Will Ripple takeover cross-border transactions?

Kristóf Hajdú, Konrád Widder, Gabriel Valenzuela

November 2018

The banking industry is currently undergoing a revolution at a fast pace. The growing popularity of FinTech disruptors is changing the traditional way of banking since conventional participants are being pushed to spark innovation and enhance existing payment systems. One of the main innovations is observed in the field of cross-border transactions. A high number of FinTech firms are trying to enter the market and replace banks as intermediaries. The current incumbent is Swift, an interbank messaging service which is handling half of the world’s high value cross-border payments[1]. But a new player seems to be taking over the industry, as Ripple Labs offer innovative solutions for payment systems, with the use of the most advanced blockchain technology, solving most of the problems that cross-border transactions are facing nowadays.

Cross-border payments are responsible for only 20% of total payment volumes; they involve around 40% of global payments transactional revenues and generated $300 billion in revenues in 2015. A significant part of this revenue has been attributed to high value business-to-business (B2B) payments with revenue margins of around 20 basis points.

The current payment systems for cross-border transactions are obsolete for a number of reasons. First of all, they are costly, annual fees surpass $1.6 trillion[2] since transaction values are between $15,000 and $20,000 on average, it indicates a fee of $30 to $40 per transaction which makes this a lucrative business for banks[3]. Secondly, it uses the methodology of correspondent banking involving several parties which makes the transaction cumbersome and slow. Finally, they have been subject to transparency issues, as the exact fees are unknown at the time of initiating the payment.

Ripple - the largest player of this segment – wants to overcome these shortcomings by offering fast, transparent and cost-effective payments to customers.

History of Ripple

Ripple’s story starts in 2004 with Ryan Figger, who created a payment protocol named Ripplepay. His aim with this system was to allow individuals and communities to create their own money.

Later, in 2011 Ripple was redefined as a digital currency system and with this change every transaction could be verified by consensus among members of the network. In the next year the Ripple team co-founded the OpenCoin Inc. which began developing a new payment protocol called the Ripple Transaction Protocol (RTXP) based on Ryan Fugger's concepts. With this protocol, individuals and companies can make direct transfers to each other using XRP (Ripple’s digital currency). Making XRP a shorter and cheaper alternative to transfer money, compared to the traditional payment systems. One year later, Ripple announced the Bitcoin Bridge which links the Ripple protocol and Bitcoin. Thus, Ripple owners can transfer money to a bitcoin address without much trouble.

In 2014, Ripple Labs decided to reach more people. Since that time Ripple allows for cross-border payments for retail customers, corporations, and other banks.

Ripple Labs co-founder, Chris Larsen said: "Ripple simplifies the [exchange] process by creating point-to-point and transparent transfers in which banks do not have to pay corresponding bank fees”[4].

At the end of 2017 Ripple became the second largest digital currency, surpassing Ethereum in market capitalization, as many big banks (e.g. Bank of America, HSBC) have started using XRP in their cross-border payment transactions.

Cost & Savings

One of the multiple advantages of using Ripple and the blockchain on cross-border transactions relies on all the savings for both the bank and the customer, as a result of the efficiency that it generates on such transactions. Santander, one of the first banks to use Ripple, has said that adopting blockchains could save the banking industry $20bn a year in back-office costs[5]. These savings are explained by the pre-funded accounts that most banks, especially in emerging markets, need to hold in order to be able to make international payments for such destinations. Ripple, eliminates this obstacle as the transactions are tied from one point to the other in real time giving the opportunity to banks to source liquidity on demand.

A good example of how Ripple lowers the costs of cross-border transactions can be found in Japan, where about 45,000 thai workers send money regularly to their families who encounter high fees in the traditional bank transfers. For thai workers, it may take up to 12 hours of work to pay for a single remittance fee which is on average $50 USD. Even after paying such amount, the quantity of uncertainties might end up taking even more time and money from the thai worker[6].

This all happens as the infrastructure for such payments is outdated and inefficient as it was created 30 years ago, that’s why Ripple Labs created xCurrent, the cross-border payment technology used by banks that partnered with the company in order to link bank accounts from Japan and Thailand having significantly lower transaction fees and offering complete certainty with an email that confirms the transaction to the remitter in a matter of minutes.

Penetration into the mainstream (day-to-day transactions)

As XRP has become the second largest crypto currency, only after Bitcoin, this surge in value follows the more than 100 banks and payment providers that RippleNet claims to have, with a stronger presence in the Asian market.

The recent surge on XRP value has put even more pressure over companies like Visa and MasterCard, who have been surpassed on speed and capacity of transactions by Ripple’s infrastructure. There have also been rumors that Ripple could have a link-up with Swift, the Belgian payment systems giant, but all has been denied by Garlinghouse, Ripple’s CEO[7].

An example of how Ripple has penetrated the market of cross-border transactions, can be observed as Santander launched a smartphone app called One Pay FX that lets customers send international payments in a matter of seconds and tells them when they will arrive in real time. Instead of the standard international financing plumbing, One Pay FX uses a closed, permission, quasi-blockchain system operated by Ripple[8]

Nevertheless, Ripple Labs keep launching new services to boost the usage of their digital currency, such as xRapid, a tool created for payment providers to speed up money transfers into emerging markets using XRP. All of these services help XRP penetrate the world of cross-border day-to-day transactions.

Improvements on electronic payments systems derived from Ripple disruption

It is clear that the disruption caused by FinTech companies has had a beneficial effect on electronic payment systems.

Financial technology can influence speed, transparency, security and costs, which are the reasons for the banks to invest huge amounts of money into FinTech to come up with improved services, as they have already seen the potential profits derived from digital currencies.

