I am not a subject matter expert, and am not a financial advisor on whether or not you should invest in cryptocurrencies or Stellar. I have tried my best to maintain accuracy but everything is purely my opinion. I will be adding more and revising to make this article better and better.
Cryptocurrency is still so new that it can be quite difficult for the general public to understand how specific cryptocurrencies work and their key differentiators.
After extensive research over the weeks, I’ve finally been able to answer some of my biggest questions regarding one of my favorite cryptocurrencies, built on the Stellar network, called Lumens.
The main goals of Stellar are easily understandable, whereas the technology can be extremely difficult to understand, especially if you’re someone like me and don’t have a strong technical background in computer science or fintech (financial technology).
Recently, I set forth on a mission to try to really understand the big picture of how Stellar’s technology can impact the world, how the technology works, why it’s better than other blockchain technologies, and what may drive the Lumen token higher and higher.
After weeks of research, including reading the Stellar whitepaper; the Stellar.org website, blog, and publications; and a vast array of talks given by Jed McCaleb, Dr. David Mazières, Joyce Kim, and other key opinion leaders, I’ve finally compiled enough information to explain the goals of Stellar Foundation, the problem it solves, the solution it offers, and how it works on a social and economic level.
As a disclaimer, although I’ve thoroughly researched this subject, I am not a computer scientist, nor am I an expert in financial technology. My background is as an entrepreneur and as a marketer — this means that this piece is my point of view and I try to back it up with sources as necessary. I plan to evolve and edit this piece as I fill in the gaps and learn more about the Stellar project.
Stellar foundation aims to solve two key problems. I’d like to start by explaining:
1) How Stellar can make impactful social changes, and
2) Why Stellar’s underlying technology is superior to other blockchain technologies such as Bitcoin.
Stellar’s Social Mission: To provide financial services to the unbanked
First off, it’s expensive to be poor.
What do I mean? Well, if you’re in a developed country, this probably isn’t a problem you encounter on a daily basis. If I want to send money to a friend, I can use a variety of tools like Venmo in the United States, or WeChat Pay in China to instantly transfer funds.
However, when someone in Tanzania wants to transfer funds to someone else in Kenya, they pay an average of 22% of the total transfer value in network and bank service fees.
Oftentimes, migrant workers in developed nations pay a fortune to companies like Western Union to sending money back home to family members. In fact, Western Union made $5.6 billion dollars moving just $85 billion dollars in 2014. Not to mention it usually takes a long time for the funds to actually come through, and for some countries, you simply can’t transfer the money across borders at all.
Secondly, today, 2 billion adults are unbanked. Most of these people reside in lower-income developing countries where it’s hard to find access to a trustworthy or reputable bank. It isn’t uncommon for the bank itself to commit fraud against you and steal your funds.
Being unbanked has bigger repercussions than simply not being able to store your money in a bank account. Once again, this isn’t so intuitive for someone from a developed country because we take financial services for granted. Imagine if you literally could not transfer funds to other people, could not invest in anything, could not save money, and literally had no means of connecting with or participating in the global economy.
How Stellar can provide services for the unbanked through the Stellar Decentralized Exchange (SDEX)
On a technological level, cryptocurrency in itself is an amazing breakthrough that has allowed for the decentralization of currency. Previously, there was a major problem when it came to sending money digitally to someone else without having a central ‘trusted’ authority such as a bank or middleman.
The reason you need a centralized trusted authority is to essentially verify that you are giving someone $10 (so $10 gets deducted from your account) and the person you send it to gets $10 credited to their account (minus fees when applicable). Without this central authority, people can game the system.
Think of when you email a file to someone else. There is no central authority that tracks all files on computers, so when I send a file to someone else, essentially I’m making a copy of that file and sending it over to them. However, I can’t do that with money, otherwise I’d be making a copy of my digital currency and sending it to someone without it being subtracted from my account. This is the classic ‘double-spend’ issue that historically has been mediated by a central bank or trusted institution.
