“Not-So-Decentralized” Ripple Freezes $1m in User Funds

By Scott Fargo Apr 21, 2015 4:00 AM EDT

News powered by Bitcoinist.net

Article by Sean Wince

The Ripple payment network is facing criticism this week over revelations about the liquidity of some of its assets. It’s come to light that Ripple gateways — the onramps and offramps of the network — have the ability to “freeze” user funds at will. Furthermore, Ripple Labs has already used its influence to convince Bitstamp, a prominent gateway and exchange, to freeze $1 million worth of funds belonging to Ripple’s departed founder Jed McCaleb.

Also read: International Ripple Business Association Relaunches

Ripple “gateways” act as trusted entry and exit points for the payment network, providing users with specialized institutions for converting regular currencies and assets into IOU’s which can be traded on Ripple. However, there exists a relatively new feature in the Ripple protocol that enables gateways to freeze those IOU’s and prevent them from being traded. This feature was first implemented in August of last year and phased in over the following month.

page on the Ripple wiki describing the feature was submitted to the /r/Bitcoin subreddit Saturday and catalyzed a heated discussion about the issue. The Ripple wiki subsequently went down, but can still be accessed via the Internet Archive.

Chris Larsen, CEO and co-founder of Ripple Labs

Chris Larsen, CEO and co-founder of Ripple Labs

Gateways have two methods of freezing funds, each intended for different scenarios. The first is dubbed a “global freeze.” This would cease all trading activity of every IOU issued by that gateway across the board. The global freeze is intended for cases when the gateway’s wallets have been compromised, or when it wants to migrate users to a new issuing account, according to a bulletin by Ripple Labs.

The second method is more targeted. The “individual account freeze” enables the gateway to cease all trading of one person’s funds, preventing them from sending the IOU’s to another person or gateway on the Ripple network. This method is intended for users with “suspicious or unusual account activity,” users who have violated the gateway’s terms of service, or in the case of a dispute resolution being handled by a third party.

It should be noted that gateways have the option of permanently disabling their own ability to freeze funds, and were supposed to notify their users months ago if they planned on retaining the freeze feature. But it remains unclear exactly how many, and which ones, still have the ability to freeze funds on an individual and global basis.

“The Ripple protocol allows each gateway to decide its own policy so users have a choice between using a freeze or no-freeze gateway, depending on their preference,” said Monica Long, VP of marketing and communications at Ripple Labs, in a statement to Bitcoinist.net. “It is a necessary legal requirement for a gateway to operate in most jurisdictions. It also supports a healthy ecosystem by reducing risks and protecting users. If a user thinks his or her funds were unjustly frozen, he or she can take legal recourse through the appropriate channels.”

High-Stakes Ripple Freeze

The individual freeze was most notably used by on March 31 by the bitcoin exchange Bitstamp, which also acts as a Ripple gateway. Jed McCaleb, the original founder of Ripple Labs, was attempting to sell over 96 million XRP — the native currency of the Ripple network — which his family received when he started the company. Converted to US dollars, that sum of XRP was equivalent to over $1 million.

In order to “avoid and mitigate irreparable harm and damages” to the value of XRP, a Ripple Labs agent went on the Bitstamp gateway and placed an order paying $1,038,172 for McCaleb’s stash of XRP, according to a report by CoinDesk. Once the transaction completed, however, Ripple Labs demanded that Bitstamp use its gateway power to freeze McCaleb’s account and prevent him from withdrawing the actual cash.

Jed McCaleb, co-founder of Mt. Gox, Ripple, and Stellar

Jed McCaleb, co-founder of Mt. Gox, Ripple, and Stellar

Ripple Labs then requested that the transaction be reversed — it wanted the $1,038,172 returned, and in exchange it would send the 96,342,361.6 XRP back to McCaleb. The matter was complicated by the fact that McCaleb had already used some of the cash to purchase STR, the native currency of McCaleb’s new project, Stellar.

By complying with the request to freeze McCaleb’s funds, Bitstamp effectively became the middleman in a high-stakes dispute between Ripple Labs and its former founder. With the $1 million transaction frozen in time, Bitstamp decided to file a lawsuit in California district court against all parties involved. The exchange requested the court’s assistance in determining where the disputed money should go, opening up a legal can of worms that could last for months or even years.

The entire fiasco was only made possible by an eight-month-old feature in the Ripple protocol that allows gateways like Bitstamp the ability to freeze user funds. McCaleb may or may not have had the legal right to sell 96 million XRP in one big batch, but he would’ve had the technical ability to do so if it weren’t for Bitstamp exercising its freezing power as a Ripple gateway.

