Bitcoin and Ripple – The Democratization of Finance

January 21, 2014 § 23 Comments

I’ve always loved tech. From my first iPhone to exploring different apps to reading about Silicon Valley, I enjoy thinking about how technology makes our world more open and connected. This fascination has matured in me: At first I was somewhat of an early adopter; I’d read pop articles on Forbes–the innovation is exciting, and there’s money to be made. But in the past two years, through studying philosophy, religion and other cultures,  I’ve thought deeper about how the world has changed through Internet innovators like Google and Facebook. These innovations and others allow and encourage a consciousness of all people; and further, they diminish ignorance and ethnocentric tendencies. For example, my government can’t use drone strikes without the damaging effects being readily known to me. These things make us think. Peoples’ steadfast belief in this political system or that religion is easily challenged–belief and opinion are readily discussed and tested. The Internet can be thought of as the free market for information, with those beliefs/opinions/ideas that are unsound or plainly false, being ruled out over time. Of course there are ways around this if we actively pursue ignorance, and in some ways these innovations fail to be as encouraging of openness as is ideal. But one cannot deny the openness and increasing conscientiousness the Internet has enabled. How does Bitcoin interact with this? What is Ripple? The larger question: what effect will digital currency and monetary systems play in our world’s future. I think the effect will be profound; and to borrow from an IBM executive architect’s words, “I believe they are going to change the world.”

Bitcoin-Prices

Bitcoin (BTC)

Bitcoin is the first-mover. If you want to disregard it as “money” out of thin air, first realize that that is precisely how the U.S. Government creates dollars every day. But Bitcoin isn’t under control of any government, and this is what encouraged early adoption. More recently, the hype often surrounds the soaring (and volatile) value of this coin and the resulting “Bitcoin millionaires.” But many people are clueless or confused (I often still feel lost) about many of the basics of Bitcoin. Many people hear the hype, see the money, and buy in, hoping for a good investment (I may still do this). But all of that is only so exciting. What is truly intriguing is the system–the protocol–that makes Bitcoin such an innovation.

The basics:

The Bitcoin protocol is a distributed peer-to-peer network that allows transfer (reassignment) of bitcoins between parties. What does that mean exactly? Anyone can send payments to anyone else, in bitcoin, through the protocol. Who runs the protocol? The same people that run the internet; that is, anyone who chooses to. What incentive is there for people to run the Bitcoin protocol? People who run the protocol are known as miners; they are rewarded in bitcoins in a complex process called proof-of-work. The mining process is essential in that it predictably releases bitcoins into the money supply*, and, more importantly, the process is coupled with transaction completion, record, and final confirmation. This is done securely and without a central authority or intermediary; all participating servers broadcast and verify transactions. Transactions that are essentially “questionable” (e.g. attempting double spending) will ultimately be rejected; “honest” transactions are legitimized through several rounds (formally known as ‘blocks’) of verification and are then finally confirmed.

*There is a final cap on the amount of bitcoins that can be created: 21 million. However, after this, miners will continue working for transaction fees.

This leads us to the key innovation of Bitcoin: decentralized trust. Acting through this secure, decentralized mechanism to confirm transactions, Bitcoin introduces something the smartest people never thought was possible. Banks or other entities exist as a centralized authority and intermediary in financial transactions. If I swipe my debit card at a merchant or enter my credit card number online, the vendor contacts the issuing institution (bank or credit card company) to verify funds are available–this brings to bear a central authority that we generally trust. Other financial intermediaries and services like Paypal, Western Union, and Venmo act similarly but in a variety of niches. These entities charge fees, though. For example, to send $1,000 domestically, with the funds made available same day, Western Union charges a fee of $86. Bitcoin’s technology accomplishes this task securely, without an intermediary, and without sharing personal information, for a very nominal fee. If we think about sending money globally, the implications are magnified. Fees aside, the technology being used by financial institutions is slow to process transactions. In our increasingly tech savvy world, it might now seem odd that one has to wait days to receive their funds or have payments clear. Sending money overseas to a friend or a nonprofit cause will necessitate the use of several intermediaries as there is no global central authority to process these transactions. This takes time and incurs fees. Bitcoin makes it as easy as sending an email.

