Question:
What happens when someone defaults?
So lets say we got this ripple-chain from person A,B,C and D
And through the ripple-effect A is lending basically D 100$. D is burning those 100$ and is default.
Who will have to pay those 100$ then?
Well, C would be out $100, since she is the one who trusted D. But ripple-chains won't usually work like that. That's something closer to
"classic ripple". before the name was given over to ripple the crypto-currency.
For Ripple/XRP the crypto-currency, trust paths are used for converting IOUs. So person A trusts gateway 1, person B trusts gateway 2, person C trusts two gateways, 2 and 3, and person D only trusts gateway 3.
Now A only holds IOUs from gateway 1, but wants to send a payment to D. Then path-finding automatically finds the cheapest path, say gateway 1 IOUs getting sold for XRP, then that XRP is used to buy gateway 2 IOUs, and finally ripples through person C to swap gateway 2 IOUs for gateway 3 IOUs. (person B doesn't trust two gateways so B never gets rippled through). And so D receives her payment in gateway 3 IOUs (she should redeem them right away, unless she really really trusts gateway 3).
If gateway 3 goes bust, then holders of their IOUs will sell them off for far less XRP (bad luck for persons C & D who trusted gateway 3). But if gateway 3 finds an investor to bail them out, then the price of gateway 3 IOUs would bounce back to face value.