Update: Commenters affiliated with Ripple have pointed out that McCaleb was trying to sell “Founder tokens” of XRP which were subject to a vesting agreement between him and Ripple Labs. This contract was made in August 2014 and stipulated he was only allowed to sell $10,000 worth of XRP per week. However, McCaleb alleges that the hoard of over 96 million XRP had been gifted to his family members — specifically cousin Jacob Stephenson — prior to the contract with Ripple Labs, and therefore is not subject to the $10,000 per week selloff limit.

It’s worth noting that Ripple itself did not initiate the freeze of McCaleb’s funds, and this was instead done by Bitstamp acting as an independent gateway.

Also referenced was the example of digital currency exchange JustCoin, which suffered a hack and attempted theft in October 2014. At that time, JustCoin used its power as a Ripple gateway to freeze the funds of the attacker and notify Ripple administrators. This points to a potential upside of the freeze flag feature, in that it can stop a theft from being completed against a digital currency exchange.

Furthermore, commenters pointed out that the freeze flag has been common knowledge in the Ripple community for months, and that it’s a necessary feature in order for gateways to comply with the law in many jurisdictions.

Does this call into question the liquidity of assets on the Ripple network? Will we see more examples of Ripple gateways freezing user funds? Sound off in the comments below!


 

Photo Sources: Ripple Labs, Wired

  • Jabber0ne

    An advantage of Ripple to nations, companies and individuals is that there are some controls. This will make it a favorite for local, regional and national use. Bitcoin will remain the favorite for worldwide use.

  • Luke

    Dear God – what a misleading headline.

  • Ripple works with the State (currently the US govt.)…that alone should warn people off. They are corrupted at the very heart – as all State use coercion (bullying/extortion) to get what they want. Use Ripple at your own risk and don’t come a whining if/when you get cut off from your assets.

  • kris_davison

    Yeah I guessed you were a ripple guy. Yeah choice is good im not against choice.
    I choose to have control over my own assets the way Bitcoin allows without the interference of third parties.

    I’m just not a huge fan of any third party company or otherwise who can decide if I can have my own property. Such as banks who can limit withdrawals of freeze accounts.

    Which is exactly what’s been done here.

    As for reversible payments I’m not sure how good they are. If you have paid someone and not received goods I can understand why you would want big brother to break the rules of the blockchain contract and get your money back. But these issues can be resolved with escrow services which you actively choose rather than making the system inherently weaker by giving away the keys.

    I’m sure ripple is a great alternative to the banking sector I’m just not sure it goes far enough and does not fully hand control to the user and eliminate central control.

  • Sean Bennett

    Just cross-posting here from my post elsewhere that: The funds are indeed frozen at the Ripple level. The account rPQB4rgmwoaCjdX4BeoWikeshWL3fLMLD7, which holds just over a million USD.Bitstamp has its trust line frozen by the Bitstamp issuing account.

  • Guest

    I am fairly certain that Bitstamp does not process its trades through the Ripple network. Sure, it issues IOUs there and users can trade those, but it does have an internal trading engine which is true for the majority of exchanges offering Ripple/Stellar markets.

  • JoelKatz

    No.

    Bitstamp, just like PayPal, can set their own policies however they want. And if those policies are bad, then people who use those services will be subject to bad policies.

    But if you don’t accept PayPal’s policies, you can’t receive payments from, or make payments to, people who use PayPal. Ripple still allows issuers to make their own policies. But people who choose different issuers (or people who choose no issuer at all and hold XRP) can seamlessly make payments to each other.

    Imagine how great it would be if you could refuse to have anything to do with PayPal or its policies, but still use PayPal’s vast reach to accept payments from their customers or make payments to their customers. That would be awesome. No longer would people feel pressured to accept PayPal’s terms and conditions because that’s the only way they can pay people who only accept PayPal.

    If you hate SnapSwap, you can hold assets issued by Bitstamp. If you want to hold BTC, you can hold BTC issued by any issuer. If you don’t like counterparties at all, you can hold XRP. And you can still make payments to, or accept payments from, people who make completely different policy choices from yours.

    Choice is good. People being able to make different choices and still pay each other is ideal.

    Bitcoin has no support for reversible payments currently (neither does Ripple). That’s bad. Adding such support would be good, provided people could still access irreversible payments if that’s what they prefer. It would be somewhat crazy to argue that adding reversible payments would be bad because people might choose to use them and then bad things would happen.

    (I’m an employee of Ripple Labs, speaking only for myself.)

  • JoelKatz

    You don’t need a centralized exchanged to sell XRP either. So I’m not sure I understand the comparison to Bitcoin. There are freezable assets denominated in Bitcoins, for example balances at a gateway that are subject to legal action.