RippleRipple (XRP)

Ripple is much more than Bitcoin. Ripple is a currency agnostic monetary system. To use an analogy: email in the ’70s was available, but only through separate intranets–the networks were segregated. It’s 1982; enter the Simple Mail Transfer Protocol (SMTP); this innovation federated email into one technology that enabled anyone to message anyone else globally. Through the Ripple protocol you can store, trade, send and receive payments in any currency–digital or fiat (USD, CNY, MXN, BTC). Further, I can pay someone in my currency and they will receive it in their currency. For instance, if I were to send a Chinese friend $20, he will receive it in Yuan (using the email analogy: I can send an email in English to my Chinese friend and he will receive it in Mandarin). Another example–fiat to digital–if I want to pay a Libertarian friend of mine in bitcoin, I can do so using my USD; he won’t see anything other than bitcoin on his side of the transaction. The Ripple protocol federates currencies; it truly is “the Internet for money.”

But Ripple is different in some ways that draw skepticism. Firstly, it was created by a private company: Ripple Labs (formerly OpenCoin). The Ripple protocol was created with currency (XRP, or ‘ripples’) built into the network; all 100 billion, the maximum, were created up front. This has fueled skepticism and distrust, especially because the Ripple Labs founders have kept 20 billion XRP, with the remaining in Ripple Labs’ control for funding operations, distributing and giving at their discretion. As of November 30th, 2013, approximately 7.2 billion XRP have been distributed, with over 72 billion remain in holding. This, in comparison to Bitcoin’s predictable (perhaps fairer) supply of coins, could be crippling the protocol’s adoption. However, Ripple makes it clear that only a small amount of XRP is required to fund a wallet (join the network). Once that is done, you can use whatever currency you prefer within Ripple. Given this, focus on XRP value may be an indicator one is solely a digital currency speculator, which is fine, but those efforts are best pursued elsewhere. Investing in Ripple should be an investment in more than the currency; the currency agnostic protocol is the real innovation. Why a requirement of XRP? Ripples serve an essential function in that they stop ‘network spam.’ Because a small fraction of an XRP is destroyed in each transaction (this is the only transaction fee), any person trying to overrun the network will be stopped by depleting their required reserve of the currency.

Bitcoin vs Ripple: Intermediaries and Centralization

Part of Ripple’s monetary system is the gateway; these entities act as intermediaries between people and the protocol—these are how you get your paper into digital form and vice-versa. Gateways have been criticized for making the network rely on intermediaries; this because gateways will take on a “hub and spoke” pattern as users who wish to withdraw or deposit their fiat currency must go through these bank-like entities, who, in the future, will undoubtedly use fractional reserves. Ripple’s use of IOUs seems to exacerbate this issue. However, Bitcoin exchanges introduce a similar issue; if you wish to purchase or sell bitcoins—if you wish to use currency other than bitcoin—you must utilize centralized exchanges that also incur counter-party risk. But basically, if you’re using Ripple with XRP only or if you’re just using Bitcoin, then you’re on a decentralized network with autonomy of your assets and no need for an institution. But because Ripple wishes to be all things to all people—to federate currency exchange and payments—gateways are an emphasized part of the plan. Gateways will be an accessible tool for common people to use digital currency when they need or want along with their traditional currency. This also fits with Ripple Labs’  strategy of being regulator friendly; gateways, like Bitcoin exchanges, will strive for compliance through anti-money laundering and “know your customer” practices. Where Ripple emphasizes gateways, Bitcoin, perhaps to the extent the users are Libertarian, can dodge the use of exchanges and their regulators. Further, with tools like Darkwallet, Bitcoin will surely be the more attractive choice for those wishing complete freedom and privacy.

The Democratization of Finance

 I recently flew out of LAX for some training in DC. When my cab picked me up, the driver was an older guy, his clothes were quite wrinkled and he looked worn out. We talked for a bit; he was genuinely nice, but as sometimes happens, the conversation died out as the ride continued. I began to notice the ride wasn’t very smooth, though, so I got off my iPhone to avoid feeling carsick. I noticed to my dismay that my driver was actually closing his eyes from time to time–he’d actually have to swerve a bit to correct after drifting out of his lane. Mostly out of self-interest, I started another conversation with him: I asked him where he was from. He was from Bangladesh. I asked what brought him here. He had come here for work because he couldn’t provide for his family by working back home. And his family stayed in Bangladesh. I felt strong compassion and continued to talk with him (forgetting that I was also keeping him awake). He’d been working here 12 years between taxi and valet service to continue to provide for them; and he’d send as much pay back as he could regularly.

