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Summary:

The Bitcoin ecosystem’s over-reliance on a single currency exchange is a big problem. A new system called Ripple might overcome that problem… but it may run into issues of its own, too.

Bitcoin crash

To the surprise of very few people, Bitcoin has crashed. That’s not to say it’s a goner, but even those who bought into it just before the craziness of the last two weeks are now looking at losses: from a U.S. dollar exchange rate high of $266 two days ago, the crypto-currency is – at the time of writing – trading at around $70.

What went wrong? Apart from being a bubble (albeit a bubble of a kind we’ve never quite seen before), it looks like Bitcoin fell victim to a single point of failure. But wait, you say, it’s a decentralized currency – how can that happen?

Facepalm, face palmThat single point of failure is the most popular Bitcoin currency exchange, MtGox. There are other exchanges, but the bulk of Bitcoin trading happens there. MtGox claims to have been hit over the last couple weeks’ mania by the twin ills of denial-of-service attacks and sudden, excessive popularity, both of which amount to the same thing: MtGox’s systems falling over. The operation (which is based in Japan) has also shut down its own service at least once in an attempt to “cool down” the market.

And every time that has happened, a panic sell-off has been the result. That’s not surprising: MtGox’s status as the best-known exchange has led it to become the main data source for most of the Bitcoin rate visualizations out there, so when Mt.Gox goes down it affects visibility for a lot of people. And when people can’t see what’s going on, they panic, find another exchange and sell, sell, sell. Same goes for the biggest exchange unilaterally deciding to cool down the market – hardly a sign of viability.

(Some people have theorized about more sinister motives, too.)

As I write, MtGox is conducting an AMA session on Reddit, in which it is explaining what it’s doing to stem the problems:

“Upgrading computer systems means ordering more servers (two weeks timeframe), setting up (one day), load testing (two weeks) and deployment (one day). It’s a process that can take up to one month in total… We are now enforcing new rules for people placing large amounts of trades in order to reduce risks of lag.”

Hardly ideal. But what – apart from boring old state-issued currency – is the alternative?

Introducing Ripple

The ideal alternative for Bitcoin as an ecosystem is to try to even the load between different exchanges, or at least settle on one that doesn’t fall over when people get keen on the currency. However, there is also an emerging rival of sorts called Ripple (not to be confused with the charitable donation tool of the same name).

RippleAlthough its use is also pseudonymous, Ripple isn’t quite the grassroots effort that Bitcoin is: on Thursday its sponsor, OpenCoin, picked up a round of funding from Andreessen Horowitz, FF Angel IV, Lightspeed Venture Partners, Vast Ventures and Bitcoin Opportunity Fund, “an investment vehicle for Bitcoins and Bitcoin-related companies.” OpenCoin’s development chief is Jed McCaleb, the guy who founded MtGox in 2010.

However, while it doesn’t have the same Stick-It-To-The-Man vibe as Bitcoin does, Ripple does have a few advantages over its better-known rival. Chief among those is the fact that it doesn’t need currency exchanges: in fact, it is its own distributed currency exchange.

Ripple can be used to convert dollars into rupees, or for that matter Bitcoins, and send them across the world for the nominal fee of one “ripple” – this fee is only charged to stop people from swamping the system with millions of transactions. OpenCoin says a ripple is worth around a thousandth of a cent, and the company will put 100 billion of them into circulation — three quarters of which it will give away and a quarter of which it will keep for itself, in the hope that the value goes up. No more ripples will ever be created.

So, ripples are both in-service tokens for the mechanism of sending and exchanging real money, and a virtual currency in their own right. Of course, Ripple users will need to get their hard cash into the system somehow, so the system employs what it calls “gateways.” Anyone will be able to act as a gateway, even individuals and convenience stores – although online services will probably be the most convenient.

A faster self-regulating network

Ripple is a bit like Bitcoin, in that the network verifies transactions – this is essential if you’re removing the “trusted third party” role that banks usually fill, because someone needs to ensure that people aren’t double-spending their virtual money. However, there’s a big difference in how this happens.

hand shakeWith Bitcoin, nodes on the network called “miners” compete with each other to verify each block of transactions every 10 minutes. To verify a block, the miner has to complete a complex computational puzzle faster than its rivals do. In return for the electricity spent in doing so, the miner gets a certain number of freshly minted Bitcoins – this is how the system keeps working, and how new Bitcoins get brought into the system.

