Stellar (XLM): What it is and How Does it Work?

Stellar promotes itself as an open-sourced, distributed payments system, build on the idea that the international community needs a global financial network open to anyone. The project is meeting this need, connecting users, institutions, and payment ecosystems via its platform.​

In doing so, the Stellar team aims to make monetary transactions quicker, cheaper, and more dependable. In addition, their protocol connects individuals from all over the world by enabling more efficient cross-border payments.

How Does Stellar Work?

Similar to most cryptocurrencies, Stellar is decentralized. The network operates on a network of decentralized servers supported by an international group of individuals and entities – these servers backup the distributed ledger that monitors the web’s data and transactions.

Basically, the Stellar​ protocol operates like a more comprehensive, more flexible PayPal. To start using it, users need to upload funds to an anchor on the network. Similar to a bank or PayPal, this anchor then retains the money and issues credit to users’ virtual wallet in its place.

Some might be wondering why they need to exchange debit for credit with an anchor. Well, anchors act as a bridge for any given currency and the Stellar​ ecosystem. The switch enables you to formally convert your funds into Stellar​’s public ledger.

This inclusion means you can send money instantly on the network without having to wait for a bank transfer, as it happens when using PayPal. It also simplifies cross-border payments.

Let’s think about the following scenario: you want to send funds to someone living in France and would use your credited USD balance to send them money via the Stellar​ network. Stellar​ would automatically swap the USD for EUR using the lowest exchange rate, and the receiver  would be get the exchanged amount in EUR. After receiving the transfer, they can withdraw the funds from another anchor that supports EUR.

Distributed Exchange

Stellar​ also provides users with the option to place exchange orders onto the public ledger to either sell or buy other currencies. All rates are pre-determined by the user placing the order, so they are not liable to the automatic exchange rate that Stellar​ uses for personal transfers.

​In case you want to exchange, for instance, GBP for EUR, you’d place an order in the network’s order book. That order then appears in the global marketplace, which you can also refer to in order to see how your order stays against others like it. We should mention that this exchange is not limited to fiat money only; it also supports cryptocurrency and also fiat trading pairs.

Multi-Currency Transactions

As we mentioned above, Stellar​ enables users to freely send money across borders without the nuisance of formal banking procedures or currency exchange. To accomplish this, the Stellar​ ecosystem does one of the three things when you ask for a currency transfer:

  • It swaps the funds with a previous offer on its order book and automatically makes possible the exchange
  • Stellar uses Lumens (XLM), its native coin, as an intermediary for the exchange. It can convert the funds from a currency into Lumens on the global marketplace and then takes those XLM and converts them to another currency for the user receiving the money
  • In case there are no trading pairs in exchange for the two currencies, Stellar looks for offers on the network that will end up in a chain conversion into the desired currency (for instance, USD to EUR, EUR to GBP, BGP to AUD, AUD to JPY).

​This multi-currency exchange process is rather innovative, and it provides users with a flexible approach to easily convert currencies on an international level.

The Bottom Line

If other cryptocurrencies and blockchains are built for financial institutions and banking giants, then Stellar Lumens is meant for the common man. The protocol has the potential to redesign the way we process peer-to-peer transactions on a global scale.

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