Could Ripple’s Multi-Billion Dollar XRP Reserves Pose a Risk to Token Holders?
Ripple, the custodial company to the open-source cryptocurrency XRP, owns 60 percent of all XRP ever created; these holdings are valued at $22 billion at current prices. Furthermore, company ‘insiders’ also hold a large percentage of circulating XRP. Could this wealth concentration adversely impact token holders?
Risks of Wealth Concentration
The majority of XRP is owned by Ripple Inc. Furthermore, the founders of the company and its current executives hold influential amounts of XRP.
Because such large amounts of XRP are concentrated in the coffers of Ripple Inc., these holdings could result in unfavorable regulatory treatment and pose a risk to token holders.
Regulatory bodies such as the Securities and Exchange Commission, FinCEN, and the Commodity and Futures Trading Commission could enforce a number of different rulings that may hinder the use or sale of XRP.
One of the larger concerns surrounding XRP is potential securities classification. If such a classification was enacted, it would make XRP’s use as a vehicle for remittances—and the general purchase of the cryptocurrency—much more difficult overall.
Another risk is increasing supply. Ripple needs to sell XRP from its coffers to expand, disgruntled business partners may decide to cash out, and institutional clients could flood the market after getting a bulk deal on the token. Whatever the reason, as XRP’s circulating supply expands it puts downwards pressure on the price.
Primer on XRP
According to Ripple’s official website, XRP offers banks and payment providers an option to source liquidity for cross-border payments. Using XRP, banks can send payments without using pre-funded deposits of foreign currency (nostro accounts) held in other banks.
Ripple is a deflationary asset. The supply of Ripple is fixed, and each transaction incurs a small fee that is taken out of circulation.
Who Are the Stakeholders
XRP was created in January of 2013. A total of 100 billion coins were created. Of those 100 billion, 80 billion were allocated to Ripple and 20 billion were split between the three founders in the early company.
Contrary to BitMex’s findings, McCaleb’s wallet indicates total holdings of 5.2 billion. There is little concrete evidence of Britto’s holdings. Of the three original founders, Chris Larsen is the only one still actively involved with Ripple. He currently sits as the executive chairman of the company’s board of directors.
Newer participants in the company include Ripple’s current CEO, Brad Garlinghouse, and the company’s CTO, David Schwartz. It is unknown how much XRP these executives (or other insiders) hold.
Ripple’s Current XRP Holdings
Presently, Ripple’s Q3 2018 report shows that the company owns roughly 60 billion of the total XRP’s total supply:
“In Q4 2017, Ripple locked up 55 billion XRP in a cryptographically-secured escrow account. Ripple created the lockup to create certainty of XRP supply at any given time. Due to that lockup, Ripple has access to only 13 percent of the total XRP in circulation. Ripple’s sales were a tiny fraction of that amount.”
There is roughly 41 billion circulating XRP. If Ripple has access to 13 percent of these coins then 5.3 billion coins available for immediate use. In total, that puts the company’s holdings at roughly 60 billion XRP. The other 55 billion is locked up in escrow, as asserted by Ripple.
As of January 2018, according to Forbes, Chris Larsen and Jed McCaleb still own 5.2 and 5.3 billion XRP, respectively. Brad Garlinghouse and (possibly) David Schwartz, also own unspecified amounts of XRP.
These figures could suggest that upwards of 10 billion XRP in circulation are owned by company insiders. If the 5.3 billion coins that the company has for immediate use are included, then that suggests that over 37 percent of the circulating supply is controlled by a handful of parties.
That said, these insiders are likely contractually bound to how much XRP they are allowed to sell at any given time. For example, McCaleb is restricted to how much XRP he can sell based on a settlement with Ripple after leaving the company to start Stellar in July of 2013.
“The remaining 5.3 billion XRP as of February 2016 are in a custody account at Ripple and are meted out to him on a monthly basis. Since the agreement was reached, he has been allowed to sell less than 1% of average daily volume on one exchange that now itself accounts for only 1%-2% of all XRP trading volume.”
Ripple’s Incentives to Increase the Value of XRP
Early on, Ripple made it clear that it is taking steps to actively preserve and increase the value of XRP. In a November 2014 document, the company stated:
“Ripple Labs plans to retain 25% of all XRP issued to fund operations (and hopefully turn a profit) and distribute the rest to incent the participation of market makers, gateways, and consumers to utilize the protocol. Given that there is a finite number of XRP, [and] as demand for XRP grows, the value of XRP should appreciate. In this manner, Ripple Labs believe that its incentives are aligned with those of protocol’s users–both want the protocol to reach its full potential and scale.”
Given Ripple’s majority ownership of the cryptocurrency, these steps make sense to preserve XRP’s long-term value. A February 2015 excerpt from Ripple’s submission to the Conference of State Bank Supervisors iterates the company’s early emphasis on price preservation:
“Ripple Labs holds a substantial amount of XRP, which it sells from time to time… Through these sales, Ripple Labs is able to monetize these assets to fund its operations, specifically the development and adoption of the protocol. This exposes Ripple Labs to the market risk of XRP’s value. Ripple Labs has taken numerous steps to identify, monitor and mitigate sources of market risk. Ripple Labs has established legally-binding agreements with insiders and owners of large amounts of XRP that protect against a large scale sell-off of the asset.”
