Chris Larsen, who disrupted consumer finance in the 1990s and 2000s with E-Loan and Prosper, is seeking to shake up the industry again with Ripple, a peer-to-peer payment and lending system.
Ripple looks to improve on Bitcoin, the decentralized virtual currency and payment system that emerged three years ago and is beginning to gain some respectable traction. He’s teamed up with Jed McCaleb, a serial tech entrepreneur and a major figure in the Bitcoin community.
“The time has come for virtual currencies,” Larsen says. “Bitcoin has been very successful” and has shown how digital currencies can work.
Larsen would say little about the details of the venture. “We’re in stealth mode,” he says, and Ripple’s website says a beta version is “coming soon” that will let users “easily, cheaply, and safely send money over the Internet to anyone, anywhere in the world.” Dribs and drabs of the plan have been leaking out through people who have spoken with Larsen and McCaleb and from online discussion boards.
This much is clear: Ripple aims to disintermediate banks in their roles as facilitators of commerce and as lenders, and it taps into consumers’ disillusionment with the financial system since the financial crisis.
Like Bitcoin, Ripple is a decentralized peer-to-peer system offering an alternative way for parties to pay one another for goods and services. A key difference is that Ripple is also a platform for individuals to grant credit to one another.
The idea is to make debts issued by individuals tenable as a widespread form of payment. You might not trust a stranger enough to accept his $1,000 IOU as payment. But suppose the two of you have a mutual acquaintance you believe is good for it, who is willing to lend that much to the stranger. Then the stranger could pay you with that acquaintance’s promise to pay.
The Ripple system is designed to allow this kind of mutual credit issuance on a broader scale than otherwise possible. It keeps track of who knows whom on the network, who trusts whom and for how much. So if a user wants to pay someone who doesn’t know her using Ripple, the network identifies a chain of trusted intermediaries between the two.
“Ripple puts control in the hands of individual participants to decide how to issue credit, and makes them strictly responsible for those decisions,” says Ryan Fugger, the software developer who came up with the original idea. “This design is important because the power to issue currency is the power to decide what we collectively ought to value, and in my mind, that power ought to be distributed as democratically as possible.”
It may be a hard sell for consumers and merchants, even though they transact every day in dollars, a currency also predicated on trust.
“In a way you could look at the U.S. dollar as virtual,” says Dave Kaminsky, an analyst with Mercator Advisory Group. “The U.S. dollar is not tied anymore to an amount of gold at Fort Knox. The trouble is trying to start a brand new currency…because there’s not only many years back the U.S. dollar but also many people.”
But for all the drawbacks the U.S. economic system has, “we know it works,” says Kaminsky. Bitcoin has achieved a lot, but it’s hard to create a currency from scratch when most people will think the investment is dangerous, he says.
Fugger conceived Ripple in 2004 after working on a “local exchange trading system” in Vancouver. This experiment in community currency was plagued by free riders who never fulfilled their obligations, says Fugger.
“My idea to fix this was that credits should never be owed to the system as a whole, but only to individuals within the system who have explicitly agreed to trust the issuer, and bear any loss if those obligations aren't fulfilled,” Fugger says. “All that you need is a routing system for finding intermediaries to connect payers with payees who don't trust them directly.”
Fugger built the first iteration of this system, RipplePay.com, which says on its homepage that it has 3,914 users. Larsen and McCaleb, who had been collaborating on their own digital currency idea, approached Fugger this past August, and he recently handed them Ripple’s reins. According to Larsen’s assistant, there will continue to be “a decentralized open source platform owned by everyone,” and he and McCaleb are building a for-profit venture to use the platform.
“I see a future where waves of people gradually migrate their funds from bank accounts over to Ripple accounts because, as an open system, Ripple will spark a lot of innovation, leading to superior services that give people greater control over their finances at cheaper prices,” Fugger says.
Larsen first made a splash in the financial industry as a cofounder of E-Loan, a mortgage brokerage and banker, in 1996. The company was one of the first to accept mortgage applications online, and it ruffled the feathers of Fair Isaac by allowing consumers to see their FICO scores online for free, years before Congress mandated such disclosures. E-Loan is now a part of Popular Inc., the parent company of Banco Popular of Puerto Rico.
In 2005, Larsen started Prosper.com, a peer-to-peer lending market. It allowed consumers to invest in one another’s debt, theoretically giving anyone the opportunity to lend small amounts of money to strangers. Prosper offered an outlet for consumers in need of money who were unable to get a loan through a bank to tell their stories and find a lender more sympathetic to their pleas. But the individual lenders on Prosper often shunned such borrowers as well. The Securities and Exchange Commission cracked down on peer-to-peer lending in 2008, and Prosper never lived up to the initial hype.
Larsen’s partner McCaleb founded several different companies over the past decade, including MetaMachine, Code Collective, Galactic Industries and Bravo Your City. He is also the founder of MtGox, the largest of several exchanges that sell bitcoins for government currencies.
In May 2011, McCaleb floated an idea for a version of Bitcoin that would dispense with “miners”—the programmers who essentially rent their computing power to the network to verify transactions and make sure coins are not being double-spent. Mining is expensive because of the equipment and electricity required.
McCaleb proposed a system in which transactions were verified by consensus among members of the network rather than by mining. “My idea is to make the issue of trust explicit,” he wrote on an online forum.
According to Fugger, the coming version of Ripple uses a Bitcoin-style ledger, but confirms a block of transactions every few seconds rather than minutes, making it more useful than Bitcoin at the point of sale. “And since Ripple can handle obligations in arbitrary denominations, one potential use is in point of sale Bitcoin transactions,” Fugger says. The dollar, euro and yen symbols on Ripple’s homepage indicate the debts can also be denominated in such currencies as well.