What are Stellar Lumens (XLM): More Than a Just Decentralized Protocol for Fast and Cheap Cross-Border Transactions?

Stellar’s goal is to change the way the world’s payment system works today, and in this review we assess how successful it is and what the future may hold for XLM.

Area to disrupt: Cross-border payments, Cheap and fast transactions

Competition: XRP by Ripple

Founded by: Jed McCaleb and Joyce Kim

Based in: San Francisco, California, United States

Total supply:   As of July 2018 - 104,085,355,272 XLM (Increases by 1% per year)

Why did XLM experience two massive pumps in one year?

As of July 2018 Stellar ranks 8th of all cryptocurrencies by market capitalization. Lumens (XLM) are the native assets of the network. 100 billion XLM were created at genesis in 2014. XLM has no max supply. Instead, there is a fixed 1% inflation rate per year.

As of this writing, the total supply of XLM is 104,085,355,272 coins and one XLM changes hands for USD 0.21, which is really close to the lowest trading price for the first half of 2018 – USD 0.17.

Stellar has been on the exchanges since August 2014 but until May 2017 XLM was usually trading for less than USD 0.005. When Ethereum started its mainstream journey, most of the altcoins multiplied their value and so did XLM, spiking from USD 0.005 on May 1, 2017, to USD 0.067 on May 21, 2017.

On June 27, 2017, Stellar conducted an airdrop of XLM to Bitcoin holders, which lead to a drop in Lumen’s price because a lot of people start selling the “free” coins they received.

What followed was Stellar facing a serious correction and in September 2017 XLM was trading for USD 0.01. However, on November 22, a new pump started, which brought Lumen’s price from USD 0.035 to USD 0.93 on January 4, 2018. This is the current all-time high of Stellar.

Stellar – Financial Infrastructure for Fast and Cheap Cross-Border Payments

Stellar was released in July 2014 as a fork of the Ripple Protocol. It was created by Jed McCaleb – the founder of MtGox and co-founder of Ripple – and the former lawyer Joyce Kim. Stellar is an internet level protocol for cross-border payments that uses the cryptocurrency Lumen (XLM).

Stellar originated from Ripple, so they serve a similar purpose but have some technological differences. The main reason that lead to the creation of Stellar was that Jed McCaleb had a financial philosophy that was at odds from that of the remaining members of Ripple.

Stellar’s goal is to change the way the world’s payment system works today, so you can move money across borders quickly, reliably and for fractions of a penny. Its focus is not only providing a solution to bank assistance, like Ripple does, but also to facilitate easy payments between people directly. 

Stellar aims to achieve that by solving four main problems – the risk of double spending when you make digital transactions, the digital representation of currencies and assets, interoperability, and scalability.

Double Spending

To solve the double-spend problem a cryptocurrency project has to have technology that enables a secured way of storing proof possession and transmitting value in a digital form.

It wasn’t very hard for Stellar to solve this problem, because since Satoshi Nakamoto invented Bitcoin (BTC) this is no longer an issue. Bitcoin introduced to the world the immutable public record, so if someone has USD 100 in his wallet and tries to send USD 100 to two people, the second transaction won’t be accepted.

However, Bitcoin still doesn’t have a solution for the other three challenges and Stellar was designed to solve them.

The Digital Representation of Currencies/Assets

Today’s process of making cross-border transactions between people is very complicated because you have different payment networks which don’t interoperate. This leads to all kind of frictions and delays. You need the digital representation of currencies and a fast way to convert one to another. Banks are responsible for this but they definitely have problems doing the second part of the job – making fast and cheap transactions between different currencies.

Stellar solved that problem with the introduction of anchors. Anchors are financial institutions that have partnered with Stellar. They act as a bridge between existing currencies (USD, EUR, CNY, etc.) and the Stellar network.

For example, you can give a hundred dollars to an anchor and then they will put a tokenized version of that hundred dollars onto the stellar network. People can pass it around like a digital currency and when someone brings it back to an anchor, the anchor will give a hundred-dollar bill to whoever brought it to them. Payments on the Stellar network are processed in 3-5 seconds and the fee is a fraction of the penny, so this is a serious advantage over the traditional payment systems. 

