Ripple Labs has been advertising its new solution, xRapid, hand over fist. It’s supposedly much cheaper, faster and better than the competition, namely SWIFT. This is hard to believe, since xRapid itself needs to use SWIFT.

Ripple takes great pride in explaining how xRapid is cheaper and faster than SWIFT, because it doesn’t require to transfer fiat. Instead, banks buy, transfer, and sell XRP coins, which supposedly can happen in seconds (assuming AML and KYC requirements are met, but Ripple usually elects to simply ignore this huge issue).

Asheesh Birla, Ripple Labs’ SVP of Product, explains how xRapid works.

Ripple Labs has explained multiple times how a transaction is executed with xRapid, and their PR bits have been widely broadcasted online by the XRP Army.

However, Ripple Labs never talks about what happens after the transaction.

The fiat reserve problem

With xRapid, XRP exchanges stand ready to buy and sell XRP upon request from banks who need to make transactions on behalf of their clients. Ripple loves to point to one specific use case for xRapid: remittances. And for good reason: remittances usually involve sending money to third world countries, with limited access to international payment channels and illiquid currencies, conditions which usually command high fees.

Let’s take Ripple’s remittance use case, and see what happens when a Mexican XRP exchange buys XRP and sells MXN, because someone needs to send $1,000 from the U.S. to Mexico. Let’s assume 1 USD = 3 XRP = 15 MXN.

  1. Before the transaction: the Mexican XRP exchange has a balanced position of 10M XRP and 10M MXN.
  2. The request for the transaction comes in: the Mexican XRP exchange buys 3,000 XRP, and sells 15,000 MXN.
  3. After the transaction: the Mexican XRP exchange has a new position of 10,003,000 XRP and 9,985,000 MXN.

Ideally, the Mexican exchange would wait for a request to sell XRP and buy MXN, which would bring its position back to where it started from – for example, a client who would need to send 15,000 MXN overseas.

However, that’s not how remittances work. Remittances are a one-way flow from rich to poor countries. In the case of Mexico, they stand at almost $30 billion per year from the U.S. alone. This means a need to buy $80 million worth of XRP each day, every day, that’s not counter-balanced by any requests to sell XRP.

Given the scope of these flows, our hypothetical Mexican exchange with its 10M MXN of liquidity would run out of fiat after a mere 6 minutes of operation (assuming banks in the U.S. are open 12 hours per day).

How on Earth could our Mexican XRP exchange refill its fiat reserves?

Ripple’s answer: “arbitrage”

On its website, Ripple explains that:

“Arbitrage, in a sense, is similar to the traditional retail and wholesale system. You buy something at one price, sell it at another, and you take the middle—in its most basic sense.”

ripple.com

Ripple uses the “A” word no less than 7 times in its piece. It all seems very straightforward: XRP exchanges are in a position to buy XRP coins on the cheap, so they should try and sell those coins at a higher price to somebody else.

In the case of our Mexican exchange, it almost makes sense. The XRP selling pressure against MXN would make XRP cheaper in Mexico, relatively to the rest of the world. All our Mexican exchange would have to do, is to sell the 3,000 XRP in New York against some U.S. dollars, and rake in a small profit because of the price discrepancy, while also refilling its fiat reserves.

Let’s assume the exchange does just that. Its new position is: 10M XRP, 9,985,000 MXN, and $1010. The exchange has made $10, which is nice. The problem is, the $1010 are in New York, USA, and the Mexican exchange can’t use them to fulfil requests back home.

The Mexican exchange can’t use xRapid to transfer the $1010 to Mexico, because it would be on both ends of the transaction, ending up with the same excess 3,000 XRP which it wanted to sell in the first place. So, it needs to find another way. And the only other way is: the XRP exchange will need to use SWIFT to transfer the $1010 to Mexico, while also converting them into MXN.

The liquidity problem

Ripple Labs likes to say that SWIFT takes 5 days to process a transaction. Let’s assume that’s true (it’s not, SWIFT gpi makes most transfers in less than 30 minutes, but let’s assume it is for the sake of the argument).

Assuming a rate of $80M of remittances per day, the Mexican XRP exchange would then need to hold at least 6 billion MXN in liquidity, to be able to wait for the SWIFT round-trip from the U.S.

And that’s for remittances alone, whose flows are predictable and stable. What happens if big corporations try to use xRapid? What if they try to send money to Mexico, but keep it in dollars? Capital requirements double.

What if Ashton Kutcher really tries to send $4,000,000 to Rwanda, as a donation to Ellen DeGeneres’ foundation? How much capital do exchanges in small third world countries need to keep in order to be able to fill requests from celebrities doing unannounced hot shot donations?

And, one XRP exchange per country seems like a huge concentration of risk. Certainly a big economy like Mexico deserves at least three XRP exchanges, to create some healthy competition, and reduce risk.

All of a sudden, the $5 trillion Ripple pretended is being held hostage by nostro / vostro accounts (a claim for which Ripple has absolutely no proof), will become actually frozen in XRP exchanges, in order to be able to face transfer requests.

Ripple can’t be more efficient than SWIFT

If xRapid has to rely on SWIFT, how can it be cheaper? Ripple could argue that exchanges would be able to pool SWIFT requests together, and only do one or two transactions per day, and earn money providing liquidity. But you don’t need xRapid or Ripple for that – banks could already do that today, if they wanted.

The real issue in cross-border transactions is: fiat liquidity is expensive. Ripple tries to position XRP as a “provider of liquidity”, but the truth is, nobody needs XRP liquidity. People need fiat liquidity, which Ripple has no way to solve for, apart from selling trillion dollars’ worth of XRP, and setting up XRP exchanges all over the planet.

xRapid fundamentally can’t be cheaper than SWIFT, because it uses SWIFT. Why does Ripple say the opposite? Simple: it currently subsidises xRapid transactions, paying off everyone at every step of the transaction:

Let’s see how long Ripple can pretend to be running a successful operation, whose business model is in reality to sell one dollar bills for 80 cents each.

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