gatewayX would naturally be valued more than gatewayZ due to more participation, thus more volume in orderbooks and more liquidity.)

The problem: If you had 1000 USD.bitstamp and you want to pay your friend 100 USD, you will NOT be able to send him the 100 USD.bitstamp if his RCL account does not have a trustline setup to Bitstamp. Perhaps he only has a trustline setup to Gatehub. In this case, he can ONLY receive USD.gatehub. This problem of sending IOUs to someone with different trustlines is where bridging comes into effect.

For the following example of bridging USD to USD, let's assume the exchange rate is an ideal 1:1

- When you send your friend 100 USD.bitstamp on RCL, he would receive 100 USD.gatehub through the orderbooks that are filled by the market-makers and traders.

- If you had a friend in Japan who only trusted JPY.MrRipple, sending him 10 USD.gatehub would bring out an option for him to receive 1137 JPY.MrRipple. This again is bridged by the orderbooks trading the pair USD.gatehub : JPY.MrRipple.

What is, and why XRP?

XRP is Ripple Consensus Ledger’s (RCL) native token. It is not issued by any account and was created together with RCL with a finite quantity of 100 billion; no more XRPs will ever be created again. The number of XRPs will decrease over time as it is consumed for every single transaction that is made. Being a counter-party free token, you do not need any trustlines to send or receive XRPs.

XRP is used when you:

1.       Activate an account on RCL (open a wallet): 20 XRP reserved

2.       Create a trustline: 5 XRP reserved

3.       All transactions (buy/sell/bid/ask/send/cancel): Variable transaction cost

The variable transaction cost increases as the load on the network increases. This acts as an antispam measure to prevent attacks on the network.

Towards a reserve currency

As the native currency on the network with no counter-party dependence, XRP would naturally be the bridge currency of choice between entities with no direct trustlines. With the ability to provide no more than 2 degrees of separation to both entities, costs can be reduced greatly by avoiding multiple hops across orderbooks. See https://ripple.com/xrp-portal/

Banks & Market-makers

It is a common misunderstanding that banks will (as a business entity) hold XRP. The main holders for XRP are market-makers (MM). Market-makers bridge currency pairs as well as XRP through arbitrage algorithms. To do that, they need to hold various currencies and XRP on the Ripple network (RCL). Profit in MM is greater with higher network utility, and will likely be very profitable given the volume of global remittance. While MMs themselves may be subsidiary of banks, it is more likely that they are managed like investment funds. Private investors will place money with these MMs (e.g. Japan-Asia MM Fund, India-Singapore MM Fund, Asia-Europe MM fund) for earnings. Therefore, the risk of holdings are placed onto investors in exchange for profit made from network utility through market-making. Addressing volatility: The percentage volatility is high today simply because the number of participants (holdings of XRP) is comparably low. This can, and will likely be addressed through higher participation and thus pricing. If you look at bitcoin today, the % change isn't as high as other alt coins that have lower participation. More participants, higher price, less volatility.

In essence, banks won't use XRP directly. MM+RCL = RC-Cloud. Ripple Connect links them to this cloud.

• RC-Cloud : The combination of RCL + Market Makers as a black box solution.
• This is essentially what they have termed the "Ripple Solution". This is a solution to the fact that banks as a business entity do not want to hold large amounts of any digital currencies in their books. Using RC-Cloud the risk of digital currency holdings are placed onto market-makers who in turn profit from network utility. To the banks, whatever volatility happens in digital currencies are transparent to them (in the cloud), and they are only interested in the inputs and outputs (remittance utility).

See screenshot taken from https://www.youtube.com/watch?v=otERf5Nn9e8

 

Added this link in case anyone's wondering how profitable market-making is - https://ripple.com/insights/the-life-of-a-ripple-market-maker/ 

Note that in 2014-2015, RCL's volume is not nearly as high as it is today. With global remittance utility, you can only dream of how much profit MM funds will reap.

* XRP-ledger (RCL) first public market-making fund - Rialto.AI

The Intrinsic Value of XRP

Market-makers require funds to fill the orderbooks. The more funds they have, the larger their “net” will be in capturing arbitrage opportunities.

With high global remittance utility, the need for liquidity/volume will also reflect that. This gives opportunities for market-makers to earn higher profits. The less market-makers there are, the bigger the cake they can each take. Naturally, more market-makers (or investors) will come on board to grab their share, bringing in more MM-funds and thus also raising the XRP price. This naturally increases liquidity/volume on the orderbooks to meet that need. The cycle essentially creates an organic balance in the system of utility, liquidity/volume and thus token pricing. While there will always be ebb and flows, the organic direction is towards balance.

The intrinsic value of XRP therefore depends on the utility of the network (at the moment targeting global remittance as the core) as well as its position as the ideal bridge currency on RCL.

** Apart from remittances, the 2nd major use-case for XRP being actively pushed by Ripple is in payments. Payment volumes would increase network utility as well as provide the needed volumes for remittances. Both use cases can thus be seen symbiotic in nature.

Edited July 9, 2017 by Roborovskii
Updates for terminologies: XRP-Ledger & Issuances & Rialto.AI MM-Fund link

[Mercury]

Moved to tutorials