(Note: this post assumes some knowledge of Ripple. I recommend reading this introduction first if you aren’t familiar with it.)
Ripple is a project to create money out of IOUs in trust networks. Recently I’ve been learning a lot about Ripple and have been working on an implementation with a friend called Pebble (more on that soon.) In a nutshell, Ripple proposes that money can emerge from IOUs issued between trusted peers, and the ability to route payments to people who are not in your immediate network through trusted intermediaries. If you want to pay Mary for something, but she isn’t in your trust network (i.e. she doesn’t trust your IOUs,) you can still pay her if John accepts your IOUs, and Mary accepts John’s, and so on.
From writing and talking about Ripple, and working on Pebble, I’ve encountered a number of intriguing criticisms of the project. In the interest of documenting and exploring these, I’ve written this post with the most common ones. I’m also interested in defending Ripple a bit – as I think the system is much cleverer than its critics often give it credit (?) for. If you know of any other criticisms which haven’t been addressed in this post, feel free to add them to the comments. Now, in no particular order…
#1 Debt is bad, and especially bad between friends. Why base Ripple on debt?
This is a very common objection to Ripple. There are a number of assumptions which need to be dealt with before addressing the role of debt the system, though. The first is that debt is not bad. In fact, debt is the foundation of all monetary systems, across history. Whenever you supply goods and services, and rely on a ‘token’ representing your right to be paid back something of equivalent value, by someone else, you are creating a relationship of debt. The debt may be between two people, or between a person and society. A person who has a lot of money owns a lot of claim-cheques on society’s production – society is effectively in debt to that person.
On a broader level, debt is an essential means for businesses to gain capital and grow. Without debt, businesses would find it extremely hard to invest and create wealth. Since wealth of all kinds is essential to life to some degree, it’s hard to see how we could live without some amount of debt.
The second assumption in this criticism is that Ripple is all about IOUs between friends. Although it certainly can be used by friends – just as friends use money and IOUs in real life – Ripple is founded on relationships of trust. People who trust each other don’t necessarily need to be friends. The majority of transactions involve some degree of trust. On eBay, buyers and sellers trust each other without knowing each other, using reputation points as a proxy. In the ancient system of Hawala, money changers around the world transfer funds between countries by keeping ledger accounts with each other – a system entirely dependent on trust. When banks make loans, they make a decision based on trust. In none of these cases is friendship necessary to perform the transaction.
Having clarified these two points, it’s worth considering that there is some merit to reservations about debt between friends, even though that is not the core use case for Ripple. Friendships can be undermined by debt, business, and money in general. However, there will always be some place for money in friendships. Not all exchanges between friends are based on gift economies. Social situations where there is an expectation of an exchange of money are actually quite common: splitting the bill over meals, paying for tickets, making a short term loan, and buying something from a friend are all situations where Ripple can come in useful. The important point is that Ripple doesn’t attempt to further monetise friendship – rather, it provides a way for friends to keep track of IOUs where they would otherwise use money, anyway.
When I first starting working on Pebble, one of my reservations was that introducing IOUs into my social life would create some awkwardness. Strangely, I found the opposite happened. I mainly used Pebble at work, to pay back a friend for lunch and coffees when one of us was short on cash. The social effect is actually quite good: you are using Ripple, instead of directly handling money, which can be considered less offensive. (As Bob Dylan said, “Money doesn’t talk, it swears.”) Also, the act of recording an IOU on Ripple actually encourages trust – it implies that you are not going to rely on memory alone to remember to pay someone back. This is really less awkward than might be imagined.
#2 If you need money to make good on IOUs, why use IOUs in the first place?
This is another interesting criticism, which partly rests on another misunderstanding. A Ripple IOU is denominated in money, and can originate out of a monetary transfer (for instance, when you borrow money from a friend, you might Ripple them an IOU back.) However, it’s important to understand that Ripple is agnostic to the underlying transaction it records. Ripple IOUs could be issued to buy apples, piano lessons, to borrow money, or in fact anything money is commonly used for. Likewise, IOUs can be paid back in the same way – in goods, services, money or as a gift. Ripple does help record monetary debts, but is as good for any debt which can be expressed in monetary terms. (As David Graber has argued, some debts are infinite – for example, to the gods.)
#3 I want bread, but the baker who made it doesn’t necessarily want anything I’ve got. So why would the baker accept a Ripple IOU as payment?
This is one of the most interesting criticisms of Ripple, as it calls attention to the fact that our economic lives tend to be very asymmetric: we work for one employer, earn money, and spend it all over the place on all kinds of goods and services, from myriad producers. The problem which might seem to exist within Ripple is that IOUs require symmetry. If you pay the baker for a loaf with an IOU, the baker is going to need to redeem it from you somehow. Yet, you might have nothing to give back to the baker. This will usually be because as employees of organisations, we don’t produce anything personally – our production is the result of a complex social process involving many other people, and over which we don’t have direct control. Many of us are not artisans – producing goods and services by ourselves. Even if we were, the baker still might not want anything we can produce.
