Next up in our "5 Things Every Financial Services Professional Needs To Know For 2018" blog series, we will cover Ripple - a blockchain-based service that is being used successfully in the financial services arena as a settlement infrastructure technology — particularly in the areas of payments and foreign exchange.
Collaborating author: Grant Nel
We live in a world where we are exploring other planets, self-driving cars are in the headlines and over three billion people are connected online, yet cross-border payments take days, if not weeks, to settle. It is currently faster to move money from New York to London by taking it on an airplane and flying it there rather than waiting for a traditional banking transfer to settle.
Currently, global financial institutions rely on a relatively antiquated and cumbersome process to transfer funds that may take several days to formally settle. Through settlement systems, messages are sent (via SWIFT – a banking messaging network) to corresponding and/or settlement banks requesting that funds be debited/credited to particular accounts. Banks who do not have a direct relationship with each other may need to either ‘hop’ the transaction across several institutions, adding time (2-4 days) and complexity or maintain bilateral accounts (causing a decrease in cash reserves). According to a McKinsey Global Payments 2016 report, the outstanding balances on transactional accounts was in excess of $27 trillion at the end of 2015.
Ripple claims to be ‘redefining the way that value moves around the world’ by providing a blockchain-based technology that streamlines and accelerates the transfer of funds across country borders. It allows banks to connect directly through its global, real-time settlement network– known as RippleNet. Ripple allows banks to continue to use the standard messaging types for communication between them. However, as it connects banks ledgers directly, it adds value by enabling payments to settle in minutes, if not seconds, at lower costs while reducing operating expenditure and freeing up liquidity.
So how does it work?
Step 1: Payment Initiation - Ripple will automatically find the fastest way to route a transaction between sender and recipient banks within RippleNet and will calculate the payment costs.
Step 2: Pre-transaction Validation - Compliance screening and account verification checks are performed by each bank through existing message types such as SWIFT FIN or ISO 20020 thereby pre-validating the payment to facilitate straight through transfer.
Step 3: Cryptographic Hold of Funds (Secure locking of funds) - Cryptographic holds are placed on the funds across the two/three bank(s) ledgers, which cause the funds to be securely locked until the transaction is either completed or fails. Cryptographic holds act like escrow accounts, where the funds are maintained until certain criteria are met. Digital signatures are created to verify that there are holds on all required funds for the transfer. Then all funds are simultaneously released across the ledgers. There is no settlement risk as either they all release at the same time or funds are returned.
Step 4: Confirmation - Ripple provides confirmation to all banks that the transaction was successful, and the banks ledgers are updated.
The above process can work with or without a cryptocurrency (also referred to as digital/virtual currency). The most widely-used software solution used to access RippleNet is xCurrent, which does not utilize any cryptocurrency.
Ripple also allows banks to utilize its native cryptocurrency called XRP through its xRapid product. This allows banks to further decrease the costs involved as it reduces the number of participants needed in a transaction and allows banks to free up additional liquidity.
Why leverage Ripple?
The end-to-end transfer process takes minutes with the benefit of visibility of the transactions throughout. As settlement occurs simultaneously with the transaction, reconciliation and other operating expenditures are significantly reduced.
Who is using Ripple?
Ripple has over 100 clients so far, the majority of which are using xCurrent. xCurrent functions as explained under ‘So how does it work?’ above and high-profile companies using xCurrent include: Standard Chartered, MUFG Bank, BMO, Axis Bank, UBS, RBC, Westpac, Credit Agricole, Santander and American Express.
As Ripple currently connects banks and not individuals, it can ensure that all the regulatory steps are met within the process. It also allows banks to perform their own due diligence during the pre-transaction validation step.
However, Ripple’s cryptocurrency, XRP, is not yet in the clear. Securities and Exchange Commission (SEC) officials have recently clarified that the cryptocurrencies Bitcoin and Ether are not securities, thus exempting them from federal security laws. However, they have held off commenting about Ripple’s XRP, the third most valuable cryptocurrency.
Ripple believes its latest product, xRapid, will soon be adopted by major banks. xRapid works similarly to xCurrent however it leverages XRP, Ripple’s native cryptocurrency, to provide the liquidity for settlement. This allows for quicker transactions, lower exchange conversion fees and lower transaction costs. Time will tell if Ripple is able to live up to the hype!