Flare Network 101: How FXRP Supercharges XRP — AAX Academy

Despite some controversies around the project, Ripple has achieved quite some success with its global payment network. As a result, the blockchain-powered payment solution is heavily used by over 200 institutional partners of the project, while its XRP cryptocurrency has been on the rise. What’s more, the upcoming launch of the Flare Network is expected to bring even more good news for Ripple.

The Flare Network is expected to supercharge XRP with new functionalities, such as smart contract support and the ability to utilize the digital asset with non-fungible tokens (NFTs), decentralized finance (DeFi) solutions, and thousands of Ethereum dApps.

But what is the Flare Network, how does it work, and what benefits will it provide for XRP holders?

Ripple Recap

Before we take a deep dive into our topic, let’s first revisit the basics about Ripple.

Ripple is a global payment network and foreign exchange system that leverages its native XRP cryptocurrency and XRP Ledger (XRPL) blockchain platform to achieve rapid and cost-efficient payments between users. In addition to serving end-users, the project has an institutional-focused product, RippleNet, that allows banks, payment firms, and other businesses to settle instantaneous and inexpensive transactions globally.

Due to the efficiency of its payment network, Ripple features numerous partnerships with key market players in the financial industry, such as American Express, Santander, and SBI Remit. On the other hand, while Ripple can achieve high scalability and speeds of up to 1,500 transactions per second (TPS), the project’s XRPL blockchain network is increasingly centralized.

The reason for that is due to the fact that the project is managed by Ripple Labs, which controls the estimated 61% of the XRP supply. Furthermore, Ripple had its share of scandals throughout its history. This includes the case of freezing its founder’s, Jed McCaleb’s, withdrawal of $1 million of XRP a few years ago, which was later escalated into a lawsuit.

Ripple also has an ongoing high-profile lawsuit with the US Securities and Exchange Commission (SEC), in which the United States regulator claims the company violated investor-protection laws by selling $1.38 billion of XRP to customers in unregistered offerings. That said, while the lawsuit caused some panic at first, XRP has been doing well after Ripple scored some major wins against the SEC.

While the cryptocurrency’s price was standing at $0.222 on January 1, 2021, it surged to $1.45 by May 19, achieving a year-to-date (YTD) ROI of over 550%.

What is the Flare Network and How Is it Related to Ripple?

Flare Network is a highly scalable distributed blockchain network utilizing the Federated Byzantine Agreement-based (FBA) Avalanche consensus mechanism.

Unlike the XRP Ledger (XRPL), Flare integrates the Ethereum Virtual Machine (EVM) and natively supports smart contracts. Most importantly, Flare has the capability to create two-way bridges between different blockchain networks to achieve trustless interoperability. Simply put, this means that it can connect with other chains to expand their networks’ and native tokens’ functionalities by, for example, integrating smart contracts.

And this is when Flare comes in handy for Ripple as it can act as a bridge between the XRP Ledger and a smart contract platform like Ethereum.

As a result, XRP will have smart contract functionality with the ability to use the cryptocurrency for dApps, DeFi solutions, and NFTs.

What Problems Does Flare Seek to Solve?

According to the project’s creators, there are two key issues Flare seeks to solve.

First, 75% of the value existing in blockchain networks can’t be currently utilized in a trustless manner via smart contracts. Second, the project argues that smart contract platforms based on the Proof-of-Stake (PoS) consensus mechanism or its variants (e.g., DPoS) are expected to face significant security-related issues in the future.

According to the Flare team, PoS-based networks derive the safety of their networks from their native tokens. Here, they use a process in which validators lock up cryptocurrency in their wallets to verify transactions and blocks in exchange for receiving staking rewards. While this allows the network to remain secure, it doesn’t offer safe alternate use-cases for the platform’s native token.

For example, suppose lending ETH via a DeFi protocol offers a 30% annual percentage yield (APY), and staking the same token only offers a 5% APY. In that case, most users will choose the prior option as it provides much better returns.

A scenario like the above takes away a crucial portion of native tokens from staking, making the network less resilient against external threats. For that reason, the native tokens of cryptocurrency projects based on the PoS algorithm have to maintain a price increase to match the value growth of applications built on top of the blockchain (e.g., DeFi protocols). In other terms, the total value locked (TVL) in staking the native token has to be equal or higher than the TVL in protocols built on top of PoS-based blockchains.

