To understand the working of Ripple, first it is important to know what exactly Ripple is. It is a digital coin as well as a payments protocol which has created an excitement in the public,
At present Ripple has been in the news, and the banks are saying that it has potential and initially started to use it to fasten their offered services. However, several people still don’t understand Ripple and its working as well.
Ripple can be compared to the hawala network, it is much similar to it. Hawala network is a traditional, non-digital way of sending money from one city to another. It originated in medieval Arabia and is used even today at places where the banks cannot function.
A medieval banking system
Hawala can be defined as money transfer without money movement, and that too, quick transfer between distinct locations.
Let us illustrate this by giving an example; as if Alex wants to send money to Beth, then by approaching agents both the parties can settle this transaction. Here money has been transferred from Alex to Beth, without the physical notes being moved. Here Alex’s agent owes Beth’s agent money. Later on this debt can be settled or the reverse transaction may occur if other customers want to move money in opposite direction. One important factor matters, that is the trust among all the persons involved.
Moving to Ripple
Today, this job of agents is performed by websites or shops, and in the place of agents calling each other we can electronically interconnect the IOUs.
This way the work is carried out in Ripple, here Alex records on to his desired entrance say Ripple, deposits money and gives them instructions to issue funds to Beth through her preferred entrance from where she gets her funds.
Not just cash
In the given example cash can be replaced with physical gold. In case both the entrances are ready to accept and give out the precious gold, and both have a trust relationship between them, that permits the IOUs of gold, and you can transfer gold. Here, Alex gives gold which Beth receives and Alex’s agent owes Beth’s agent gold. So we can see that Ripple works not only for money, but also for gold.
Now substitute gold with anything. You can transfer anything without moving it, provided both the gateways are ready to trade. This will greatly function for non-perishable, fungible goods and can even work for beer and flowers in case the gateways want to deal in them. So it is understood that Ripple can transmit anything.
Conversion of goods
In case any gateway is ready to change cash with gold, then in such a situation, Alex can place cash at his gateway and Beth can receive gold at her gateway. So it is understood that Ripple can even transform things.
No direct trust? Find a chain
What can be done in a situation where Alex’s gateway does not trust Beth’s gateway. Provided there are mediators forming a chain of trust relationship so that the stuff can be transferred, the transaction can be carried on.
Here the technique of Ripple attempts to get the shortest route of trust relationship between the gateways. Going back to hawala, if Alex’s agent does not trust Beth’s agent, then in such case if there is a third agent having trust on the other two, there can be two IOUs: Alex’s agent owes the third agent and this third agent owes Beth’s agent.
No chain of trust? Use ripples.
What can be done if there is no trust relationship between the two gateways for the transfer of cash or goods? Ripple works in such situation, as XRP is said to be the ‘currency of last resort’ for the Ripple structure.
All the gateways offer a price in XRP of anything they deal with, as to say: a dollar is 200 XRP; 1 ounce of gold is 260,000 XRP. One can say that, as USD is the currency of last resort in the USA, each and every thing has a price in USD.
Now it is understood that in Ripple technique, anything can be transformed into a number of XRPs, and these XRPs can be converted again at the last gateway through the trust relationship.
XRP is not just a currency of last resort
Along with the advantage of being the currency of last resort, XRP has other advantages. Initially, XRP can be instantly settled, so that as soon as it is passed to the Ripple network, the possession of the thing changes and this is final and also trustless.
This contradicts to IOUs, as here even if the transfer is immediate, then also it is required to be bought back from the gateway. This will require you to have trust that the gateway will fulfill its duties, producing counterparty credit risk.
The other thing is, as very less mediators are required; it will have very less transaction fees for the exchange of XRPs.
Who owes who?
There must a person keeping a record of all the IOUs. In the traditional hawala system, every agent maintains his own ledger, and from time to time they are resolved in their chain of trust.
A public ledger of accounts, balances and IOUs are maintained and updated by every person at the same time in the Ripple network which is said to be a distributed collection of servers all over the globe. The servers by consent agree on changes. As such there is not a kind of central authority who agrees or disagrees with the transactions. Anyone by running free software on their computer can become a server.
That’s just the beginning
As you go deep, you will know more about market makers, giving prices at which they are willing to deal between the goods as cash for gold, gold for silver, silver for XRP, and this list goes on and on.
Now you will know the reason why all transaction prices a fewer number of XRP, and why the network is already filled with 100 billion XRPs.
Now you will know that the transactions built on cryptography having a distributed network with public ledger is many times better than the centralized pre- internet correspondent banking networks as SWIFT. You will see that such transactions based on distributed network are faster, cheaper, involves less risk and far better in every way.