International remittences are one area of finance that Bitcoin technology will help democratize. Democratize: to make (something) available to all people. Remittances to developing countries were estimated to reach $414 billion in 2013, which is an increase of 6.3% over previous year. And this growth is expected to continue due to globalization and migrating workers. Top recipients of officially recorded remittances are India ($71 billion), China ($60 billion), the Philippines ($26 billion), and Mexico ($22 billion). Other large recipients include Nigeria, Egypt, and Bangladesh–most are developing countries. The average cost to migrant workers for sending funds: 9% (WorldBank). My friend the cab driver shouldn’t be paying 9% in fees to get his wages to his family–not with our increasingly Internet savvy world. And of course, all of this–Bitcoin and Ripple technology–depends upon Internet access.

For me in the U.S., Internet access has become the norm:

1(Horace Dediu, Asymco; data source is ITU)

But the current stage of growth is different in each country (though the stories, similar):

2(Horace Dediu, Asymco; data source is ITU)

As discussed at the outset of this post, the Internet has given us the freedom to be informed and to communicate.  As a millennial born in the U.S., I, without thinking, might intuit that the world has the same advantages of communication and information as me. But the reach of the Internet is still largely in its growing stages, as seen below in composite:

Screen-Shot-2014-01-02-at-1-2-3.44.11-PM

(Horace Dediu, Asymco; data source is ITU)

Thus far Internet access has democratized information and communication. What Bitcoin’s innovation really means is the democratization of finance–of transactions, of conducting business instantly worldwide and with complete freedom. It’s the Internet for value. People will have autonomy and privacy with their assets, and they won’t be reliant on a bank being in their town or a grant from their government. International remittances are just one application. People affected by natural disasters, corrupt governments or war will be able to protect their assets. And those wishing to help can send aid directly to those in need–without lag in time or fear of a different party seizing the asset. This technology is exciting; it’s going to help us build a better world.

Disclosure: I own <$500 combined worth of both BTC and XRP.

BTC: 1CzirX8aQMvfsr6uVCSTKzER1Tn2HEtLSb

XRP: rnFvjyfe184HUK6ea1ymT4cxnRTkMsMnnM

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§ 23 Responses to Bitcoin and Ripple – The Democratization of Finance

  • Seth, this is a very well-written, very helpful, very insightful post. I loved so much of it and learned from all of it.

    I must ask you, with Ripple’s shortcomings, do you really feel like it is “so much more” than Bitcoin? Undoubtedly, the Ripple protocol is innovative, but with a distributed, rather than decentralized, network, does its network earn the same kind of confidence (at least initially) that Bitcoin’s does?

    • Seth Hoskins says:

      Thanks man — means a lot from a writer like you.

      Technically speaking, it seems to me that Ripple is more than Bitcoin. But I’m no computer scientist. Much more can be built on top of the Bitcoin protocol (e.g. smart contracts). As far as I know, though, the same is true with Ripple. So all else being equal, Ripple’s inclusion of all currencies and the FX abilities make it a more comprehensive tool. I agree that initially Bitcoin is deserving of more confidence, as Ripple Labs runs most of the Ripple network’s servers and holds the majority of XRP. I think only time will tell whether Ripple’s more comprehensive system is adopted and valued.

      • greg michaud says:

        nice article seth just send you some XRP!

      • Seth Hoskins says:

        Thank you sir. Feel free to share with anyone you think would enjoy the read.

      • XRP says:

        RIpple is the best thing since slice bread…

      • Good word man. I get that. My point was only that Bitcoin’s decentralized network is a real, powerful advantage of its architecture, and I feel like it’s hard to weigh the significance of these characteristics, as the implications of their (Bitcoin’s and Ripple’s) individual innovations haven’t really even played out yet.

      • Seth Hoskins says:

        But Ripple’s network (the protocol specifically) is decentralized. You’re speaking to the use of gateways when you say distributed, correct?

      • I’m no expert, but isn’t the ledger in ripple maintained by a distributed network, while BTC’s ledger is maintained by a decentralized network? And certainly, as you have noted, xrp is held by ripple labs, while BTC is mined by whomever. These are the differences I was thinking about. What do you think?

      • Seth Hoskins says:

        As I understand it, Ripple’s network is often termed “distributed” because its servers are largely run by Ripple Labs and a few gateways. And, looking ahead, skeptics expect only banks/gateways will run the protocol because there’s no incentive for the common person to (unlike Bitcoin’s mining). Perhaps it would have been more accurate for me to say the Ripple protocol is open source and able to be decentralized, but that this depends on further adoption.
        In contrast, Bitcoin looks more attractive on this point, but there are concerns about the mining process becoming increasingly concentrated. As the proof-of-work process becomes all but impossible for common people, skeptics worry that future mining will be controlled by only a few who have the computing capacity to make it worthwhile. This would make the network “distributed,” leaving the protocol more susceptible to an attack, or perhaps causing an oligopoly (reducing competition in transaction fees). But perhaps market forces would keep this balanced? What’s your opinion there – your economic knowledge is better than mine.