On the other hand, Swift enhanced its own messaging system to a higher level as a response to the expansion of Ripple. In order to reshape the current picture of cross-border transactions they have launched Global Payments Innovation (GPI), an upgraded service using the same correspondent banking system as previously, but with an increased speed and transparency.  What it all means to customers and businesses? As a result of the harsh competition in this segment, users will experience much lower costs, faster speed and end-to-end tracking of payments.

As every coin has two sides, Ripple has also some limitations which threaten its usage in day-to-day transactions. Basically, we see that Ripple mainly focuses on banks, so now XRP is stuck in the banking industry. Moreover, the firm has no intention to change this in the near future.

Furthermore, the main problem stems from the way XRP’s were distributed. Ripple owns 60% of XRP’s which is considered to be a high fraction compared to other crypto networks. As a result of this centralized system, users might be afraid of using Ripple since the company can easily cash out and crash the whole market. In addition to that, it also leads to increased volatility, which might scare the most risk averse investors.

Volatility

Ripple is very different in its objective to Bitcoin, but they are greatly correlated in their performance. Consequently, it has a huge volatility. To have a better perspective of its volatility, its historical maximum and minimum values of XRP were $3.28 and $0.002, which, considering the short existence of the XRP would mean that the digital currency increased more than 163,900% in value, only to lose most of these gains bringing it to its current value of $0.35. We see that the main reasons behind the hectic price movements are the lack of regulatory oversight and the fact that cryptocurrencies do not have an intrinsic value therefore investors can rely on market sentiment. Since March, its price has experienced a lot of volatility as the graph shows below.

Source: www.investing.com

Many people have been using Ripple as an investment because it is a new technology, but it has now started being used as a payment currency for cross-border transactions, where Ripple has found its new source of growth. As the financial bubble that digital currencies experienced on 2017, product of the initial hype over this new and disruptive digital asset seems to be over, the actual use in everyday transactions has become the new way for which digital currencies can expect an increase in value, giving us the expectation that in 10 years they might even replace centralized currencies. Nevertheless, Ripple could certainly become part of a new generation of payment systems that could easily spread all over the world, as a result of its advantages over traditional cross-border payment systems, allowed by the decentralized system that Ripple uses for the verification of transactions. However, its volatility should be lower than it has been recently, due to the switch from financial bubble to cross-border payment currency as the reason for the changes in the price of XRP.

Despite of this, governments could kill this idea as they have banned digital currency trading as it has happened in China and South Korea. These bans have had a tremendous impact on the price of Ripple, as those are two of the biggest markets for digital currency trading.

Most researchers analyze user sentiments related to digital currencies on social media, (e.g., Twitter) or quantified Web search queries on search engines, such as Google. Furthermore, other variables have been analyzed, such as price volatility and trading volume and although there exist many models that try to forecast digital currencies’ future performance, unexpected news can easily ruin these models’ accuracy.

Is Ripple here to stay?

There are still a lot of questions that remain unanswered about Ripple’s importance and permanence in the banking industry, but one thing is for sure, is quickly becoming the currency of choice for cross-border transactions, at least in the Asian market, where it has gained a lot of popularity. It is also clear how Ripple has changed the payment systems forever, as other competitors –such as Visa, Mastercard and Swift- are trying to catch up with the innovations that the blockchain and cryptocurrencies are bringing into the market. Even after the huge volatility seen in the past, we would expect for it to slow down and open the doors to new more risk averse investors, who could bring the cryptocurrency to an even higher status, not only in the cross-border payments but also into the everyday use. On the other hand, it will also be extremely interesting to see how the governments handle this kind of disruptions in terms of regulation and taxation for income in digital currencies. Furthermore, another subject to take into account comes from the improvements in the payment systems, generated by the introduction of digital currencies, for which the payment systems could either catch up and take Ripple out of the market, or stay below the digital currencies capacity and stay in the game as minor players.


Footnotes

[1] Arnold, M. (2018, June 06). Ripple and Swift slug it out over cross-border payments. Retrieved from https://www.ft.com/content/631af8cc-47cc-11e8-8c77-ff51caedcde6
[2] Ripple, T. (n.d.). One Frictionless Experience To Send Money Globally. Retrieved from https://ripple.com/
[3] McKinsey&Company (2016) Global Payments 2016: Strong fundamentals despite uncertain times. Retrieved from https://www.mckinsey.com/~/media/McKinsey/Industries/Financial%20Services/Our%20Insights/A%20mixed%202015%20for%20the%20global%20payments%20industry/Global-Payments-2016.ashx
[4] Team, E. (2017, March 27). Blockchain and the Ripple effect: Did it ripple? Retrieved from https://www.finextra.com/blogposting/13888/blockchain-and-the-ripple-effect-did-it-ripple?fbclid=IwAR3px0aQCUhchdIgFYnGUKGKu9-Bgml4-ho41wEW8g8Ts09WrgOlxYfogJk
[5] Nailing It; Blockchains. (2018, September 1). The Economist (US)
[6] Ripple, T. (n.d.). Banks - Global Payment Uses Cases.Retrieved from https://ripple.com/use-cases/banks/
[7] Lam, E., & Amin, H. (2018, November 13). Ripple Is Aiming to Overtake Swift Banking Network, CEO Says
[8] Nailing It; Blockchains. (2018, September 1). The Economist (US)

References


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Kristóf Hajdú

MSc Finance (Duisenberg Honours Programme in Quantitative Risk Management) at VU Amsterdam

Konrád Widder

MSc Finance at VU Amsterdam

Gabriel Valenzuela

MSc Finance at VU Amsterdam