According to Flare’s creators, while this creates a beneficial scenario for investors (as they can make larger profits from the cryptocurrency’s long-term value appreciation), it is not an ideal case for network participants utilizing the token for everyday activities.

As capital is diverted from other uses to secure the network, it would significantly increase commerce costs, the project’s team argues.

Flare Network seeks to solve the above two issues of PoS-based chains by utilizing the FBA-based Avalanche consensus algorithm and eliminating the link between the value of its native Spark (FLR) token and the ecosystem’s security. While the blockchain solution still uses Spark to operate, the digital asset is mainly utilized (in terms of security) for discouraging users sending spam transactions.

Since Spark is not utilized for providing validators economic incentives, Flare Network can enable the trustless usage of smart contracts with cryptocurrencies that otherwise don’t support them.

What Is FXRP and How Does it Bridge XRP With Other Blockchains?

FXRP is the trustless representation of Ripple’s XRP token in the Flare Network. At the same time, it also refers to the protocol on top of Flare that makes this possible.

For that reason, FXRP is a big deal for Ripple as it bridges XRP with other chains, allowing the cryptocurrency to support smart contracts while offering holders the chance to utilize it in DeFi solutions and a massive number of dApps via Flare.

How Does FXRP Work?

With FXRP, any XRP holder (called originator) can send the cryptocurrency to a set of addresses (called agents) on Ripple’s blockchain.

As the next step in the process, agents will mint the originator FXRP on Flare via smart contracts. The newly issued FXRP features a 1:1 value peg with XRP while being secured with Spark tokens.

In case a user seeks to redeem his FXRP for XRP, he sends the prior token back to the Flare smart contract. After that, the agents will transfer the equal amount of XRP to the user’s address on the XRP Ledger.

Interestingly, if the agents fail to send the XRP to the user within a specific time, the network will compensate him his XRP holdings’ value along with an extra amount of coins that covers the transaction fees for repurchasing the digital asset. The most important aspect of FXRP and other interoperability protocols on top of Flare is that the whole process in which two chains are bridged (and the native token of one is moved to the other) is decentralized.

This contrasts with how Wrapped Bitcoin (WBTC) is issued on Ethereum by moving BTC from the Bitcoin blockchain to the smart contract platform. While WBTC allows Bitcoin to be utilized across DeFi protocols and other Ethereum dApps, the process to achieve that requires centralized custodians to hold BTC as collateral and mint (and later redeem) WBTC, which are transferred to users by merchants.

On the other hand, there is no need for centralized custodians in the Flare Network to bridge blockchains. Instead, a large number of agents provide Spark as collateral for each protocol on top of the chain, which includes FXRP. Interestingly, just like users borrowing crypto-backed loans in the digital asset space, agents have to deposit more collateral than the value of the FXRP tokens they can mint. While the XRP-FXRP peg stays at 1:1, the collateral ratio is 2.5. In practice, this means that the value of the Spark tokens agents deposit has to be 2.5 times more than the value of one FXRP token. Flare requires agents to maintain the 2.5 collateral ratio (by mostly purchasing more Spark if the collateral’s value falls against FXRP) at all times.

It’s also important to mention that the agents’ Spark gets locked up in a smart contract after minting tokens. If an originator redeems their FXRP for XRP, the network releases the agent’s collateral back to him. In exchange for providing collateral for minting tokens, originators pay a creation fee to agents in XRP, which incentivizes the latter parties to support the network. At the same time, Flare punishes agents for bad behavior.

When an originator seeks to redeem his FXRP for XRP, the network provides the agent two deadlines. If he can only meet the second deadline but not the first, he gets his collateral back but with a small penalty fee charged. In case the agent misses the second deadline as well, Flare will consider this a redemption failure, in which the network burns 50% of his Spark collateral and returns the other 50% to him.

Simultaneously, the originator receives 1% extra after his redeemed XRP to cover the costs of token buybacks.

Flare: Supercharging XRP With Increased Functionality

Originally published at https://academy.aaxpro.com on May 20, 2021.