With Ripple, the nodes on the network also maintain a shared ledger – the equivalent of Bitcoin’s blockchain – but they don’t compete with each other to do so. Instead, the system uses a complex consensus mechanism to make sure transactions get verified and added to the ledger.

As this process has nothing to do with mining the virtual currency, there is no need to control the timing of the verification, meaning transactions can happen within seconds rather than in 10 minutes or more it takes with Bitcoin. This is clearly a big advantage, and there are others, such as the ability to create a chain of IOUs, either through people they personally know and trust, or by using ripples.

But…

Thus Ripple solves some of Bitcoin’s problems: transactions can take place more quickly, there’s no need for shaky third-party exchanges, and the whole shebang doesn’t need to waste a bunch of electricity on solving computational problems. However, I suspect Ripple will have its own problems.

The first is to do with money-laundering. This is also a big potential problem for Bitcoin – although good luck to anyone who tried that this week – but I’m a bit confused about how well-controlled these “gateways” will be. Ripple’s own explainer states that “your neighbor or corner grocery could be a gateway,” but OpenCoin told me that “we believe these gateways should be properly licensed and regulated in the same way as other financial institutions,” Does. Not. Compute.

The second problem is OpenCoin’s role in Ripple. The company maintains that it’s “just here to pay to develop and promote the network,” and doesn’t control Ripple, but at the same time it’s a for-profit company (hence this week’s investment) that has a vested interest in seeing the value of ripples increase. At the very least, there may be an inherent problem of perception here, particularly for those subscribing to Bitcoin’s core ethos.

Ripple will also need to find enough “validating nodes” to ensure an above-board network consensus process. Unlike Bitcoin’s miners, these nodes don’t get anything for their efforts other than seeing the system stay up and running. Granted, they also don’t need to expend as much electricity in doing their job, but their participation is still not a sure thing.

Finally – and perhaps most importantly – Ripple is really hard to understand, compared with traditional “fiat” currency. A lot of pieces need to be in place for it to work, and a lot of education needs to take place too. I would even go so far as to say that Ripple is more complex (even on a conceptual level) than Bitcoin, and that’s saying something.

Still, Ripple is interesting, and perhaps having an official sponsor will make it more viable than Bitcoin. Whatever happens, it’s another step towards the post-experimental use of digital currencies.

  1. this open coin will fail spectacularly. It has nowhere near the brilliance and self perpetuity of btc

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  2. There will not be multiple virtual currencies. If this gains any traction, Bitcoin will die and so will Ripple. Fragmentation will serve to kill the whole thing.

    I will not support it.

    Bitcoin supporters need to get infrastructure in place quickly to ensure its dominant role: easy to use wallets, easy to use tools for real world vendors, and reliable exchanges. The next 6 months are critical.

    Mt Gox might have screwed this whole thing up. Bitcoin, however, has not been comprimised.

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  3. michael gedi Friday, April 12, 2013

    if you do want to exchange money from UK to trade on the transfers in bitcoin, I wrote a guide on how to transfer funds:

    http://bitcointransfer.blogspot.co.uk/

    best wishes

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  4. Now that the bubble has popped and people have come back to Earth, good analysis can be made on all this.

    This isn’t the end for Bitcoin (yet), but rather a transition point. If anything, Bitcoin and cryptocurrencies like it will do to the financial system what Napster did to file sharing online: force the mainstream to switch. However, as a currency by itself, it was far too volatile for use (not including a bunch of other reasons why). You will see the diehard believers stick by it (even though the ideology behind the system died the money users began clamoring for the market to be shut down during the bubble).

    It’s also an interesting time to consider buying into it and similar cryptocurrencies, from an investment viewpoint, as they are near all time lows.

    http://www.ghostagenda.com/2013/04/12/the-bitcoin-crash-now-you-can-buy-in/

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    1. Simon Rönnqvist Friday, April 12, 2013

      Yes all p2p currencies tend to follow each others, that’s also true for Ripple’s XRP. Probably since it’s the same community using them.

