From the telegraph to the telephone to the Internet. Photo: Henrik Johansson
This is part 2 of our blog series discussing how Ripple can benefit banks and other financial institutions. Check out part 1: The True Cost of Moving Money.
A good way to understand the state of payments is to consider the evolution of electronic communications technology.
Experiments using electricity to send messages over wires or cables began in the mid-1700s and would start finding success at the turn of the century.
The network effect
These early prototypes became known as electrical telegraphy and became one of the first forms of electronic communications. The utility of the system depended on its reach, defined by its network of interconnected cables.
By 1866, a cable connecting North America and Europe was successfully completed, enabling near instant transatlantic communication for the first time.
Over time, telecommunications tech would continue to improve with the invention of the telephone and later, the rise of the Internet. Even so, the model by which we connected with each other never quite changed much even if the underlying technology did. Today, much of our communications networks are defined by connecting as many people and places as possible with copper wire, fiber optics or some other physical cable.
There are parallels with the way payments are evolving today. Like the situation with the original telegraph, the current system works but has a few downsides—the service bottleneck at the so-called “last mile”, high operating costs, limited availability, and limited reach.
And because the underlying networks are similar, switching from the telegraph to the phone or the Internet won’t necessarily address every issue—comprehensive broadband penetration in the U.S., for instance, remains a challenge. But that doesn’t mean upgrading isn’t hugely beneficial. Despite presenting similar integration challenges when compared to the telegraph, the phone and the Internet provide far superior utility.
The Ripple effect
With the way correspondent banking works today, any bank with a large enough international footprint can become a correspondent. The more bilateral relationships the bank has with other financial institutions, the more powerful its correspondent network.
Smaller institutions don’t have the resources, scale or banking relationships. As such, they develop agreements with correspondents to gain access to an international network.
Believe it or not, Ripple operates in similar fashion. Large banks and financial institutions on Ripple could essentially become correspondents. But there are also fundamental differences relative to how things work today even while maintaining the exact same connections.
Today, a payment might hop through multiple institutions via existing rails. The problem is that each hop adds additional delays, required to eliminate settlement risk. Moreover, the process isn’t fully transparent so it’s unclear exactly how long the payment will take or how much it will cost.
With Ripple coordinating settlement, a payment could take the same path with the same hops. But in this case, each hop settles instantly at exactly the same time, any time of the week.
Likewise, it might not make sense for smaller institutions to maintain a vast network of market makers. As they already do today, they can develop relationships with correspondents to gain the benefits of the Ripple network.
Consider the telegraph—a series of telegraphs can relay a message for it to reach its ultimate destination and each operator could conceivably work harder to relay the message more quickly.
The telephone, on the other hand, might “relay” the connection through multiple stations to enable the same outcome as the telegraph—delivery of a message to the receiver. The difference is that telephony infrastructure enables this process to happen much faster and much cheaper with less interference by intermediaries.
This isn’t the telegraph
But while there are similarities to the way things work today, the difference is that Ripple provides far greater utility. Unlike correspondent banking as we know it today, banks can use Ripple to enable real-time settlement across two or more parties simultaneously in real-time, 24/7.
Most importantly is that this technology isn’t just cheaper, faster, or more efficient, it’s inherently transformative. By allowing disparate payment systems to interoperate, Ripple enables the Internet of Value, a world where money moves like information does today.