XRP Vulnerable to Supply-Side Pressure
As XRP and stakeholders in the company continue to increase the circulating supply, the value of the token will experience strong downwards pressure. Further exacerbating this risk is XRP has relatively low trading volume compared to Bitcoin and Ethereum. As explained by Investopedia, this makes XRP more vulnerable to price drops:
“One risk of low-volume stocks is that they lack liquidity, an important criterion in stock trading. Liquidity is the ability to be easily bought or sold in the market without a change in price.”
For December, XRP’s 24-hour trading volume fluctuated between $300 million and $1.7 billion. XRP’s trading volume sits at roughly an eighth of Bitcoin’s and a fourth of Ethereum’s.
Lower trading volume is usually a sign that a cryptocurrency’s books are thinner than its competitors. If a large token holder was to dump their XRP, it would likely cause a greater drop in price than if someone were to sell the same percentage of total coins for either BTC or ETH.
As mentioned above, those such as McCaleb are regularly selling their holdings of XRP. Some even worry that McCaleb could single-handedly “decimate the price”:
Jed McCaleb is selling more XRP than he is supposed to according to the 2016 agreement he has with Ripple Inc
Jed is the the single largest individual holder of XRP. He can absolutely *decimate* the price if he chooses, and he has motivation in the form of Stellar to do so https://t.co/NgOyO3yUXq
— Kyle Samani (@KyleSamani) September 24, 2018
Furthermore, Ripple regularly sells from its treasury to fund expansion. Based on the company’s quarterly reports, on average, roughly 100 million XRP (or about $37 million) is sold every month from escrow to expand the company.
Of the effective circulating supply of 25.7 billion, that is an annual inflation rate of roughly 5 percent including McCaleb’s liquidations. All other things constant, in an efficient market the price should decrease by this same amount as the supply expands.
In that vein, it is critical that Ripple maintains a long-term outlook for its XRP holdings if it wants to maintain price growth of XRP. If the company or its employees look to dump XRP for short-term gains, then token holders will be left holding the bag.
Arguments Against Wealth Concentration
Understandably, high levels of wealth concentration raise alarm with many in the blockchain community. Many people prize Bitcoin because of its anonymous and decentralized qualities, and the cryptocurrency space as a whole echoes this ethos.
Purists argue that Ripple violates the tenant of non-trust—of not trusting any single organization or group of people to look after the best interest of the whole. These tenants are baked into Satoshi Nakamoto’s white paper and the community overall.
Some of these arguments are valid. Ripple as a company could violate the long-term value of XRP for short-term gain.
Wealth concentration also provides for a larger point of failure. Ripple’s large holdings of XRP are a potential target for regulators. Any adverse enforcement against XRP could cripple its use, and consequently, its price. Not only that, internal company gridlock or politics could also render XRP inert.
To emphasize the risk of wealth concentration, Anthony Pompliano’s fund, Morgan Creek Digital Assets, created an index fund that is exposed to 75 percent of the digital market, and includes major coins such as Bitcoin, Ethereum, Bitcoin Cash, EOS, and Litecoin.
One of the criteria for selection of coins in the index was:
“Fewer than 30% of its current issuance held by the protocol’s foundation or related operating business.”
According to the methodology, such coins were not included because undue centralization may “potentially threaten” the fundamental value of a distributed network.
Flaws with Bitcoin and Ethereum
Oftentimes, a counterargument is that Bitcoin, Ethereum, and other public blockchains also tend to be highly concentrated in terms of wealth.
For Bitcoin, wealth is concentrated in the top 3 percent of Bitcoin addresses. That top 3 percent owns 96 percent of the total Bitcoin supply; Ethereum is slightly less but similarly concentrated. Something to note is that these figures are skewed by cryptocurrency exchange wallets.
Not only is wealth concentrated in BTC and ETH, but the owners of these coins are also anonymous, and therefore near-impossible to hold accountable. Large coin holders can dump their holdings if that benefits them, even if it is done at the expense of other investors.
Proof of work mining is another point where public networks are vulnerable. There is evidence that mining cartels are forming in Bitcoin and Ethereum, and that these cartels could conduct a 51 percent attack on each of these networks, violating the trustworthiness and immutability of those networks.
Finally, because of the open-source nature and governance of these projects, large coin holders exercise limited control over the adoption and technological development of these blockchain protocols. Therefore, software improvements and adoption initiatives tend to be slow and uncoordinated.
Benefits of Ripple Inc.
Unlike Bitcoin and Ethereum, Ripple is unencumbered by decentralized governance. The company can leverage its large reserves to foster adoption, spur development, and secure customers. Consequently, a large portion of XRP’s value is derived from the efforts of Ripple. Ripple is more nimble than its uncoordinated peers. Greater mobility could result in more rapid appreciation of XRP spurred by faster adoption and more institutional use.
The crypto community is often embroiled in debate as to whether Ripple is ‘centralized.’ The debate has no resolution because the dimensions that these projects will get evaluated against will change to suit people’s arguments.
There are tradeoffs, however. Bitcoin is not strictly better or more decentralized than Ripple, and vice-versa. Bitcoin, Ethereum, Ripple, and any other cryptocurrency project have strengths and weaknesses and fulfill different niches.
With that in mind, what is important for crypto aficionados is to evaluate which aspects of a project are important, and which risks are acceptable to them.
Consider evaluating Ripple’s business model, team, and product. Decide whether Ripple will act in XRP holders’ best interests. Critically think about how XRP compares with other alternatives, such as Bitcoin, Ethereum, and other cryptos. If those things point in favor of XRP, then its long-term outlook is bright.
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