First Bitcoin, now Google-backed OpenCoin: a new disintermediation threat for banks

Solomon Teague
Published on:

The success of electronic currencies such as Bitcoin has turned the worlds of currencies and payments systems upside down. The latest player to join this game is OpenCoin, which in April received seed capital from a consortium of venture capitalists, including Google Ventures. Rather than becoming merely another payments system, OpenCoin is looking to be a paradigm-changing payments system that disintermediates traditional bank platforms.

OpenCoin’s innovation is Ripple, a payments network that allows users to trade any currency in the world, including bitcoins as well as ripples – its own proprietary currency. It has been dubbed the “world’s first open-payment network”.

Ripple allows people to send money anywhere in the world, quicker and cheaper, it says, than any other payments system.

It creates a single environment in which people on opposite sides of the world can trade, without recourse to the silos – credit card processing companies, currency exchanges and banks – that each add a layer of cost and delay to a transaction.

“It is the fastest payments system ever built,” claims Patrick Griffin, executive vice-president of business development at OpenCoin.

Trades can be conducted between any currency pairs, searching for liquidity wherever it is found on the network – which hosts many market makers – at a rate that tracks the interbank wholesale rate.

If there is no liquidity available for the desired pair – between two small, emerging markets currencies, for example – the gap is bridged by ripples, with the transaction completed via two pairs trades. And there is no limit to the size of transactions – an advantage but also a considerable risk, making it particularly important for users to protect their log-in details.

In its current, embryonic state, Ripple is likely to appeal to those wishing to make expensive, cross-currency payments that would usually be handled by systems such as wire transfer – for example, remittances from overseas migrant diasporas.

However, its potential is vast, and considering the speed at which payments are made – a matter of seconds – its backers hope the network could become as ubiquitous as a phone line.

“Some would consider us to be like MasterCard, but the ultimate vision of Ripple is more akin to that of an infrastructure vendor like FIS Global,” says Griffin.

It is a peer-to-peer, self-regulating and self-perpetuating network, running across any and multiple servers, making it immune to problems in any single location, akin to the peer-to-peer file-sharing service BitTorrent.

By contrast, Bitcoin’s over-reliance on a single-server exchange, MtGox, contributed to the crashing of the currency in early April.

The transaction history of every node in the Ripple system is public, going back to the genesis of the node, and can be audited by a regulatory or law enforcement authority. However, its decentralization puts it beyond the reach of any one central organization and means it cannot be shut down, says Griffin – even by OpenCoin itself.

Ripple says it created 100 billion ripples and no more can be created, protecting the value of the currency from future inflation. Each transaction is subject to a tiny cost, one one-hundred-thousandth of a ripple, or one one-thousandth of a US cent.

This value is permanently destroyed in the system as a security feature. It ensures no trader can attack the system by swamping the market with millions of transactions to take control of 51% of the network power, which would allow them to double spend transactions – that is, spend the same money twice – at will.

The other cost associated with using Ripple to make payments will come from the third-parties that serve as gateways to the network. These are limited in number but should grow to include many of the traditional financial services companies and others, from local convenience stores to online portals.

Current gateways include: Bitstamp, serving Europe; SnapSwap in the US; and rippleCN in China.

There are opportunities for third-party providers too. Ripple was originally designed to allow phone apps, credit cards and other ancillary services to be developed to make it more accessible. Asked whether OpenCoin should be seen as challenging banks' monopoly of global payment systems, Griffin said: "OpenCoin does not compete with the banks, which should ultimately serve as important gateways to Ripple. Instead it will become a vital part of banking infrastructure."

Critics of Ripple are numerous, propelled especially by anti-establishment sentiment. Bitcoin’s anti-establishment credentials are boosted at a time when the concept of credit is in existential crisis – given perceived debasement of currencies by G7 monetary stimulus policies and a lack of trust in banking systems.

As a result, Bitcoin is seen as a democratic, grass-roots currency-for-the-people, while rightly or wrongly many seen Ripple as a corporate giant-in-waiting that will ultimately become another cog in the financial machine.

OpenCoin denies that Ripple – a payments network – and Bitcoin – an electronic currency – are in competition.

Perhaps the most frequently cited criticism of Ripple is that, of the 100 billion ripples created, only a small proportion are in circulation, with the rest held by OpenCoin.

This creates trust issues around a relatively young and unknown company, which takes on the role of central banker, using its reserves to smooth volatility and guard against future shocks.

OpenCoin says holding a small percentage of ripples ensures its interests are aligned with its users, and that it has an interest in the efficient and fair distribution of ripples to make its system run smoothly.

However, for critics, this quasi-central bank model is precisely what many were looking to escape by turning to digital currencies – especially Bitcoin – in the first place.

Instead, the hoarding of ripple reserves by OpenCoin is seen by some as evidence the primary motive of the venture is personal enrichment, rather than the refinement of payment infrastructure.

Some will always find a way to criticize people making money off a good idea, but few will deny Ripple could become a game-changer for payments systems.