  • Don Akers says:

    But the real question – how many bitcoins to purchase a quality tennis racket?

  • marc c says:

    Hi Seth.
    Nice article. very well explained but for me Bitcoin and Ripple are just not comparable. Bitcoin is a digital currency. Ripple is a monetary system and a protocol and a digital currency, that is open to all currencies. So Ripple eventually is a lot more than Bitcoin.

    One sees nowadays showing up once in a while: “We accept Bitcoin” . Ok that’s nice, if one has BTC that one wants to spend. But imagine you run an internet store and you can add a Ripple based payment processor: you’ve instantly opened your store to accept every currency on earth and all your client needs is a Ripple wallet with some value in it of one or more currencies among those you are prepared to accept. Whether that’s USD, XRP, EUR, BTC, CAD, … just name it and it goes …totally free: no fees, no cost…and that payment processor can be a sophisticated high end one, but it can be just as well a simple link, like this one

    https://ripple.com/client/#/login?to=rHfiPsNcbyR9vXJEQ3P6X6ifDMngHEUo7w&dt=988769&amount=0.01%2FCAD&tab=send

    That example link will invite you (try it out!), by way of your Ripple wallet, to pay me 0.01 CAD with a reference destination tag 988769 (ie invoicenumber)

    a few seconds later I will receive my CAD cent in my wallet with the reference tag to clear the cart, safe and painless with ANY additional cost at all … Oh no, sorry, forgot to mention the 0.000001 XRP fee to prevent any form of DDoS attack … But REALLY that’s all extra cost (as you see close to nothing) – just enough to keep the network useful … all times

    • Seth Hoskins says:

      Ripple is more “eventually.” Indeed; very well put. Ripple Labs has a chicken or egg dilemma going on right now. And it’s made more of a dilemma by Bitcoin increasing acceptance.

  • Stu says:

    When I read this “arbitrage” kept coming to mind regarding Ripple. I don’t know where the opportunity for such a thing exists with this, perhaps the currency/FX aspect, or maybe it’s impossible because it is too seamless for such a thing. Currency rates fluctuate by exploitable amounts in very short periods of time; but probably not as short a time as ‘money’ can flow through Ripple. Seems like an incubator for high frequency trading type arbitrage. Hmmmm. But for some reason that kept churning around in my head. That will be a developing thought. What think ye?

    I understand that Bitcoin payment systems are taking hold. But does anyone have an example of any legit online or brick & mortar retailers utilizing Ripple-based eCommerce? I’m prob an old-timer here compared to most of you so go easy on me with the dumb questions LOL.

    Ripple does seem like “so much more” to me – a comprehensive protocol that can provide shelter even for a rival. The fact that there is room in Ripple for Bitcoin but not vice-versa seems to put this into perspective for me. If I am understanding it correctly.

    Great post Seth! I hear the WSJ is looking for moonlighting cyber-coin journalists. 😉

    • Jonathon Beers says:

      Stu- to whatever extent it occurs, arbitrage is generally a good thing: it’s economic efficiency in action. What’s unhealthy in an economy is when irrational price differences go unaddressed, because that’s an indication that some barrier to arbitrage exists. Those barriers result in inefficient markets.

      • Stu says:

        Agreed that the results are generally a good thing. Arbitrage is an invitation for a free lunch. And free lunches don’t go unnoticed. If they’re out there they’ll be rushed upon and devoured like the last twinkie approaching its extinction day. But efficiency requires making order out of chaos in order to manifest. Right now efficiency is still developing in these systems so it is safe to say there is some disorder. Where there is disorder there are inefficiencies and there lives arbitrage opportunity. But typically not for long. Some on Wall Street live and die by the sword that is arbitrage. It’s out there, even in “efficient” markets. Those that find it and exploit it, all the while helping to reduce or in some cases remove the same inefficiencies they are exploiting, will profit. I am wondering what the hedge funds will make of all this.

