Stellar is a blockchain that uses a Federated Byzantine Agreement (FBA) consensus algorithm which is a radical departure from Bitcoin's proof of work consensus algorithm. Although FBA allows Stellar to be fast, scalable, and cheap to use, we see a classic case of the scalability trilemma here - that is, in an effort to build something that’s both scalable and secure, some decentralization is sacrificed in the process. Over the past several months, Stellar has garnered a significant amount of attention primarily due to its high profile partnership with IBM and because of its similarities to Ripple - a cryptocurrency that rallied astronomically during the bull market. The two projects share a co-founder, Jed McCaleb, who left Ripple to found Stellar after a disagreement with Ripple management. Today, the Stellar project is guided by the Stellar Development Foundation (SDF).
How does Stellar work?
Stellar uses a Federated Byzantine Agreement (FBA) consensus algorithm. Unlike Bitcoin's proof of work where a series of nodes race to find the next accepted block, FBA nodes work together to reach consensus on what the next block looks like. In proof of work, unless malicious nodes represent more than 50% of the computational power of the network, their blocks will be rejected by well-behaving nodes, which wastes the bad actor’s computational power. Whenever they find new blocks, well-behaving nodes in proof of work networks like Bitcoin and Ethereum are rewarded with newly minted coins and transaction fees. However, with FBA, it’s not computationally expensive to build the next block, so nodes are not punished for malicious behaviour. They could be blacklisted by well-behaving nodes and excluded from the consensus process, but a bad actor can quickly spin up, at little cost, many malicious nodes to outnumber the well-behaving nodes.
The academic paper published on Stellar's consensus algorithm provides a good high level explanation of the algorithm:
"In FBA, each participant knows of others it considers important. It waits for the vast majority of those others to agree on any transaction before considering the transaction settled. In turn, those important participants do not agree to the transaction until the participants they consider important agree as well, and so on. Eventually, enough of the network accepts a transaction that it becomes infeasible for an attacker to roll it back. Only then do any participants consider the transaction settled. FBA’s consensus can ensure the integrity of a financial network. Its decentralized control can spur organic growth."
FBA enables Stellar to have a high transaction throughput. The theoretical ceiling is about 1000 transactions per second. To prevent spam, there is a fee charged per transaction. Nodes participating in Stellar's consensus process are not rewarded for validating transactions, the fees from each transaction are put into a global fee pool that is redistributed to Stellar wallets regularly.
Lumens has an inflationary supply
Stellar's native asset is called a lumen. The total supply of lumens increases by 1% annually. The inflation, along with the lumens in the global fee pool, is paid out to any Stellar wallet with more than 0.05% of the total supply of lumens voting for it. With a total supply of 100 billion lumens, a wallet needs at least 50 million votes to receive inflation. The amount of new lumens received is proportional to the number of votes the wallet has. Each wallet can vote for another wallet, with the number of votes equal to the number of lumens the wallet owns.
For wallets that do not meet the minimum vote requirement, they can participate in an inflation pool to still earn inflation. However, inflation pools typically charge a fee to use.
Custom assets and a built-in decentralized exchange
Stellar allows users to issue custom assets and trade them in a decentralized exchange (dex) built right into its protocol. Stellar's transactions can contain orderbook functionality, such as order posting and matching. Users can thus issue custom assets and trade these assets right away with other users in the dex.
Stellar's protocol enables developers to create smart contracts. However, its smart contract scripting system is not Turing complete, meaning it has limited expressiveness. As described in the documentation, a "Stellar Smart Contract is expressed as compositions of transactions that are connected and executed using various constraints". The system is expressive enough that developers can create basic smart contracts like multisignature smart contracts and time bounded transactions.
Similarities to Ripple
After a fallout with other Ripple executives, Jed McCaleb left Ripple and forked Ripple's codebase to create Stellar. However, Stellar’s codebase has since been largely rewritten. Stellar may share similar semantics and function to Ripple, e.g. both blockchains focus on payments and use an FBA consensus algorithm, but at an implementation level, they are very different. For example, Stellar has re-architected its consensus algorithm (the Stellar Consensus Protocol) such that its implementation is significantly different from Ripple's.
Another critical difference between Stellar and Ripple is that the total supply of lumens increases by 1% annually whereas the total supply of XRP is always decreasing. There is no natural growth in the supply of XRP and the XRP used as transaction fees are burnt.
The team behind Stellar
As previously mentioned, the Stellar project is guided by the Stellar Development Foundation (SDF). The SDF is a nonprofit organization founded in early 2014 by Jed McCaleb and Joyce Kim. McCaleb is a talented software developer and a serial entrepreneur. Prior to Stellar, he created the popular peer-to-peer file sharing networks eDonkey and Overnet. He also founded the infamous Mt. Gox Bitcoin exchange (which he sold to Mark Karpelès who subsequently ran it to the ground). McCaleb then went on to create Ripple.