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  5. half of all ripple-currency will forever be in posession of the company? damn right, “it doesn’t have the same Stick-It-To-The-Man vibe” :o

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  6. Simon Rönnqvist Friday, April 12, 2013

    I think you misunderstood an essential thing about Ripple; it’s not really a Bitcoin-alternative as much as a companion.

    It’s true that on a conceptual level Ripple sound very complicated, but from the user’s perspective it’s a real simple piece of software to use. It feels just like loading in whatever currencies you need through a gateway and then sending them off just like you transfer money between bank accounts today, but as accessible as sending e-mail.

    Ripple is not all about its own currency XRP (or “ripples”). It’s about IOU:s which are proofs of debt that the gateways issue. (Just like a bank is in debt to you once you deposit cash and get higher numbers on your account.) These can be used as virtual money representing any currency as long as there’s a chain of trust leading to the gateway (which means I trust a friend up to a certain amount who trusts the gateway up to e certain amount). Trust what? Trust that they’ll return their debt agains an IOU they issued. Let’s hope they don’t play around with the money like banks do! :) An IOU can represent any currency, including bitcoins.

    When there’s no chain of trust these IOU:s can automatically be swapped through the exchange system, or even automatically swapped into another currency at the best available exchange rate. In the beginning however this chain of trust might be harder to find and available swappable IOU:s in the exchanges might be few. For these occasions XRP is used as a backup, so in the end XRP won’t problably be used very much.

    Instead of competing with Bitcoin, Ripple actually provides a p2p trading platform and serves as a tool for instant transactions (instead of having to wait an hour as with bitcoin’s own transactions). It’s essentially a Bitcoin companion, that also could solve the very problem that ignited the bitcoin crash this time (as you suggested) by providing a unified p2p exchange.

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  7. JimboToronto Friday, April 12, 2013

    “The company” will release so many and and retain so many? It involves a “company”?

    That’s a deal-breaker. One of the most important aspects of Bitcoin is there is no sleazy “company”, bank, government or other malefactor to interfere, regulate, profit or otherwise rip off the peer-to-peer network.

    Yes, Mt Gox is a company and that is the biggest problem in the current Bitcoin trade.. Luckily it is not a Bitcoin-related problem. Bitcoin traders already have many exchanges to choose from.

    I’m amazed that so many people use Mt Gox as their sole BTC exchange when it involves expensive international bank transfers that can take days.

    When I make an anonymous cash deposit to my Canadian exchange at a Canadian chartered bank, the total cost is $3 and the funds are in my anonymous account usually in less than an hour and a half. I can then buy bitcoins and transfer them to exchanges in as many countries and foreign currencies as I want at zero cost and generally within ten minutes. Withdrawals simply reverse the process. It’s all fast and free.

    This isn’t like the stock market where you hire a broker with one trader with one seat in one exchange. Every Bitcoin holder can be his own trader with seats in multiple exchanges.

    Mt Gox isn’t the problem. It’s a matter of educating people about diversifying access.

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  8. If you still wanna buy Bitcoins in the UK, directly without intermediators on ebay or other middle men (with huge fees) is difficult, I made this guide with a simple process:
    http://howtogetbitcoinsuk.blogspot.co.uk/

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  9. bitcoin woooooot!!!!!!!

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  10. People are just so Ignorat about online currencies.
    As soon as Bitcoins gain real tranction and become important, that moment several governments in the World will ban Bitcoins.
    What I mean by that is that bank transfers regarding Bitcoins will be strictly forbidden.
    The same thing happened to Neteller in the US and to Onlinepoker, both were banned for the high potential of Money Laundering.

    Paypal and Moneybookers already don’t allow and don’t work with Bitcoin provider.

    To some BTC fanatics it might sound that it is impossible to forbid bitcoints.
    But If you want to have a marketcapitalization of 30 billion or more that only works if regular Banks and retailer work with the currency. But thats not possible if the gouverment forbides it.

    Also some might not know, but for the same reason it was forbidden to own Gold in the US in the 40s.

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