Ripple’s blockchain has been developed to enable fast and cheap global transfer of money. It enables real-time gross settlement that aims to make global payments as fast as sending an email. With Ripple, users make payments to each other by using cryptographically signed transactions denominated in either fiat currencies or Ripple’s internal currency (XRP).
To help us understand how the protocol works, let’s use the Hawala system to explain, which is a method of transferring money without any actual movement. Suppose Ian works in the US and wants to send GBP 100 back home to Jane who lives in the UK. He gives his bank (called a Gateway in Ripple’s lingo) the money and a password which he shares only with Jane. The bank will inform Jane’s bank to release GBP 100 to anyone who knows the password.
After Jane comes and states the password, she is given the money. Ian’s bank now owes Jane’s bank an equivalent of GBP 100. The two banks can keep an IOU (I Owe You) trust between themselves in the hope that another transaction will happen in the opposite direction.
Because trust is involved between the two gateways, what happens if Ian’s bank does not trust Janes’ bank? We would need to find an intermediary agent who trusts and is trusted by the other two. Ripple works by finding the shortest trust chain from the start agent to the end agent, or if no trust chain can be found, the value can be transferred using XRP, the resident coin in the network.
For XRP-denominated transactions, Ripple can make use of its internal ledger, while for payments denominated in other assets, the Ripple ledger only records the amounts owed, with assets represented as debt obligations. Every agent places a value of anything they trade in expressed as XRP.
If there are no trust relationships, then Jane’s agent will receive XRPs equivalent to GBP 100 from Ian’s agent. If Jane has an XRP wallet, Ian could send XRP directly to her, and she can in turn simply go to an agent that accepts XRP in exchange for GBP.
Each transaction across the network uses a hundred thousandth of an XRP. The longer the trust chain, the more the fee. If the transaction is done via XRP, the fee is just 1/100000 XRP, and the settlement is instant and the fee is burnt forever.
Transacting could be free, but then that would expose the network to loop attacks that would effectively shut it down as no money is being expended.