What is Ripple and how does it work? A beginner's guide to XRP

Ripple is a company that aims to provide cross-border payment solutions to banks and financial institutions.

The company's business resolves around XRP -0.90% , the native cryptocurrency of the XRP Ledger. Ripple uses XRP as a bridge currency to facilitate the transfer of value between different fiat currencies for its customers. Anyone can also make transactions of XRP across its network.

This article provides a comprehensive understanding of Ripple and XRP.

What is XRP?

XRP is a digital currency that was designed to offer an alternative to Bitcoin. It was conceived with a specific focus on enabling rapid, low-cost cross-border transactions. This is something that most cryptocurrencies can do — with caveats regarding fees and block times — but Ripple's goal is to provide this function as a service to businesses.

Unlike Bitcoin, which depends on a proof-of-work consensus mechanism, XRP operates on a consensus mechanism based on the Federated Byzantine Agreement (FBA) model. This model does not necessitate mining or staking to validate and record transactions. Instead, it relies on trusted validator nodes, collectively known as the Unique Node List (UNL), to achieve consensus and maintain the transaction ledger every 3 to 5 seconds.

One of the unique aspects of XRP is that it was pre-mined at a very early stage of its development. A total of 100 billion XRP tokens were pre-mined and made available in 2012.

How does XRP work?

XRP represents an innovative approach to blockchain technology and financial services. Understanding how it works can help users navigate the evolving landscape of digital finance, whether as consumers, investors, professionals or entrepreneurs.

1. Consensus algorithm: Unlike many other blockchain networks that use proof-of-work or proof-of-stake, Ripple utilizes an alternative consensus algorithm. This means that transactions on the Ripple network are validated by a group of trusted validators rather than through mining or staking. These validators come to a consensus on the order and validity of transactions.

2. Issuance of XRP: Ripple holds a significant portion of the 100 billion pre-mined XRP tokens in escrow, and a small amount of XRP is released to the market periodically to fund network operations and promote liquidity.

3. Liquidity provider: XRP serves as a liquidity provider in the Ripple network. When two parties want to transact across different fiat currencies, XRP acts as an intermediary, allowing funds to be transferred quickly and efficiently. For example, if someone wants to send US Dollars to a recipient in Japan who wants to receive Japanese yen, XRP can be used as a bridge currency to facilitate the exchange.

4. Transaction speed and cost: Ripple's design aims to provide cross-border transactions quickly and affordably. The consensus algorithm enables transactions to be settled in a matter of seconds, and the use of XRP as a bridge currency can reduce transaction costs compared to traditional banking methods.

5. Gateways and trust lines: Users must establish trust lines with gateways on the Ripple network to hold and transact XRP. Trust lines allow participants to exchange value within the network while maintaining the integrity of the system.

6. Decentralization: Ripple's network and the XRP ledger are considered more centralized compared to other cryptocurrencies like Bitcoin or Ethereum — due to Ripple providing a preferred list of validators. This centralization has been a point of controversy and debate within the crypto community.

Who created XRP?

The XRP Ledger was created by Jed McCaleb, Arthur Britto, David Schwartz and Chris Larsen. McCaleb, Britto and Schwartz began development of the XRP Ledger in 2011, finishing the code in 2012. 

Once the blockchain went live, a new company received 80% of XRP to build out ways to use the cryptocurrency. This company was called NewCoin, then OpenCoin. The founders argue that Ripple itself did not create the cryptocurrency, only that they did as individuals and that its supply was gifted to a company that later became known as Ripple.

How to mine XRP?

Unlike other popular cryptocurrencies like Bitcoin and Ethereum, Ripple's XRP does not require mining. The XRP Ledger, on which the Ripple network operates, employs a consensus mechanism that eliminates the need for mining. 

Therefore, the concept of mining Ripple does not apply as it does in other cryptocurrencies, since all tokens already exist and are gradually released into the market.

SEC vs. Ripple litigation

The most significant ongoing legal battle involves Ripple and the United States Securities and Exchange Commission (SEC).

This litigation, initiated in late 2020, has significantly impacted XRP's market position and has been a source of uncertainty for the cryptocurrency's future. The SEC alleged that Ripple Labs, along with two of its executives, conducted an unregistered securities offering by selling XRP, which the SEC classified as a security. They claimed that Ripple Labs raised over $1.3 billion through offering XRP.

Ripple Labs, however, disputed this classification. It argued that XRP performs numerous actions, such as acting as a means of exchange, that make it not a security. They contended that they have not violated securities laws and that the SEC's action was an overreach of its authority. 

In June 2023, Ripple won a partial legal victory with the SEC when a judge ruled that, though the direct sale of XRP to institutional investors constituted unlawful securities sales, Ripple using "blind bid" sale (not knowing who the buyer is) did not break securities laws. 

In October 2023, the SEC dropped claims that Garlinghouse and Larsen violated securities laws. This was a move that allowed the agency to more quickly appeal parts of the case it previously lost.

Ripple's continued resistance against the SEC's allegations has resulted in a prolonged legal battle with an uncertain outcome. This ongoing litigation has raised questions about the regulatory landscape for cryptocurrencies and the potential implications for other digital assets.