BMJ Score: 4.1
Description27 Investors read this
Stellar is designed specifically for moving money across borders. In addition to a protocol designed to speed up transaction time, Stellar is built specifically to facilitate cross-border transfers. The result is a project which has quickly become a major cryptocurrency success story, with numerous major institutions embracing it as a potential market leader for international finance.
The Problem and Solution
Virtually any transaction you conduct online comes at a price. Whether it is using a credit card or exchanging currencies, one or more of the entities who facilitate that system will generally charge for their services. Often, especially when it comes to cryptocurrency, the process will lag, taking potentially hours while the network resolves your transaction.
This is the problem that Stellar would like to solve.
Stellar is a payment network designed to provide low-cost, low-friction, high-speed online transactions. The goal, according to the project’s website, is to connect “banks, payments systems, and people” so that all involved can “move money quickly, reliably, and at almost no cost.” In particular, the project emphasizes its system for moving money across borders reliably and inexpensively.
Similar to bitcoin, Stellar is built on a distributed ledger system. Nodes on the network will process each transaction. However, it uses a somewhat different architecture from bitcoin called the Federated Byzantine Agreement. Instead of requiring each member of the network to confirm a transaction, with FBA each node selects a second network of separate, trustworthy nodes. When one of these networks confirms the transaction, it is approved. According to Stellar, this reduces processing time down to several seconds.
Stellar is also built on a network of relationships with banks and other financial institutions. These act as what the project calls “anchors.” As the Stellar ledger records credits and debits among accounts, users of the network can then use participating institutions to settle those assets (either withdrawing money for a credit or paying for a debit).
The result, according to project designers, is a highly efficient system money transfer service. The low latency of the network means that it can hold down costs, making microtransactions far more efficient than under ordinary mechanisms. Meanwhile, the distributed network of anchors allows users to interact with institutions across borders, reducing the cost of changing currencies and sending money around the world.
It is an architecture which depends more than most projects on network solvency (that is, the distribution, volume and reliability of network participants). Nevertheless, it is a well-designed concept that has attracted the attention of top-tier players ranging from Deloitte to IBM.
Stellar was designed by Jed McCaleb, founder of such projects as Mt. Gox and the cryptocurrency Ripple. McCaleb is also an advisor to the highly respected MIRI project. He has a deep background in the alt-coin industry, as well as the technology industry in general, and is a highly respected executive.
Stellar runs on a token called the lumen. While it is an essential element of the project’s architecture, it is also the biggest potential weak spot of this design philosophy.
The lumen is a blockchain-based cryptocurrency processed, as noted above, according to the FBA architecture. Stellar users conduct their transactions in lumens which are distributed according to the debits and credits on the public ledger. (The lumen also funds the nonprofit Stellar.org project, which has taken five percent of the initial set of lumens for operating costs.)
By using lumens, Stellar is able to create its low-cost transaction model. It does not have to deal with expensive third-party processing fees or the challenges involved with currency swaps. Instead, users at any participating anchor node (say, a bank) can simply buy, sell, or withdraw lumens in their own currency for a fraction of a penny per transaction.
For example, an American user might buy a set of lumens and credit them to his friend in Vietnam. The American’s debit would be recorded to the ledger, reducing his wallet by the nominated amount, and the Vietnamese user’s wallet would receive a credit. Then the Vietnamese user could visit a participating bank and withdraw his account in Vietnamese dong. In both cases, the bank actually buys and sells the lumens, creating an intermediary transaction which prevents messy currency transfers.
This is a fine and feasible system as long as the Stellar network can maintain financial institutions to act as anchor participants. However, it all depends on the value of the lumen. As long as users spend money in the form of lumens, their actual accounts will be vulnerable to the well-known fluctuations in value inherent to cryptocurrencies. Someone who receives a remittance on Stellar, for example, will need to withdraw it almost immediately in order to ensure that they actually get the money they expected, not an amount heavily adjusted for market swings.
This is an inherent weakness of Stellar’s currency-based model, one which makes exchanging money across its network inherently more unreliable.
Users who are interested in Stellar can learn more at the project website, Stellar.org. The lumen is for sale on most major exchanges. Ready to know more about how to invest in the world of New Finance? Subscribe to the Bitcoin Market Journal newsletter today!
Bitcoin Market Journal analyst briefing for Stellar.
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