Interoperability

Stellar has a concept of distributed exchange in order to make things interoperable. What it allows you to do is, for instance, if you are from Ireland and want to send money to China, you go through the distributed order book that’s built into the Stellar Network and make the transaction in three to five seconds with no currency volatility risk.

Scalability

Solving those problems won’t mean much if the system can’t scale. So, how does Stellar solve this issue? The answer is that they have their own proprietary technology called Stellar Consensus Protocol (SCP). The goal of the consensus algorithm is to determine the way everyone in the world agrees on which transaction is valid and which is not. Its key properties, which will be discussed in more detail later, are decentralized control, low latency, flexible trust, and asymptotic security.

LUMEN (XLM)

Lumen is a cryptocurrency, just like BTC. Lumens are the native assets of the Stellar Network. Originally, when the project was launched in 2014 the coin was called Stellar (STR), but in 2015 it was renamed to Lumen (XLM) to distinguish it from the Stellar network itself and Stellar.org – the nonprofit organization that contributes to the development of the network.

XLM serves two purposes.

First, every payment on the network has a minor base fee of 0.00001 XLM in order to prevent spam transactions. The funds from the base fees are added to the inflationary pool.

Second, XLM acts as a bridge between pairs of currencies. However, this function is possible only if enough liquidity is provided between XLM and the currencies involved.

Stellar Consensus Protocol (SCP) – a Model Suitable for a Worldwide Consensus

In 2015 David Mazières, who is a professor of Computer Science at Stanford University, introduced an alternative to Byzantine Fault Tolerance (BFT) called Stellar Consensus Protocol (SCP). SCP is a construction for a Federated Byzantine Agreement (FBA).

SCP has four key features: decentralized control, flexible trust, low latency and asymptotic security.

SCP is decentralized which means that anyone can participate in the consensus process. There is no central authority which decides who can be a validator. Rather, each validator decides which other validators to trust.

Flexible trust means that users have the freedom to trust any combinations of parties they see fit. Their list of trusted validators is called a quorum slice.

For example, if you want to become a validator and you believe that Bank of America is trustworthy, you may require its acknowledgment of all transactions in order for you to agree with them.

The quorum slices of each validator overlap to form a quorum or network-wide consensus on a transaction.

SCP has low latency, which means that the transaction speed is fast. In FBA there is no mining. Instead, there is message passing and voting, which allows transactions to be confirmed every three to five seconds. In addition, it is a lot cheaper than mining, because you don’t need racks of machines all over the world to keep the network going.

Asymptotic security means that no amount of computer power can overtake the network. For example, in Proof-of-work, if you control 51% of the computing power, you dictate the network, but in FBA an attack using computer power is not possible because solving cryptographic puzzles is not a component of consensus.

Stellar Development Foundation controls 82% of the token supply

Stellar.org or Stellar Development Foundation (SDF) is a nonprofit organization that has a major role in the development of Stellar. It serves two main purposes.

  1. To maintain the code and to make sure that Stellar protocol keeps upgrading.
  2. To grow the network, so it becomes widely adopted.

SDF tries to increase the adoption of the network in different ways, but there are two most effective methods.

First, they partner with a variety of brands and companies such as IBM, Deloitte, and Icici Bank.

Second, they distribute Lumens to individuals and partners.

As of July 2018 the total supply of XLM is 104,085,355,272 and 100 billion of them were created after the launch in 2014.

However, the circulating supply at the moment is just 18,760,872,265 XLM, which is less than 18% of all coins.

SDF claim that XLM will be distributed in the following matter:

  • 50% to individuals
  • 25% to partners
  • 19% to Bitcoin holders
  • 1% to XRP holders
  • 5% held by SDF to support operational costs

From an investor’s point of view, we find it a little concerning that the creators of a decentralized project are still in control of more than 82% of the total supply of coins, no matter the fact that SDF intends to distribute them. The point of decentralized cryptocurrencies is exactly the opposite – to have no central authority controlling the money supply.

In addition, XLM is meant to be an intermediary currency. Its design is to facilitate a transfer and once the transfer is done, Lumens will be released back into the network. In other words - you don’t need that much XLM to have a very liquid network.

As such, users have no incentive to hold on to these coins long-term, which in my opinion, makes investing in XLM quite risky. However, as always, do your own research before investing in any cryptocurrency or initial coin offering.