The Two Sides of Ripple

 December 31, 2017

By

 Guy Ettlin

The Ripple token XRP has had a very successful close to 2017. There has been a 10-fold increase in price over the course of a month with XRP trading at $2.30 at the time of writing. This could be due to speculators pushing up the price, as is likely happening with many coins that have enjoyed recent record highs. But as many have pointed out, Ripple is worth looking into as an investment option for the long-run because its value proposition is uniquely promising, considering it could replace SWIFT as the global choice for international settlements.

A Two-Step Process

However, recent sources have also pointed out that the value of the company Ripple doesn’t necessarily translate into true value underlying the XRP token that people have been buying into. A closer look at Ripple’s strategy to bring international banks on board their mission unveils that the company, in fact, appears to be planning on using two steps to achieve their ultimate goal of becoming the go-to system for settlements.

The first step involves getting banks excited about their underlying technology by offering a system called xCurrent. This is Ripple’s enterprise software solution that lets institutions tap into the powerful and efficient system for cross-border payment processing that the company Ripple has developed. It supposedly saves users significant portions of their funds on top of speeding up the process and increasing security. In short, it connects banks more efficientlybut doesn’t necessarily get rid of the set-up used in SWIFT settlements whereby banks need to fund Nostro and Vostro accounts and decide on the interval of settling these accounts and the rates they will use. In other words, banks need to maintain parts of a rather inefficient system, but they can send any currency they want using xCurrent and do not need to buy large amounts XRP tokens to conduct settlements. In fact, they only need enough XRP to pay the network fees associated with each transaction.

Because this still involves some inefficiencies, Ripple proposes that banks use XRP to settle transactions. This is the currency that is native to the network and brings about even greater savings. It is advertised as a be-all and end-all solution to cross-border payments, and that is effectively what long-term investors are betting on when they buy XRP. This will come about once XRP is the universally accepted token for settlements on the Ripple network, held and trusted by all members of the network.

Looking at this two-step approach, it appears that the company is using a type of foot-in-the-door technique to get banks on board, only to sell the main solution to them in a second step.

Step one is already happening very successfully but step two is still quite far away. This is because of the risk of using XRP in the settlement process. Banks will only use the token if the price is relatively stable and not motivated solely by beliefs about its future price track. They are interested in settling transactions in the cryptocurrency that is the globally accepted reserve option. It is questionable whether XRP is on the path to becoming the said option. Both parties to the transaction would need to be willing to hold and exchange XRP at any given time.

What Does This Mean for Investors?

It is easy to fall into the trap of thinking that investing in XRP means investing in the company Ripple. This is only partially true.

Ripple, the company, has come up with arguably one of the best applications of the blockchain technology in existence. The ultimate mission of the company remains the same, but unfortunately buying XRP doesn’t exactly translate into buying a stock in the company. XRP will only truly take-off once it is universally used by all banks using the system and at a stable price that doesn’t raise currency risks in transactions. Banks will not care how much a single token is worth because it is simply used as a bridge currency, but since supply is limited, one can bet on daily transaction volumes being high which needs to be sustained by a limited amount of tokens carrying value from A to B, therefore putting upward pressure on the price of XRP. 

In such a scenario, investors could be confident that they are putting faith in a token that has real, tangible and measurable value. This stands in contrast to a scenario in which XRP becomes more valuable simply because everybody believes that it has value that translates into a higher trading price. There are many obstacles on the path of achieving the former, including the question whether XRP will be globally trusted and accepted. While XRP will enable banks to more easily tap into new and expanding markets, it remains open whether this is a strong enough incentive to use it. Ultimately, one of the main questions to be answered is whether at some point in the future the benefits of the savings associated with using XRP on the Ripple network will outweigh the risks associated with using the token in the eyes of the financial institutions using the technology.

Conclusion

As of right now only the network fee of a transaction needs to be paid in XRP and that is likely not a strong enough market force to justify the recent price hike. Therefore it is reasonable to assume that a lot of speculative value is currently driving the XRP trading price, which is fine in the short-run but likely not sustainable in the long-run. This means investors planning to buy and hold XRP need to be aware of the delicate structure of Ripple’s value proposition and need to decide how much value (i.e. how much price saving on behalf of the institutions using the network) they truly see over a longer time horizon.

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