Many people in the Bitcoin community have heard about Ripple and Open Transactions, but it seems that these two projects are rather difficult to understand. Most people understand the basic idea of these payment systems allowing Bitcoin-esque frictionless payments for more traditional currencies, but the details of each plan can get rather confusing. People get excited at the prospect of using dollars, euros, or gold backed cryptocurrencies, but how does it all work? Are there really any differences between these two projects? Let’s take a look at the facts to see what both of these projects have to offer.
Open Transactions is basically a collection of federated servers where people can issue their own currencies. Before there was Bitcoin, there were various private currencies available on the Internet, which were sometimes backed by gold. Some examples of these types of digital gold currencies include e-gold and Liberty Reserve. The real problem with these currencies was that governments don’t like competition. In the case of Liberty Dollars, the United States government actually determined the creation of competing currencies that undermine the value of the US dollar as an act of terrorism. With Open Transactions, anyone can store gold, silver, dollars, euros, Apple stock, crude oil futures contracts, or anything else in a safe as the backing for a digital currency. The issuers of the currency use cryptography to ensure that they aren’t allowed to modify the account balances of their users. Each user also receives a receipt after each transaction with their entire account balance, which means the currency can be reissued on a new server if an old one is shutdown or destroyed. This still leaves the problem of third party risk. You have to make sure that someone has the asset they are using to back their new digital currency. One way Open Transactions avoids this problem is through smart contracts. Essentially, bitcoins or any other cryptocurrency can be used as an insurance policy against someone who is issuing a gold-backed digital currency. In a situation where, for whatever reason, the users of one of these digital currencies believes that there is no gold, silver, or other asset in a vault somewhere, they can initiate a claim for bitcoins rather than the physical asset that is supposed to be backing the currency. For example, if you wanted someone to send you some of the gold they were using to backup a currency and it turned out they didn’t have any gold, some bitcoins that were already tied up in a smart contract could be sent instead. This is about as close as you can get to incorporating the trustless properties of Bitcoin into more traditional forms of money.
The Ripple system is one that takes advantage of IOUs. Users of the payment network can effectively deposit any currency to their Ripple account through a local gateway. It works in a manner similar to the checking accounts that most people have used in the past, but it takes the banks out of the equation. Instead of giving someone a check that can eventually be redeemed for cash from your bank account, you are basically giving someone an IOU that you will be able to fulfill on your own. Those IOUs are then turned into tradeable assets. For example, let’s say that Bob, Alice, and Greg go out to lunch. Bob and Alice trust each other and Alice and Greg trust each other, but Greg and Bob are meeting for the first time. Bob pays for a $30 lunch, and Alice and Greg intend to pay back Bob with $10 each. Bob doesn’t know Greg, but he trusts that Greg will pay back the $10 because Alice trusts Greg. In the Ripple system, the $10 owed to Bob from Greg is as good as $10 in cash to anyone who trusts Greg or Alice. If Bob wanted to send $10 to his nephew for his birthday, he could send him an IOU for the $10 that Greg owes him for lunch. The point of this IOU system is to basically create a cheaper, faster, and more efficient payment network. The speed and efficiency of the payment network is greatly enhanced by the fact that you don’t need to wait for payments to clear.
Pros and Cons
Ripple vs Open Transactions is a somewhat controversial topic in the cryptocurrency community, but I have to go with Open Transactions as the superior invention when comparing these two systems side-by-side. These are basically two different brands that offer variations of a similar product or service. Bitcoin purists will probably enjoy Open Transactions due to its reliance on cryptography for the purposes of removing trusted third parties from the world of payments. Having said that, it’s also important to note that Open Transactions is a complete financial cryptography library rather than just a payment network. Open Transactions’s dedication to removing third party trust makes it a more secure and private option for payments, but it can also enter many other parts of the financial world.
Open Transactions is a more exciting project than Ripple because it aims to replace third parties with cryptographically secure computer code in the areas of payments, exchanges, contract settlements, and more. While it’s true that you only need to trust the people you trust in real life for Ripple to work, the reality is that opening the system up to credit and IOUs means that you’re also opening the system up to defaults. Breaking off the reliance on trusting third parties is also taken to the next level by Open Transactions with features such as voting pools and Lex Cryptographia. Opencoin, the company behind Ripple, acts as basically a central bank behind the Ripple currency because they premined all of the Ripple tokens that are used to pay for transaction fees on the Ripple payment network. I don’t really have a problem with the idea of using a token system for various Bitcoin 2.0 applications, but it seems like it won’t be needed in the case of next level payment solutions. FellowTraveler has also taken at look at some of the pros and cons of Open Transactions, Ripple, and other payment systems on the Open Transactions forum, and I highly recommend taking a look at some of his thoughts on the matter.