Businesses exploring the best way to receive international payments in 2023 are quickly discovering that they have no shortage of options to accept foreign currency from foreign customers. And that includes blockchain-based cross-border payment solutions like Ripple. The American technology company has long had a mission to “build breakthrough crypto solutions for a world without economic borders” – but how do blockchain-based cross-border payments work and should your organization use them?
Making foreign payments using traditional banking systems means establishing multiple intermediaries between the payer and payee. And as each link in the chain charges a fee to facilitate the transaction, the cost of international payments mounts. In addition, those transfers may be delayed if cross-border payment requests coincide with a weekend or public holiday. The pre-financing of foreign accounts also blocks working capital.
Ripple’s blockchain-based cross-border payments, on the other hand, promise settlement in seconds, not days. And transaction costs are kept low by removing middlemen from the equation that are no longer needed to provide customers with competitive last-mile payment rates.
How Does Ripple Work?
Ripple’s solutions are built using the XRP Ledger, a blockchain for IOUs and enables transactions between different types of payments. The digital ledger has a number of features that make it attractive to fintech providers looking to modernize financial services, including on-chain escrow that can pass and release XRP once payment conditions are met.
Using XRP as a digital intermediary, Ripple operates cross-border payment settlement in more than 50 countries, allowing users to send different currencies using the blockchain-enabled system. Senders receive a fiat-to-fiat quote on prices and FX, and payees can be paid immediately in their chosen currency.
Ripple is an interesting case study of how fintech providers are using blockchain to modernize financial services. Rather than competing with traditional banks, Ripple is reaching out to them by offering its digital currency payment rails as a fast, more efficient alternative to older systems like SWIFT.
Ripple vs SWIFT
SWIFT, a member-owned global cooperative specializing in secure financial messaging services, connects more than 11,000 banking and securities organizations. And the organization headquartered in Belgium has customers in more than 200 countries, giving it an edge over Ripple.
But announcements by SWIFT, such as a successful experiment to move tokenized assets using its infrastructure, show that even dominant players must adapt to a financial future that may increasingly rely on blockchain.
A common criticism of cryptocurrencies is their energy needs, with Bitcoin miners driving up the profits of energy companies and chip makers. A move from proof-of-work to proof-of-stake reduces this carbon footprint by reducing the computing requirements of running a digital ledger. Instead of mining cryptocurrency, users can earn rewards by staking their cryptocurrency to participate in the blockchain’s consensus mechanism.
The safety net stems from the idea that stakeholders don’t want to put their locked-up cryptocurrency at risk by trying to add invalid blocks to the chain. But there are fears that proof-of-stake networks could become centralized if a large amount of cryptocurrency is controlled by just a few actors.
The XRP ledger, which underpins Ripple, gets around this by using a different method to reach consensus on adding blockchain assets. XRP uses what is called a federated byzantine agreement, which relies on validators overlapping in their approval of yet-to-be-added transactions. For example, if 80% of validators agree on adding a block to the chain, those details are assumed to be trusted.
And nodes have their own unique node lists (UNLs) of validators, which they believe provide reliable information – and delete them if they fail to reach consensus. Overlap between UNLs ensures continuity throughout the community, with the XRP Ledger drawn to proven validators and shying away from untrusted nodes. But there may be a catch.
A study by researchers at KAIST in South Korea on Stellar — a cryptocurrency that also works using the federated Byzantine agreement method to reach consensus — showed that instead of encouraging decentralization, the approach could become dependent on certain key nodes.
“We show that all nodes in Stellar cannot perform SCP [Stellar Consensus Protocol] if only two nodes fail,” the KAIST team writes in its paper. “To make matters worse, these two nodes are managed and controlled by a single organization, the Stellar Foundation.”
And like Stellar, Ripple has its own validators, which can be problematic if those nodes are the dominant link between the various UNLs. Also, blockchains are not bulletproof and have residual failure modes – something David Schwartz, Chief Technical Officer at Ripple, admits.
“It is important that we continue to innovate to reduce the likelihood of them occurring and reduce their severity, even if it is a bit embarrassing for the industry to point the finger at these failures,” he said on Apex – the XRPL development summit, talking about the ongoing evolution of the XRP Ledger.
— RIZ.XRP ☀️ (@RizXRP) July 19, 2023
In Ripple’s case, the ledger could halt its forward progress if too many validators fail before people can respond to the problem. And, as Schwartz points out, the goal is to have ledgers that provide maximum reliability. That’s why developers are working on solutions like Negative UNL – a hallmark of the XRP Ledger consensus protocol designed to improve “liveliness”.
“Using the negative UNL, servers adjust their effective UNLs based on which validators are currently online and operational, so that a new ledger version can be declared validated even if several trusted validators are offline,” explains the latest XRP Ledger documentation.
Given the roller coaster ride cryptocurrencies have been on recently, it is promising to see fintech companies being transparent about potential weaknesses. And if these are signs that blockchain developers are building solid and well-tested foundations, digital ledger projects may still live up to the hype.