The SDF has a board and a group of advisors that consists of many well known individuals such as Patrick Collison, the founder and CEO of Stripe, Greg Brockman, former CTO of Stripe, Sam Altman, president of Y Combinator, Keith Rabois, Partner at Khosla Ventures, and Naval Ravikant, CEO and co-founder of AngelList. The Stellar Consensus Protocol was developed by David Mazieres, a Stanford University Computer Science Professor who now serves as Chief Scientist for the Stellar Development Foundation.
You'll notice that Stripe has a significant presence in SDF management. That's because Patrick Collison took an interest in Stellar very early on his company, Stripe, provided $3 million in seed funding to the budding project.
In late 2017, IBM announced a pilot blockchain project where the Stellar network was used to settle cross-border payments between 13 countries and 7 currency corridors in the South Pacific. This reduced the time needed to settle these payments from a few days to several seconds. Lumens was used as a bridge asset to exchange between the myriad of currencies involved. IBM is working on scaling this cross-border payments solution to more banks worldwide.
The company is also aiming to help its clients issue custom assets on Stellar. According to Jesse Lund, IBM's Head of Blockchain Solutions, they are "very very close" to having a central bank issue a fiat currency as a custom asset.
The importance of the IBM partnership for Stellar cannot be stressed enough. IBM has a large banking business with strong partnerships all over the world. With IBM promoting Stellar adoption, the network has a much greater chance at widespread institutional adoption.
Many other companies are using Stellar
Besides the high profile IBM partnership, many companies are already using Stellar as a payments solution. The list includes:
- TEMPO: a European licensed remittance provider that has issued a EURO-backed token called EURT on Stellar that they are actively using for their remittance program.
- coins.ph: a mobile financial service provider in the Philippines.
- Parkway Projects: a financial technology provider creating modern banking solutions delivered through Africa’s banks to businesses and individuals.
- For more examples of businesses using Stellar, check out the Partners directory on Stellar’s website.
The Stellar Development Foundation owns a large amount of lumens
The SDF holds a unusually large amount of lumens. There are 104 billion lumens in existence and only 18.6 billion lumens are owned by the public. For a cryptocurrency development team to control more than 80% of all available tokens is unheard of. A few years ago, even doing a premine was frowned upon. However, we do need to point out that the SDF has a mandate that dictates that 95% of the initial 100 billion lumens are to be given away for free to increase adoption and strategic development on Stellar; only 5% are reserved for operational expenses.
With a well meaning mandate or not, one of the main problems with development teams owning too much of their own token is that they could sell the tokens on the market, drop its price, and essentially take money from the community. It's not easy owning an asset if there's always a threat of the development team selling their massive stake.
The supply of lumens inflates exponentially
The supply of lumens increases by 1% a year. This is inflation at an exponential rate. Exponential growth is incredibly fast, especially given a long enough time. As an example, if you increase your net worth by 1% a day, in one year, your net worth will grow by almost 38 times. Similarly, assets with an exponentially growing supply are often very bad long term stores of value.
However, as mentioned above, wallets are eligible to receive a proportional amount of this inflation based on how many votes the wallet has. A wallet is only eligible to receive this inflation if at least 0.05% of the total supply of lumens has voted for it. 0.05% of 100 billion is 50 million. Most people will not be able to receive this many votes and, unless they participate in any inflation pool, will be cut off from the inflation. Even with inflation pool participation, users are often receiving less than what they are entitled to because inflation pools tend to charge fees to use.
Because Stellar’s FBA consensus algorithm does not reward validators nor punish malicious actors, it’s much cheaper to attack the network than a proof of work or proof of stake network. An attacker can spin up an army of cheap validator instances and quickly outnumber the well-behaving validators. Even if the well-behaving validators could blacklist the army of new validators, it would still be hard for new network users to figure out which consortium of validators to trust. The simplest answer of the “consortium with the most validators” is wrong in this instance. As such, Stellar’s consensus algorithm requires a systemic centralization of trust in a core consortium of validators in order to prevent attacks such as a flooding of malicious validators. The algorithm is not open and accessible for everyone to be a validator; in order to be one, you need to have at least one validator in the trust consortium of validators whitelist you.
Again this is a great example of the scalability trilemma. For a network to have more throughput, decentralization is sacrificed. Stellar has impressive throughput, up to 1000 transactions per second, yet decentralization must be sacrificied in order to achieve it.
In summation, Stellar is a cryptocurrency that is fast, has a high throughput, and is cheap to use. The protocol itself is feature-rich; it allows users to issue and transact with custom assets, trade these assets in a protocol-level decentralized exchange, and create basic smart contracts. We’ve also seen Stellar experience significant business adoption with companies all over the world using it as a payments platform. Stellar's biggest partnership is with IBM. The tech giant is actively promoting Stellar as an interbank payments solution.
As with all cryptocurrencies, it’s important to be cognizant of the project’s weaknesses. For Stellar, project weaknesses include Stellar's development team owning more than 80% of all lumens, the supply of lumens having exponential inflation, and the fact that Stellar’s FBA consensus algorithm tends to be more centralized.
Despite these weaknesses, Stellar is definitely an impressive cryptocurrency with great potential.