    • Seth Hoskins says:

      I’ve thought about the possibility of arbitrage before, but there isn’t enough volume or diversity in currencies being traded in Ripple right now (so it appears to me, but I’m no trader).
      There is not really any merchants accepting Ripples (XRPs) at this time. Bitcoin is way ahead there.
      And thanks for the compliment! Who knows, maybe in the future when I know something about anything. Haha.

      • marc c says:

        Seth you say “There is not really any merchants accepting Ripples (XRPs) at this time. Bitcoin is way ahead there.”

        I’m not with you here. Why would one want to pay in XRP, and even in BTC?.Just because? The biggest innovation IMHO lays not in WHAT we will use to pay, but HOW we will do that. With Bitcoin the latter is innovative, but you’re still tied to the currency. Ripple solved that problem by innovating in the way the transport of value, and that completely agnostic for currencies to use
        Once merchants will see THAT enormous difference between Bitcoin an Ripple, they will switch to Ripple (or something like that), wherein besides USD, EUR, CAD and Bit and alt coins, or whatever, can be used to get payed.
        So it’s not just XRP that will or has to be adopted: it’s the Ripple Network as a whole being 4 in 1 (a protocol, an exchange, a payment system and a currency) that has it all to change the world of money movements…
        XRP is only a small piece in this and even within Ripple there is no need for any merchant to except them as a currency ….
        The nice thing about Ripple is that it can serve as a fine bridge between fiat currencies and the upcoming cryptos what will make the hurdle for banks, payment systems, merchants and clients almost no-existent if on a sudden day some Bit or another alt coin can have a possible use case…

  • Jonathon Beers says:

    Seth, excellent choice in material; this is a fascinating subject.

    There’s another aspect to Bitcoin that I think is the most exciting part– could be worth expanding on this if you continue to write about bitcoin. To me, the best thing about Bitcoin is that it sidesteps the problem of centralized banking. Many, if not most people intuitively sense that the monetary policies we’ve become addicted to are unsustainable. Some (myself included) believe that we are inviting inevitable future disaster through the endless rounds of quantitative easing. Unfortunately, those of us who worry about this problem appear to be powerless to address it– Keynesian economics still holds sway in most influential circles, and it’s goaded on by a political calculus that is dedicated to patronizing its supporters (think endless welfare benefits, kickbacks to corporations, bloated bureaucracies… you name it… there seems to be no limit to the ways our society has become accustomed to shoveling money out the window) regardless of the long-term imprudence. Bitcoin changes all that. If Bitcoin takes hold as a (or “the”) predominant worldwide currency, one of the side effects will be that the problems of monetary policy and ill-advised tinkering with the money supply will ultimately evaporate. Bitcoin is, essentially, the equivalent of the gold standard for purposes of macroeconomic analysis. Of course, the gold standard comes with its own set of inherent weaknesses and challenges. But, I for one, would rather contend with the vagaries of impartial market forces than continue to be at the mercy of a central banking system that’s clearly given itself over to vice.

    Incidentally, have you thought at all about what happens to the velocity of money when there are no “centralized authorities or intermediaries?” Where would credit come from in an economy without banks? Or would banks still exist, but with some diminished role? Or does this have no impact at all on banking, except with respect to the currency involved? Obviously, in order to function at all, every modern economy must have a system capable of supplying ready access to credit. How does Bitcoin impact that requirement?

    • Seth Hoskins says:

      I hope my post alluded to the fact that Bitcoin is impervious to government control—and that this is really attractive in some circles. Those interested could be anarchists, libertarians, those with corrupt governments, but could also simply be someone who believes inflation is out of control (as you noted your discomfort with quantitative easing). My problem with Bitcoin as a currency, and the reason I didn’t speak to it, is that it’s just way too volatile. Bitcoin is worth ~$800 because the protocol holds great promise as a technology. But, since its creation, there are other protocols/currencies that are arguably just as good. And while Bitcoin is still totally beating them out, I’m not convinced this is because of a better protocol—it may just be because it’s the first mover with the most matured network.
      The velocity of money? Well, money will move fast, haha. I don’t think Bitcoin or other digital currencies will undermine banks at all. But I do think banks, in order to be “future proof”, would be wise to utilize the new technology offered here.

  • Jonathon Beers says:

    Also, have you read “How America Ate All the Low-Hanging Fruit, Got Sick, and Will (Eventually) Feel Better”? It’s a very short read, and worth the time. It was a widely discussed book (pamphlet, really) when it came out and it touches on a lot of the same ideas that you bring up in your intro.

  • Stu says:

    Money laundering and the dark net. Not good news on the Bitcoin advocation front.

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