What is Stellar? | The Ultimate Beginner’s Guide
Stellar is an open platform for building financial products that connect banks, people, and payment networks everywhere. Founded by an accomplished crypto entrepreneur and backed by an impressive group of advisors, is Stellar capable of changing the way we make international payments?
In this beginner’s guide to Stellar, we’ll cover:
Stellar is a distributed payment network which aims to make sending money internationally as cheap and easy as sending an email. While Stellar does offer a native cryptoasset called Lumens (XLM), the currency serves only a complementary role in the network’s design. Stellar’s primary use cases revolve around remittances and banking the unbanked, and the network prioritizes accessibility, security, and low transaction fees above all else. The ultimate goal is to create a financial network that is inclusive to everyone, including the poor, who are currently being underserved by expensive and outdated financial institutions.
Stellar was founded in early 2014 by Jed McCaleb — the same Jed McCaleb responsible for founding P2P file sharing network eDonkey, Bitcoin exchange Mt. Gox (which he sold to French developer Mark Karpelès before the infamous security breach), and Ripple. Notable members of Stellar’s advisory board include Keith Rabois, Matt Mullenweg, Sam Altman, and Naval Ravikant.
The Stellar name is given to two entities:
- The Stellar network refers to the distributed payment network responsible for processing financial transactions. Lumens (XLM) are the tokens native to the Stellar network; primarily serving as a bridge currency.
- Stellar Development Foundation (SDF), also referred to as Stellar.org, is a nonprofit responsible for maintaining the Stellar network. Operational costs are covered by the 5% cut of total Lumens supply retained at launch, in addition to tax-deductible donations from the public.
Stellar began as a fork of the Ripple protocol after Jed McCaleb left the project citing philosophical differences. McCaleb’s breakup from Ripple was a messy affair, ending with him attempting to sell the entirety of his 9 billion ripples, a move that would have had significant impact on the XRP market. McCaleb later settled with Ripple in a court deal that would limit the amount of XRP he could sell at one time.
Though originally based on code borrowed from Ripple, Stellar underwent a complete network upgrade in November 2015 after claiming there were flaws in the underlying Ripple consensus mechanism. Ripple’s chief technology officer Stefan Thomas responded with a blog post titled, “Why the Stellar Forking Issue Does Not Affect Ripple”, concluding “there is no threat to the continued operation of the Ripple network.” Stellar is no longer considered a fork of Ripple as it uses completely different code since the 2015 revamp.
Stellar, like Ripple, is a payment network first and a cryptocurrency second. Stellar uses its native cryptoasset, XLM, as a means to better transfer fiat currencies rather than attempt to replace them.
Stellar: PayPal on the Blockchain
On the surface, the Stellar payment network functions similarly to PayPal. First, users deposit money onto Stellar through a trusted intermediary like a bank. Stellar then credits their account with the appropriate amount, and users are then free to send those funds to anyone on the network.
Stellar’s payment network differentiates itself from PayPal by its use of blockchain technology. Blockchains provide numerous benefits to traditional servers, including decentralization, transparency, and security. Perhaps the most enticing reason to choose Stellar over PayPal is Stellar’s extremely low transaction fees. Transaction fees exist within Stellar for the sole purpose of preventing network spam, and are therefore very cheap. Base fees are currently set to .00001 XLM — a fraction of a penny.
Stellar can maintain these low fees because all transacting parties reside on the same network. This is in contrast to transactions through traditional financial systems, which are often subject to a long series of detours, racking up multiple conversion and processing fees along the way to their destination. Stellar is cheap, even compared to other cryptocurrencies, because there are no miners to pay. Transaction fees collected on Stellar are later redistributed back onto the network via inflation — more on that later.
Multi-Currency Transactions
Stellar makes international payments easy with their multi-currency transactions. For example, say you want to send me euros using your USD balance. This transaction can be completed a few different ways:
- Currency conversion. The Stellar ledger features a native orderbook for each currency/issuer pairing to deal with foreign exchanges. In this case, Stellar would look for someone wanting to sell EUR for USD and automatically complete the trade.
