Oh, and see Deprived response for why Ripple is actually flawed in how liquidity providers work.
I do really see a problem now. Probably it is not a good idea to exchange IOUs automatically. It is not only the problem of trust, but the problem of different issuer's policies too. It can't be solved with a simple numeric field, there should be some way to attach a contract to the IOU, so that when one grants trust, s/he could accept the terms. But wait... Looks like there are contracts in Ripple:
https://ripple.com/wiki/Contracts .
TradeFortress, what did you do to issue IOUs? I just don't know how it is done in Ripple.. Did you have to create and sign a contract?
You just issue them - no contracts, no need to have any BTC, no need to be owed anythig yourself. Only two requirements to issue ANY amount of debt:
1. You have some XRPs
2. The person you're issuing to has unused trust towards you at least equal to the amount of debt you're creating.
Make an alt account, trust your main account for a billion BTC and you can send a billion BTC to it. That simple. And if someone else trusts you AND a gateway then those 1 billion BTC can be exchanged for ones issued by the gateway (up to the lower of their trust to you and their trust to the gateway). As far as ripple is concerned they're all just BTC with equal value (to anyone who trusts both issuers).