  • frowgbat

    Am I the only one who sees this as a positive? Seems like Jed was breaking contract on top of attempting to buy a direct competitors product…? So ripple disrupted and prevented something that was illegal and people are criticizing them? IMO this has very positive implications for the future of this company and crypto in general…

    It’s like if the Dev of say, TRON, had made a deal with the CRAVE team and the TRON dev was going to break his contract and dump his allocated stash of TRON in one big market sell…AND THEN on top of that use the money to buy CRAVE … and everyone is pissed because something like this was prevented LOL….

    panic sell please

  • kris_davison

    The issue is that ripple has more in common with PayPal and old school banking than crypto. Its a shame its even mentioned in the same sentence as Bitcoin.

    Bitcoin eliminated the need for a single point of control. Ripple just brought it back as “a necessary feature” which is true if the rest of the sentence read.
    “A necessary feature to strip power and control of assets away from the many and into the hands of the few”

  • OneMillionGateways

    Truth! That is just an advanced and untypical usage of it (so far!).

  • Mitzplik

    In fact, an account can set no-freeze, so the assets issued by it cannot be frozen, so XRP is not the only one.

  • vortex

    Read it, still says what I thought it says.

  • OneMillionGateways
  • vortex

    They are frozen by bitstamp’s ripple gateway, not bitstamp’s exchange.

  • OneMillionGateways

    “Yes, an exchange, not an open currency transaction network like bitcoin.” The Ripple protocol is also a completely open currency exchange. What is your point? Anyone can use it, or not use, at will.

    “Actually it does, it was through the efforts of Ripple Labs using the feature built into the ripple protocol to freeze his funds, this would not have been possible with bitcoin as you don’t need a centralized exchange to sell bitcoin to someone plus your coins can never be frozen.”

    That is completely not true. The funds are not frozen on the gateway. They are frozen by Bitstamp due to a breach of contract dispute, something that any exchange can do.

  • vortex

    “Freezing is a necessary feature of any currency exchange.”

    Yes, an exchange, not an open currency transaction network like bitcoin.

    “The $1 million is locked up in a legal dispute that has nothing to do with the Ripple protocol.”

    Actually it does, it was through the efforts of Ripple Labs using the feature built into the ripple protocol to freeze his funds, this would not have been possible with bitcoin as you don’t need a centralized exchange to sell bitcoin to someone plus your coins can never be frozen.

  • Just doing some quick math, XRP price had to be over 5000 Satoshis (with BTC/USD averaging $250) and it’s currently 40% lower than that. Perhaps if Ripple Labs had let Jed crush the market, this would have been a lot cheaper for all parties involved – it’s not like an mildly liquid instrument akin to micro-cap stock can’t crash and then rebound.

  • OneMillionGateways

    You would likely get wrong information. “I don’t think Bitstamp processes its trades trough the ripple network.” is completely inaccurate. Bitstamp has a Ripple gateway where they issue BTC and USD for trading. In fact they are the first major Bitcoin exchange to have a Ripple gateway. They charge a marginal transaction fee for such trades. As an exchange is a custodian of funds, the attorney for Bitstamp, who is also the attorney for Ripple Labs, made the request with an independent 3rd party (a judge) to settle the issue which is a proper place for a breach of contract dispute.

  • +1 That sounds like it would be an interesting episode!

  • John Barrett

    Hey Jared would you have any interest in being a guest on my podcast?
    Sounds like you have interesting info to share!
    Thanks!
    John Barrett
    Host of Bitcoins and Gravy
    http://www.BitcoinsAndGravy.com

  • It is interesting how it works that is for sure. I wonder how the legal dispute will work out for McCaleb and others.

  • Jared Deckard

    I don’t think Bitstamp processes its trades trough the ripple network. Most exchanges that offer ripple (or stellar) don’t. It is cheaper and faster to process trades through Bitstamp’s internal database. I think ripple stopped this payment the old fashion way: the threat of legal action via paperwork.

    [Disclosure: Former employee of Stellar]

  • OneMillionGateways

    Freezing is a necessary feature of any currency exchange. Bitstamp and others can do this at will. The $1 million is locked up in a legal dispute that has nothing to do with the Ripple protocol. It is about a breach of contract dispute between Ripple Labs and Jed. The only asset on the Ripple network that cannot be frozen is XRP because it has no counterparty risk like Bitcoin.

  • tommytrain

    Ripple wiki is intact: https://wiki.ripple.com/Freeze

    Wiki, also contains specs for Ripple Identity, an OpenID protocol Ripple is developing for cryptographically securing ID credentials to allow KYC and AML compliance without losing control of user data. https://wiki.ripple.com/Understanding:_Ripple_Identity

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