- Use Lumens. Lumens (XLM) are the native cryptoasset of the Stellar network. XLM can act as a bridge currency in situations where there isn’t an active market between two currencies. If nobody wants to sell EUR for USD, Stellar will instead look for a USD -> XLM offer, as it simultaneously seeks a XLM -> EUR offer. The network then makes those exchanges and completes your USD -> EUR conversion.
- Finally, if the previous options have been exhausted, Stellar seeks out offers available on the network that eventually lead to the desired conversion. Here’s an example path of what this process can look like: EUR to AUD, AUD to BTC, BTC to XLM, XLM to USD.
Stellar Consensus Protocol: How Transactions Get Validated
Stellar may not reward its validators for maintaining the blockchain, but they still have a job to do. Stellar nodes use a modified ‘federated byzantine agreement’ form of consensus, called the Stellar Consensus Protocol, to determine if transactions are valid or not. In this system, every node maintains a list of other nodes it wants to listen to, resulting in a chain of nodes essentially saying, “I trust this transaction so long as X amount of my friends also trust it”.
The Stellar Consensus Protocol is considered an open membership system: anyone is free to become a validation node, and nodes can choose which other nodes they wish to follow instead of being fed a list from a central authority. This makes Stellar’s network design more decentralized than similar networks using delegated byzantine fault tolerance (dBFT) such as Ripple or NEO.
That being said, at this point in time Stellar only has 20-30 nodes powering its network. This lack of participation is a common side effect of systems choosing to forego economically incentivized consensus mechanisms. Validators exist on Stellar solely because they are willing to dedicate their resources for the sake of the network.
Inflation On the Stellar Network
New lumens are added to the Stellar network at a rate of 1% each year. The inflation mechanism runs on a weekly basis, distributing the inflation pool to any account on the Stellar network receiving over .05% of total votes. The size of the inflation pool is determined by the following formula: (number of lumens in existence)*(weekly inflation rate) + fee pool. Votes are weighted based on the amount of lumens you hold; 1 lumen is equal to 1 vote.
Every account has the option of participating in this voting process, but the lucky winners will need to earn a minimum of .05% of total votes — that’s 9,233,901 votes based on today’s circulating supply. Winners are paid out their share of the inflation pool; earn 5% of total votes and you’ll get 5% of the total pool. Some XLM holders have formed groups in which they combine their voting power to a designated account and split the earnings among all participants.
Stellar’s XLM is available on a variety of different cryptocurrency exchanges, including Binance and Bittrex. These two exchanges handle a combined daily volume of over $16 million in XLM alone; putting them behind only Korean cryptocurrency exchange Upbit.
There are a healthy selection of wallets capable of holding your XLM securely. Stellar.org lists a total of 11 compatible wallets, including 4 desktop wallets, 4 mobile wallets, and 8 web wallets. The safest place to store your XLM is in a hardware wallet. The Ledger Nano S is a good option that is compatible with XLM.
It’s worth pointing out the disclaimer on Stellar’s wallet page: “Stellar.org does not own, maintain or operate any of these wallets.”
Stellar wants to become the standard method of sending money around the world. The team is taking a bottom up approach, focusing on money transfer and remittance companies instead of large, risk-averse banks. Stellar believes banks need to see the protocol succeeding elsewhere before they actually begin using the network. IBM has declared they are a believer, which is a pretty good start.
It’s Stellar’s opinion that the fees associated with moving money, especially across borders, have a disproportionate impact on the poor. Working families, for example, spend $44 billion every year on Western Union or similar middleman fees. Stellar sees this massive number as an unnecessary expense being taken from people by an outdated financial architecture.
Stellar finds itself standing alone in a middleground: not quite in the cryptocurrency crowd, and not quite in the legacy payment network crowd. Stellar is significantly more decentralized than PayPal, but with no incentive mechanism for validation nodes, it is unclear just how decentralized Stellar will remain. Stellar’s ultimate success will depend on its adoption by legacy financial institutions, and how the network will be able to scale. Assuming it succeeds, however, Stellar has the potential to revolutionize the way people transfer money.
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