The brainchild of Jed McCaleb and Joyce Kim was formed back in 2014 when it was forked from the Ripple protocol (This has changed now. More on this later). Stellar, according to their website, “is a platform that connects banks, payments systems, and people. Integrate to move money quickly, reliably, and at almost no cost”.
Using Stellar, one can move money across borders quickly, reliably, and for fractions of a penny. All that sounds pretty amazing, but how does it all work?
In this guide we are going to give you a deep-dive of the technology behind Stellar.
Jed McCaleb is one of the most well-known figures in cryptocurrency because he was the founder (or a co-founder) of 3 pretty famous (or infamous if you will) projects.
Back in 2006, he founded the exchange Mt. Gox because, in his own words, he wanted a way to get more Bitcoins. He eventually sold it to Mark Karpeles, whose mismanagement brought about one of the biggest crisis in crypto history.
In May 2011 McCaleb founded Ripple, a cross-border payment system which enabled cross-border decentralized system without depending on mining. However, things quickly turned sour between McCaleb and Ripple. He realized that there was some fundamental misunderstanding between the two parties which was past redemption.
In 2014, along with Joyce Kim, they forked off from the Ripple protocol and founded The Stellar Development Foundation. Ever since then, Stellar has grown from strength to strength. Just looking at the names in their advisory board proves as much: Keith Rabois, Patrick Collison, Matt Mullenweg, Greg Stein, Joi Ito, Sam Altman, Naval Ravikant etc.
Features of Stellar Blockchain
Before we go into more details, let’s do a quick run through of the features that are available in Stellar. How it gets the features will be clearer in subsequent sections, but for now, it will give you a framework. Shoutout to Boxmining for the content.
- Has a decentralized and open database.
- Confirmation time: 3-5 seconds.
- Can enable thousands of transactions per second.
- Uses the Stellar Consensus Protocol.
- Enables Multisignatures and Smart Contracts.
- The stellar token is called “Lumen” and denoted by “XLM”. A 100 billion XLM has already been pre-mined.
- Has a 1% fixed annual inflation.
So, How Does Stellar Blockchain Work?
Now that we know how Stellar came about and its features, let’s look at how it actually works. First, let’s do a brief overview and after that, we can go in-depth.
Suppose, Alice wants to send money to Bob. Alice lives in the United States and Bob lives in Nigeria. She wants to send $100 USD to Bob which will be converted to Nigerian Naira. How will it work?
Suppose, Alice belongs to Bank A based in the US and Bob belongs to Bank B based in Nigeria. Both these banks are connected to the Stellar network and are “Anchors” (more on this later). Ok, so now let’s see what happens.
Alice sends Bob $100 USD and the transaction intent is sent to Bank B within seconds to see if Bob is compliant or not.
The moment Bank A gets the green signal from Bank B, they deduct the funds from Alice’s personal account. The USD is then moved to Bank A’s pool account and then moved into the Stellar network in the form of credits aka Lumens, the native Stellar tokens.
Once inside, the network looks for the best exchange rate to use in order to convert the Lumens into Naira.
The money then moves to Bank B’s base account which then gets credited to Bob’s account.
That is a general overview of how the Stellar payment system works. Now, let’s go deeper.
#1 A Decentralized System
The first that you need to know about the Stellar system is that it is a decentralized, peer-to-peer network. The diagram below gives you a pictorial idea of how a decentralized network works as opposed to a centralized network:
Image Credit: Stellar.org
In a decentralized network, there is no centralized entity which makes all the decisions in the system.
#2 Ledger System
Up next, we have the open ledger.
All the transaction details in Stellar are stored in the blockchain which acts as a transparent and open ledger. Anyone in the network can look at the ledger and see all the transaction details.
All the decisions and verification made by the network is done via consensus. Stellar uses the Stellar Consensus Protocol which will be covered later on. The process of coming to a consensus on Stellar happens every 3-5 seconds.
#4 Anchors and Credit
We have used the term “Anchors” earlier. What exactly does that mean? Anchors are entities in the Stellar network which can hold a deposit and issue credits as and when required.
As the Stellar website puts it, “They act as a bridge between different currencies and the Stellar network. All money transactions in the Stellar network (except the native digital currency of lumens) occur in the form of a credit issued by anchors.”
Stellar’s mechanism is heavily dependent on Anchors and one needs to completely and totally trust the anchors to do their job for you which are:
- To hold your deposit.
- Issue credit for you.
The “Anchors” are not really a new concept. Paypal is a very well known example of an anchor. Let’s take a look at how Paypal works.
Image Credit: Ebay
If we break down all the steps, it will look like this. Suppose Alice and Bob are transacting through PayPal:
- Alice sends some money to her PayPal account.
- Her PayPal balance gets updated (credits).
- Alice decides to send some money to Bob, and sends him the money from her PayPal balance.
- Bob’s PayPal balance gets updated. Bob can then withdraw the balance into his bank account.
This is pretty much how the Anchors work in Stellar as well…however, there is one major difference.
All the anchors share the same network aka the Stellar network. Because of this one difference, the system is faster and more powerful.
#5 Distributed Exchanges
Another important component of the Stellar system is the exchanges. In order to understand this, we need to know what “offers” are. Offers are “public commitments to exchange one type of credit for another at a pre-determined rate.” The Stellar ledger becomes a sort of marketplace which helps us buy and sell different currencies.
All the offers in the stellar ledger form an “orderbook”. The network has an orderbook for ever currency/issuer pair. Eg. there is an orderbook to convert ICICI bank/Indian Rupees to Bitstamp/Bitcoin.
#6 Multi-Currency Transactions
One of the biggest features of Stellar is its multi-currency transactions, meaning Alice can send her USD to Bob in the form of Euros. This seamless decentralized forex is the beauty of stellar. Transactions can happen in one of the following ways (for the sake of convenience, we will be taking USD/EUR as an example):
Direct Exchange: The stellar network can look in the USD/EUR exchange to see if someone wants to buy EUR for USD. If there is someone present then the transaction happens instantaneously.
Indirect Exchange: The network can also look for people who are looking to get USD in exchange of Lumens. They can connect that person to someone looking for Lumens in exchange of Euros and make the transaction go through.
Conversion Chain: Finally, if none of those conversions are available, then the network can go through a chain of conversions. Eg. USD/INR, INR/BTC, BTC/XLM, XLM/EUR.