What is the Interledger Protocol, and how does it work?

What is the Interledger protocol?

The Interledger protocol (ILP) facilitates payments across two or more payment networks, aiming to enable direct transactions while also allowing for the involvement of intermediaries where necessary. It is a payment protocol fostering interoperability among diverse financial systems.

By seamlessly connecting ledgers from several institutions, the open-source Interledger protocol aims to streamline inter-bank transactions, reducing processing times and costs for participants. Like the internet routes information packets, Interledger operates as a network of computers that enables the transfer of value across separate payment networks.

Within the Interledger network, nodes fulfill various roles: senders initiate value transfers, connectors serve as bridges between senders and receivers, facilitating currency conversion and forwarding value packets, and receivers accept the transferred value. While Ripple’s XRP (XRP) token can be used for settlements within the protocol, other settlement options are also available.

Who created the Interledger Protocol?

Cryptocurrency and payments solutions company Ripple primarily developed the ILP. The original work started in 2015, and Stefan Thomas, Ripple’s former chief technology officer, made significant contributions. 

The objective of establishing this protocol was to integrate different ledgers and set up an Internet of Value (IoV) through standardized digital asset exchanges. ILP serves as a testament to the innovative drive and the spirit of collaboration propelling advancements in financial technology and cross-chain communication. 

Although Ripple led the initiative, the World Wide Web Consortium (W3C) provided feedback on the design of ILP, which is still undergoing active development, with numerous organizations and individuals contributing to its refinement.

Challenges faced in cross-border transfers

Conventionally, cross-border transactions often encounter challenges due to the fragmentation of payment protocols, making it difficult for the protocols to communicate via connectors.

The involvement of intermediate banks, while sometimes necessary for facilitating transactions between indirectly related banks, can further complicate the process, increasing both cost and duration. Before the payments reach the intended recipient, they pass through numerous channels, complicating the process and increasing security threats. 

To address the challenges, the Interledger Protocol uses a cryptographic escrow to facilitate the transfer of funds across connectors. Cryptographic escrow is equivalent to a two-phase commit procedure in the Interledger Protocol white paper. The procedure is divided into two phases:

• Phase 1: The first stage is to establish a set of requirements for a transaction to proceed or fail.
• Phase 2: The processing of transactions after the necessary conditions are satisfied.

For ledgers, cryptographic escrow refers to the conditional locking of funds between two parties. Only after pre-specified conditions are met, the funds are released. Otherwise, the transactions are nullified, and the funds are returned to the sender.

How does the Interledger Protocol work?

The Interledger Protocol (ILPv4) lies at the heart of Interledger, defining how nodes transfer value across the network. It employs a request/response paradigm, using compact ILPv4 data packets as its units of exchange.

One payment from a source to a destination gets fragmented into several ILP packets. Each ILP packet encapsulates transaction details safeguarded by the participating nodes. The protocol defines three packet classifications: prepare, fulfill and reject.

The sender creates the prepare packet and sends it to the connector, who relays it until it reaches its designated recipient. The recipient could accept or reject the packet by responding with a fulfill or reject packet. Connectors relay the receiver’s response back to the sender. Upon receiving a fulfill packet, the sender confirms successful delivery and continues sending prepare packets until the full value transfer is complete.

However, a reject packet can be sent by the receiver if they refuse the transfer or by a connector if they cannot forward it. Payments can also expire. In these scenarios, no balances change, ensuring security within the Interledger Protocol.

To perform value transactions efficiently, Interledger functions independently of any one payment network. Value transmission in tiny data packets ensures inexpensive, secure and fast transactions. 

Atomic vs. universal mode of implementation in the Interledger Protocol

The ILP can be implemented in two modes: atomic and universal. Atomic mode involves notaries, while universal mode works between untrusted connectors.

In atomic mode, the system integrates notaries, an ad-hoc group entrusted with verifying and validating transactions. Atomic mode transactions typically take place between reliable connector nodes connected to financial institutions.

Universal mode, however, functions between untrusted connectors without the presence of notaries. Instead, this mode makes use of XRP, Ripple’s native currency, to execute transactions. Fund transfers using universal mode are time-sensitive. If the transaction isn’t completed within the stipulated, the system nullifies it. This time sensitivity is crucial for ensuring the efficiency and reliability of transactions within the Interledger protocol.

Does the Interledger Protocol use XRP?

ILP functions independently of any specific cryptocurrency, including XRP. The protocol operates as a flexible framework facilitating smooth transactions across multiple ledgers, regardless of the digital asset involved.

While Ripple strongly advocates for ILP adoption and incorporates XRP into some of its solutions, ILP itself doesn’t enforce the use of XRP. Instead, XRP focuses on establishing an open and inclusive system for seamless cross-network payments that could incorporate digital assets.

Although the role of XRP is primarily limited to the Ripple ecosystem, its interoperability is applicable outside of the network as well. The currency can be integrated with various financial institutions and payment platforms, making cross-border payments more efficient and accessible. 

While ILP’s extensive cross-network protocol is much more sophisticated than XRP’s direct interoperability, Ripple has been promoting partnerships and integrations between ILP and XRP. 

Advantages of the Interledger Protocol

The foremost advantage of the Interledger Protocol is the promotion of interoperability across various payment networks, facilitating seamless cross-border transactions. It has made international payments more efficient, quicker and financially feasible.

The Interledger Protocol’s architecture empowers developers to introduce innovative financial products, leveraging its decentralized design to create reliable and secure platforms. Notably, ILP supports micropayments, allowing users to make small payments globally and offering a distinct advantage over conventional payment methods.

For decentralized finance (DeFi), ILP has emerged as a critical facilitator. It enables users to transfer assets across blockchain networks without hindrance, boosting liquidity and simplifying the management of multiple wallets.

In addition, the ILP can handle a high volume of transactions over multiple networks because of its highly scalable design. Because of its modular architecture, it is straightforward to integrate with existing infrastructure and systems and can quickly adapt to the changing demands of organizations and consumers. 

This scalability is essential for supporting the expansion of global payment networks and meeting the needs of diverse users, from individuals making small transactions to large enterprises conducting high-value transfers.

The future of the Interledger Protocol

The Interledger protocol holds the potential to unlock a future where financial systems are more accessible and inclusive.

Micropayments could be made possible via the ILP, which would support innovative business models and enhance financial inclusion for presently underserved populations. It may revolutionize international remittances, making them more affordable and quicker, significantly impacting people who depend on these transactions. 

As the Interledger ecosystem grows and matures, it may bring further innovation and the possibility of closing the gap between traditional finance and the realm of decentralized, blockchain-based systems.