8 August 2020
The Stellar Network is one of the most used blockchain networks in the world. It consistently posts over 1 million operations per day, according to Blocktivity.info. And its native coin, XLM (Lumens), is one of the top 15 cryptos in terms of market cap.
But many crypto users may wonder exactly what Stellar does.
This article will explain how the Stellar network functions and what users can do with it.
Use Cases for Stellar Lumens
The Stellar network was created to help people move assets around in the world and swap them with each other digitally. These assets include fiat currencies, precious metals, cryptocurrencies, stocks, bonds, and any other valuable objects people may want to trade conveniently. However, we already have banks, stock brokerages, crypto brokerages, and gold vaulting services to do these things. So in order to explain why Stellar was created, we first have to consider what kind of problems exist with these current systems.
The Challenges of Banks
Let’s take banks as an example:
i) Transfers within the same bank
If I want to give you $100, the easiest way for me to do this is to hand you cash. But this only works if we can meet face-to-face. If we can’t meet face-to-face, I’ll need to first deposit the cash in a bank. Once this is done, the bank will issue me credits in an account within its own database. Assuming that you and I are using the same bank, transferring the credits is now easy. All I have to do is request that the bank move credits from my account into yours. Once you’ve obtained the credits, you can “call in the loan” or “withdraw the deposit.” In this case, the bank extinguishes the credits in your account and pays you cash.
ii) Transfers Between Banks
This works great as long as we are using the same bank. But what if we are using different banks? In this case, both our banks need an account with a clearing unit , such as a Federal Reserve Bank. If both our banks use the same clearing unit, my bank can request that some of its credits be sent to your bank’s account with the clearing unit.
My bank can also send information to the clearing unit stating that credits are being sent on my behalf and are intended for your account. While this system is better than nothing, it can lead to increasing complexity as users get further apart. And each layer of bureaucracy slows transaction speed and increases cost.
As one example of these inefficiencies, international ACH transfers can take up to three days to process. Wire transfers are usually faster, but they can cost $40 or more in fees to process. To solve these problems, many users attempt to bypass the banking system by using payment processors such as Paypal or Payoneer. But this produces additional cost and only works if both users employ the same payment processor.
iii) Currency Conversion
As if the above problems were not bad enough, users also have to contend with differences between fiat currencies from one country to the next. This means that banks and payment processors must hold multiple currencies, exposing themselves to volatility. The banks need to be compensated for this risk, and this compensation increases the cost to users even more.
How Stellar Works
Stellar seeks to solve these problems by allowing users to transfer assets or swap them in seconds. Here is how Stellar attempts to accomplish this.
On the Stellar network, credits or tokens are issued by anchors. An anchor could be a traditional bank, remittance service, crypto brokerage, gold vaulting service, or any other institution that has a large quantity of assets it wants to make transferable.
Anchors should allow users to “withdraw” assets by burning tokens and receiving real-world goods in return. For example, an owner of USD tokens issued by Anchor A should be able to burn these tokens and receive cash from Anchor A in exchange. However, the relationship between users and anchors relies on trust. Users should not deposit an asset with an anchor that isn’t trustworthy.
Unlike banks in the banking system, anchors on Stellar do not issue accounts to users. They simply issue tokens that are held in the user’s Stellar account. In other words, it is the user that holds the token, not the anchor.
If a user wants to hold a token issued by an anchor, he must first issue a trustline from himself to the anchor. He does this from within his Stellar wallet. Trustlines ensure that spammers cannot send worthless tokens to users without their permission. Once a trustline is established, the anchor allows the user to deposit or buy the asset and receive tokens in his Stellar wallet.
On the Stellar network, accounts are created through public/private key cryptography, just as they are with other blockchain networks. When a user first sets up a wallet, he generates a private and public key. The public key is hashed to produce the Stellar account address. Once a user has his address, he can submit a trustline transaction to the network. From then on, the Stellar nodes will recognize the address and keep track of its balance.
Nodes are computers that hold the global ledger of the Stellar network. A node could be as large as a mainframe server or as small as a laptop. Unlike Bitcoin, there are no “hash problems” on the Steller network. So nodes do not need to have high processing power.
There are two types of nodes: watchers and validators.
- Watchers: Each watcher keeps a copy of the global ledger. It also monitors the network for transactions and submits transactions to the validator nodes. Watchers cannot update balances in the ledger.
- Validators: Validator nodes are tasked with the job of keeping the ledger updated. But they can only do this according to the rules of the Stellar Consensus Protocol (SCP).
We’ll explain the SCP in a section below. For now, just remember that Stellar account balances are kept by nodes, not anchors. Unlike with Bitcoin and Ethereum, there is no reward for running a validator node on Stellar. Presumably, this means that only individuals who do a lot of business on Stellar will be willing to run nodes.
To solve the problem of needing to swap between different currencies and assets, Stellar contains a decentralized exchange that runs directly on the network. This exchange is part of the Stellar network. It is not a smart contract coded by a third-party the way Ethereum DEXs are. This means that users do not need to fear bugs in the contract that could allow it to be hacked. However, users do need to trust the Stellar code itself – since the exchange is part of that code.
Lumens or XLM is the native coin of the Stellar network. Unlike tokenized assets, Lumens is not issued by an anchor. For this reason, it does not require trust. On the Stellar network, XLM is used as a bridge currency for swaps between tokenized assets.
For example, let’s say a user wants to swap Euros for Yen. But he can’t find anyone to take the other side of this trade. As long as there is one user who is willing to swap Lumens for Euros and another user who is willing to swap Yen for Lumens, the user can still make his trade.
Each time a user makes a transaction on the Stellar network, he must burn a small amount of XLM. This is what gives XLM its value and allows it to serve as a bridge currency on the network.
How to Use Stellar to Send Cross Border Payments
As outlined by the Stellar Development Foundation regarding cross border payments, a process known as path payment:
Like any payments system, Stellar allows one user to send currency to another. User A can send User B dollar tokens or lumens or whatever. But Stellar also allows a user to send one currency and have the recipient receive another. Essentially, you can send and exchange money in a single atomic transaction.
A Stellar wallet will be needed to send and receive these tokens. You can find information about wallets at the official Stellar wallets page. You’ll need some XLM as well. It can be purchased from numerous crypto exchanges, including Binance, Coinbase Pro, Bithumb, and Kraken.
Stellar is one of the most active blockchain networks in the world. But reports about what it does and how it works can be confusing. This article has attempted to provide a simple explanation of the Stellar network.
We don’t know whether Stellar will replace traditional payment systems over the long-run. But it seems to be making strides in that direction. For this reason, crypto users and investors may want to keep an eye on the network as it expands.