Much of the criticism of Ripple's valuation has focused on XRP, its platform's native cryptocurrency. Critics say that XRP cryptocurrency has not gained sufficient traction among businesses to warrant its current valuation. XRP's traction can be interpreted as its valuation as an asset or transaction medium between banks on Ripple's platform.
In effect, the role of XRP in Ripple's ecosystem has become a critical determinant of Ripple's overall market valuation. Amid the general brouhaha, however, XRP'sutility within Ripple's ecosystem of products remains somewhat of a mystery to some.
Key Takeways
- XRP is the token used on the XRP Ledger to facilitate transaction fees and costs and to provide liquidity.
- XRP is publicly available for purchase or trade on exchanges.
- The Ripple ecosystem was designed to enhance cross-border financial transactions by banks and financial institutions.
What Is The Role Of XRP In Ripple’s Ecosystem?
Current cross-border transactions occur between siloed technology systems that are not connected. Ripple uses an interledger protocol, which enables the routing of payments through interconnected ledgers to connect these systems.
Think of it as being similar to TCP/IP, the protocol that underpins internet systems and enables disparate computers and systems to talk to each other. The ledgers that constitute this protocol can be a part of the financial institution’s network or be trusted nodes in a network that spans multiple entities. The overall system technology is designed to increase transaction processing speed for cross-border transactions.
As clever and future-forward their technology may be, interledgers still do not solve the problem of pre-funding fiat currencies in accounts for foreign exchange transfers. Known as nostro and vostro accounts, they are managed by financial intermediaries, such as banks and money transfer agencies, at either end of a transaction to ensure liquidity for their foreign exchange transactions.
This is where XRP comes in.
Ripple’s products use XRP to ensure quick liquidity. xRapid, another Ripple product, uses XRP as a “bridge asset” or an asset that businesses and financial institutions can use as a bridge transfer between two different fiat currencies. In such a scenario, the financial institution can purchase an equivalent amount of XRP and send it through Ripple’s network. Ripple refers to it as “third-party liquidity provisioning” and states that it is ideal for banks that do not have a corresponding relationship with each other.
As a cryptocurrency, XRP has lots of use cases. It can act as a currency, a security, a commodity, lending, or as a utility token.
XRP as a Currency
Ripple's solution is not a new concept. In fact, XRP's role can be considered similar to the U.S. dollar's role in international markets. The greenback, or the U.S. dollar, is the bridge currency used for numerous international trade transactions and currency conversions. It is especially useful for conversions between thinly traded currencies on international markets. For example, a conversion between Kyrgyzstani som and Japanese yen would be routed through U.S. dollars.
While it can also be used in xCurrent and xVia, Ripple's other two products, XRP transactions in xRapid, have certain advantages. According to Ripple CTO Stefan Thomas, XRP is quicker and cheaper at fractions of a penny and about three seconds faster per transaction compared to other digital assets. XRP also offers other advantages: using XRP, banks can source liquidity on-demand in real-time without having to pre-fund nostro accounts.
But transactions using XRP come with their own set of risks. For starters, XRPs bridge asset status means that financial institutions are dependent on Ripple to provide liquidity for transfers. Its supply and demand determine transfer value and count as an external risk. That risk is magnified if you consider the inherent dangers of using a cryptocurrencytraded in volatile markets. For example, spikes or crashes in XRP's value could hinder transfers and increase or decrease their value.
XRP as a Security
In February 2018, the United States Securities and Exchange Commission (SEC) alleged that Ripple Lab executives Bradley Garlinghouse and Christian Larsen manipulated the XRPprice by slowing down or speeding up sales depending on the market. The SEC accused Garlinghouse and Larsen of creating “information asymmetry” that allowed them to continue selling off XRP at a “substantial risk to investors.” The crux of the accusation was whether XRP could be deemed a security offering.
In 2020, former Commodity Futures Trading Commission Chair, Chris Giancarlo, arguedthat XRP should not be deemed a security offering because it did not fit the criteria of the Howey test. However, a potential conflict of interest was apparent because the law firm Giancarlo represented—Willkie Farr & Gallagher LLP—also acted as legal counsel to Ripple.
In July 2023, a judge issued a summary judgment declaring that XRP was a security when it was offered to institutional investors. The judge determined that when XRP was sold on exchanges in blind transactions, it was not considered a security.
How Does Ripple Work?
Ripple Labs, Inc. is the business that created the XRP Ledger and the cryptocurrency XRP. XRP is used to pay for transactions and as the exchange medium that bypasses the slow and sometimes inaccessible traditional cross-border payment system.
How Risky Is Ripple?
As a company, many factors affect Ripple's ability to conduct business. Regulations, demand for its services, and many other influences must be overcome to remain profitable. The cryptocurrency XRP is as volatile and risky as other cryptocurrencies.
Why Would Banks Use XRP?
Ripple designed the XRP Ledger to accelerate cross-border transactions with banks and financial institutions in mind. Banks can benefit from XRP because it is instantly convertible to other currencies, and transaction times are measured in seconds rather than hours or days.
The Bottom Line
XRP has an underlying role in Ripple's activities and products. Exactly what that role is and the dependencies and influence that may exist between the two are not yet fully understood. They may never be as long as cryptocurrencies are unregulated and their definition as a currency or investment is undetermined.
The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read ourwarranty and liability disclaimerfor more info. As of the date this article was written, the author owns 0.01 bitcoin.