This criticism carries some weight, but it isn’t a knock-out blow to Ripple, because it fails to account for the role of credit routing. Credit routing, as explained, is the process whereby one person can pay another person who doesn’t trust their credit, by sending an IOU through a trusted intermediary. This means that while the baker doesn’t have much use for my IOU, he does have use for something else which I can offer: my credit network. If I am trusted by lots of peers, the baker can use my IOU to buy something he needs from someone he needs to pay, by using me as an intermediary in a payment chain. The IOUs of a person with a large number of connections is going to be very useful to the baker. I expect that as Ripple becomes more advanced, we will be able to quantify and see the numbers of relationships and amount of trust a person has before accepting their IOUs (assuming you don’t know them personally.) Finally, Ripple is an architecture of participation: the more connections people form, the further their IOUs can travel, increasing their purchasing power from the rest of the network.
#4 It’s too hard to build a sufficiently large, connected credit network to make Ripple successful.
In relation to this criticism, I take the view that experimentation will decide this, rather than armchair theorising. Also, it’s important to note that even without a dense network, Ripple will be useful as a mere accountancy tool between peers. The credit routing capabilities may emerge slowly from this simpler use case.
As far as my opinion goes, I think there are some strong reasons why Ripple will see the kind of adoption and network-weaving which will make it a successful alternative to money. I think the reasons are so strong that it would be foolish to dismiss Ripple’s potential out of hand. The first strong reason was alluded to in the previous paragraphs: there are selfish reasons why people will want to grow their own trust networks. This is a good example of a complex system which has emergent behaviour based on the self-interested interactions of its constituent parts. We don’t need to rely on altruism to build the Ripple network – it will build itself, merely because as people add more connections, they will increase their own ability to spend their IOUs as money.
Another reason I’ve mentioned in a previous post is the small world characteristics of trust networks. In economic life, there will be large nodes who are trusted by a great many people. These nodes will provide the glue that binds the network together: no two nodes will ever be too many hopes away from each other, as long as they are connected to one of the network’s larger nodes. I could imagine that in the future, large trusted nodes will create businesses out of charging interest for payment routing services. In so doing, they would be even further incentivised to help build the network. But this leads us to the next criticism…
#5 Nodes with more connections will have more power in the network. Isn’t this undemocratic?
It is undemocratic – if by democratic you understand egalitarianism. However, it is fundamentally meritocratic. Those who can leverage high degrees of trust can charge money to allow smaller nodes to connect to them and use their networks. This doesn’t harm anyone – it makes a valuable service available to people who need it and are willing to pay. Much like banks, such nodes assume some risk in order to turn a profit.
Whether it would be possible for a few nodes to form a kind of cartel, extorting large fees from smaller nodes, or attempting to shut individuals or entire sections of the network out, is of course a possibility. However, in a large, networked environment, the influence of any single node will be limited. Competition dynamics and low barriers to entry (anyone can create their own node) will also make it difficult.
#6 What happens if users break each other’s trust, by not paying back an IOU? Won’t that mean the person who accepted it lost money?
Yes. As in real life, when you trust someone by extending them credit you take a risk. If you make a mistake, or are deceived in some way, you have to bear a loss. This is in fact an important constraint which makes credit creation efficient. If those who took bad risks were bailed out (sound familiar?) by the government, it would create “moral hazard,” encouraging reckless risk-taking. The reliance on trust ensures that people think carefully about their decision to accept an IOU. Trust metrics will also ensure that there are strong reasons for people not to ignore their IOUs, as it will affect their long term ability to get credit on Ripple. Finally, it’s worth pointing out that in real life, as in Ripple, all money depends on a degree of trust – this is nothing new.
#7 Wouldn’t it be a problem if two individuals created millions of pounds of Ripple credit, and spent it?
Two individuals in the Ripple network can create as much mutual credit as they want, so it is possible for Jack to issue a million pounds worth of IOUs to Jane, as long as she is willing to accept them. However, there is not much Jane could do with those IOUs if she couldn’t find someone other than Jack to accept them as payment. Even if she did, the million pounds of IOUs would only travel as far as them. It’s not likely that anyone would be getting ready to sell their yacht to Jack, unless they believed that Jack could make good on his millions of IOUs. Otherwise, Jack’s “millions” are just promises which the rest of the network is unwilling to accept as payment, and therefore harmless.
#8 Ripple relies on an underlying fiat currency as a unit of account. Doesn’t this mean it’s not an alternative to fiat money?
It’s true that Ripple will probably be most useful when IOUs are denominated in a familiar currency, like sterling or the dollar. However, this is only because we are already familiar with such units for measuring value. It is just a convention, and could be changed to reflect amounts of hours, or other non-fiat currency units (such as Bitcoin, if it ever stabilises enough.) Alternatively, it’s possible that Ripple could become a currency in itself, which floats against others on an exchange. Ripple changers would provide liquidity to the system, and allow price discovery. So, there is no reason why Ripple should always be tied to national money – in the long run, it may make sense not to.
That’s it for now. I hope this posts shows why Ripple is a lot smarter than many of its critics think, and could well be a money system of the future. This isn’t to suggest that Ripple is flawless or doesn’t have challenges – rather, I hope to explain why it’s an idea worth pursuing. If you know of any other criticisms which I’ve left out, or have anything to add, please leave a comment.
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