Ripple (XRP) — What is the Right Amount of Centralization?
On Sunday, we published an in depth 64-page analysis of the XRP digital asset to our client base, which explores the project’s technology, economic measurement, valuation, and legal and regulatory risks. XRP is one of the oldest and largest projects in terms of network value, trailing only Bitcoin and Ethereum, and certainly one of the industry’s most contentious. We believe this contentiousness is largely a result of a long-standing difference between centralization and the trustless, permissionless, and censorship-resistance principles underpinning the open-source crypto movement. XRP was created and continues to be largely maintained by a central organization, Ripple Labs, a model that was unique when the asset was first created, but no longer holds true for the industry today.
Our analysis of the project is a little more even handed than the XRP commotion currently in the industry and is predicated on the observation that degrees of decentralization (or centralization), have benefits and drawbacks, particularly when your target customer is a large financial institution. The benefits of centralization are customer support, a relationship manager, and a single point of technical contact for customers, something that shouldn’t be underestimated when we keep in mind the target market. That is something truly decentralized projects often lack. Additionally, on the technical side, the centralized structure can enable better scalability, less contention when it comes to software upgrades, and lower risks of Sybil Attacks.
As for drawbacks, the centralization is in direct opposition to the open source ethos espoused by the cryptocurrency community and many benefits that the technology has created, like the aforementioned trustless, permissionless, and censorship-resistance features. These drawbacks are significant. It is true that both network consensus and software development are largely controlled by Ripple Labs. At its current incarnation, the Ripple Protocol Consensus Algorithm (RPCA) provides a “default and trusted” list of 16 servers maintained by Ripple Labs that ultimately decide upon the validity of all transactions in the network. This gives Ripple Labs great control, but if the company and its 16 default servers were to disappear, the network would most likely immediately fail to reach consensus. Validating nodes would have to manually change the config file in their servers to unknown entities, which carries several security risks and is not a user-friendly process. Therefore, it’s hard to support the argument that the XRP network would survive without Ripple Labs. This is supported by the fact that the company contributed to most of the project’s code in GitHub and holds a large percentage of XRP, 61% of the total supply, most of which is now in escrow.
We applaud the project’s transparency in terms of the its market operations, and the quarterly XRP Markets Report is exemplary. We wish more projects did this. We also think there is some interesting information that can be gleaned from the history and split of XRP sales, that we’ve highlighted to our clients.
Its decentralization strategy is also commendable and is intended to increase the diversity of the default validators in the network. However, if we look at Ripple’s mission and its core demographics, a level of centralization between the RippleNet and Ripple Labs will most likely need to continue to exist. Ultimately, whether decentralization is a requirement for what Ripple Labs is trying to accomplish comes to down to one’s personal philosophy of the value of decentralization.
We think it is helpful to think of Ripple Labs as an enterprise software company that has developed interfaces and APIs for financial institutions that in some, but not all cases, use the XRP digital asset. Its current product offerings include xCurrent, a financial institution messaging system like SWIFT, xRapid, a real-time payment platform that uses the XRP digital asset, and xVia, an upcoming payments interface that targets emerging markets. Financial institutions that use these assets make up RippleNet, the interconnected network of market participants. We note that many in the industry have reported that XRP serves no purpose, but we disagree: it depends on the software product. To that effect, Ripple Labs has had some success with pilots and actual implementations, which have the potential to increase demand for and use of the XRP token. Still, it is very early, and broad adoption continues to be a work in progress.
XRP also has some interesting technical features, like advanced payment options, a decentralized exchange, high transaction throughput (~1,500 TPS, although the current throughput is much less), and the ability for trusted gateways to issue IOUs that can represent real world assets and cryptocurrencies. Our analysis shows that 1,460 issued assets have traded on the network since its inception.
We encourage readers to parse through press releases carefully to determine whether a partnership announcement is a pilot or deployment, and whether the application, like xRapid, uses the XRP token. The broader community often reads these press releases incorrectly, which offers the opportunity for eagle eyed investors to take advantage.
Ripple Labs is a defendant in several ongoing lawsuits that present an overhang for XRP that investors should be aware of. Of greatest importance is the R3 lawsuit which could result in 5B XRP, 13% of the distributed total tokens, changing hands. There is also a class action lawsuit, which may open Pandora’s box to answer the question “is XRP a security?”, which is also important to watch. It is difficult to predict the timing and outcome of these lawsuits, but we will watch both closely.
Finally, we noticed several issues and discrepancies with publicly available XRP blockchain and token supply data the community should be aware of. We even found small data discrepancies with similarly named functions within Ripple’s APIs, which often did not match the information we pulled from the rippled node. This is something to be aware of as it will affect valuation measurements for investors.
As always, we welcome any questions and comments about our work. Our opinions are informed by the code that we analyze, software that we test, economic activity that we measure, and risks that we assess. We strive to be objective with our work and exhaustive in our due diligence process.
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