The problem with always having a trusted intermediary is that you’ll always be relying on a middle man to send your money to someone else. This also means that you’ll always be at the mercy of a financial institution if they choose to raise fees. Even worse, not all banks play along with each other, and anyone who’s sent funds overseas knows you literally have to deal with numerous financial institutions all with their individual fees to get money to someone else.
Today, if I wanted to send $100 to my friend in Eastern Europe from the United States through a bank, I’d get hit with a $25 wire transfer fee and she’d get hit with a $25 wire transfer fee which results in a net loss of 50% due to fees.
Then, Bitcoin came along — a secure way to send digital currencies, cutting out the middleman and thereby decentralizing currency.
However, Bitcoin has major problems.
It is based on a ‘proof-of-work’ system, which in short is a computational way to verify the accuracy of transactions in a secure way. The main thing you need to know about proof-of-work is that a number of people all over the world with computers, who we call miners, use a crazy amount of computational power to solve puzzles. Since the puzzles take so much time and power to solve, it is difficult for evil people to change the Bitcoin blockchain which in turn guarantees security.
Once transactions are confirmed, they are added to a global, decentralized ledger. A ledger is simply public documentation log that everyone agrees upon that will note Person A sent X amount to Person B, etc.
Bitcoin’s ‘proof-of-work’ system results in large problems when it comes to scalability and speed. Because each transaction needs to be verified through computational puzzles, sending currency is slow, oftentimes up to 30 minutes, and extremely expensive. Imagine trying to send $30 but being nicked $15 in fees. Due to the demand for computing power to confirm Bitcoin transactions, the maximum number of transactions per second with Bitcoin is somewhere around 3–7. Visa, on the other hand, is well over 20,000 transactions per second.
Then, factor in the environmental concerns. Today, Bitcoin uses as much energy as the entire country of Denmark — and it doesn’t even have widespread adoption yet.
As you can imagine, numerous other cryptocurrencies set forth to try to solve these major problems involving decentralization, speed, and energy consumption. At the same time, alternative cryptocurrencies also need to ensure the principles of “liveness” (allowing the system to function in the presence of failures and attacks) with “security” (ensuring that only accurate, consistent, and correct values are agreed upon).
The Stellar Consensus Protocol (SCP) was created to address these problems.
How Does Stellar Lumens Work on a Technical Level?: The Stellar Consensus Protocol (SCP)
First, we have to talk a bit about the Stellar Consensus Protocol (SCP) which was created by Dr. David Mazières, a professor of computer science at Stanford University.
The SCP took some time for me to wrap my head around. Essentially, the SCP is a way to tackle the scalability and speed problems Bitcoin has which were detailed above.
Today, people expect the speed of a digital transaction to be a few seconds. This means that the Stellar network needs to reach consensus very fast while ensuring accuracy. Consensus is a vital component of decentralized networks which involves the entire network reaching agreement on a set of values. If consensus is not met, you then have a network all saying and recording different things.
Due to these speed issues, SCP cannot use a similar consensus protocol to Bitcoin’s ‘proof-of-work,’ but it does still have to maintain accuracy and security.
This is challenging because a global network of decentralized servers has to agree that I sent you $10, you received $10, and $10 was deducted from my account. There has to also be enough protection if a bad actor tries to take down the network.
These attacks are often done through evil or untrustworthy hacked nodes that try to break the consensus in different parts of a distributed network.
All of the consensus has to be done accurately in a matter of seconds, otherwise you will have a scaling problem. The SCP utilizes what they call a Federation in order to fulfill fast consensus. A Federation is just a group of trusted nodes that can decide to trust other nodes and thereby add to consensus. Any entity can set up and run a server, but that doesn’t mean that everyone else is going to trust that entity.
Each node communicates with one another and accepts verification and reaches consensus every 2–5 seconds with other trusted peers. Eventually you have an entire network of peers that trust each other mutually through other trusted peers. This is how the SCP forms consensus about who can actually form consensus in the first place without creating a central body that owns it all. Your end result is completely synced ledger every 2–5 seconds.