Stellar works in a similar way to all decentralized payment systems. There is a distributed ledger, powered by a network of decentralized servers and nodes. The information between the nodes is updated very quickly - in a period of two to five seconds. All transactions on the Stellar network are recorded on a shared public ledger, which makes them accessible to anyone around the world.
To understand how Stellar works in detail, think of it as a quicker, cheaper, and more flexible PayPal. All the user has to do is to deposit funds to an anchor on the network. The anchor fulfills the function of the bank in the case of traditional money transactions. He holds the deposited funds and then credits the virtual wallet. That way, anchors ensure there is a bridge between the deposited currency (as the network supports traditional currencies and crypto) and the Stellar network. The whole process works similarly to swaps transactions where you formally convert your funds once you deposit them and make a transaction. Here is an example – you have an account in EUR and want to send funds to your friend in the USA. Once you make the transaction, the Stellar network will convert the EUR amount in USD by using the lowest FX rate. Sometimes this may require multiple conversions to help you get the best rate. However, in each scenario, the transaction is finalized within 5 seconds. The recipient will then be able to withdraw the USD through a USD-supporting anchor. All this allows for high-speed transaction execution. Users don’t have to wait for an extended period of time to get authorization for their transfers, unlike the case with banks where operations can take up to several hours. However, you should bear in mind that anyone who intends using the Stellar network to make transfers or store funds should also hold XLM. Users should set aside and maintain a certain amount of lumens for each type of assets in their accounts (more on the matter here).
The network is currency agnostic, which means it supports all types of assets, including conventional currencies and crypto-assets. Conversions on the Stellar network may include the native token (XLM), as well as other digital currencies. Banks, for example, have the freedom to use their own cryptocurrencies to facilitate their transfers.
Stellar employs a unique consensus protocol that makes it more flexible when compared to Bitcoin, for example. Instead of needing the entire network to verify a transaction, Stellar uses an algorithm called Federated Byzantine Agreement (FBA), which streamlines the whole process by relying on quorum slices. This means transactions can be validated by just a small group of the network, which speeds up the process significantly. You may wonder how is this secure, and how are the risks accompanying the lower number of involved nodes, overcome? Each node on the Stellar network has to choose a set of other trustworthy nodes. Think of it as a mini-network of nodes (called quorum slices). For a transaction to be approved, there must be a consensus between all nodes in the set. This means the Stellar network needs fewer resources to validate transactions, which allows it to process up to 1 000 operations per second.
The Stellar network is independent by design and is controlled entirely by its nodes. The nodes on the network use a specially-designed algorithm called the Stellar Consensus Protocol. The SCP was designed by David Mazières, a professor at Stanford University, and allows the network to run with minimal computing and financial resources, making it available to institutions, businesses, and non-profits of all sizes. The idea behind the design of the SCP is to overcome the flaws in Bitcoin’s mining mechanism by providing a flexible, energy-efficient, and speedy way to validate transactions.
Stellar is also considered a system for tracking ownership. It uses a distributed accounting ledger that collects two types of information about each user on the network – his account balance and what he wants to do with his money (in terms of buying and selling). While the first one is typical for most payment networks’ blockchains, the idea of throwing users’ operations in the equation allows for trade automation and the development of more functionalities.
Stellar has become so popular due to its ability to streamline cross-border transactions. It has disrupted the existing model where banks have to maintain accounts in local currencies in foreign countries to be able to serve two clients. Thanks to Stellar’s infrastructure, transactions happen on the blockchain instantaneously, without the need for intermediaries, conversion, or reconciliation of currency accounts. And most importantly - at a fraction of the cost.
For the first five years of its operation, the Stellar network has handled more than 450 million operations, initiated by over 4 million users. According to Stellar.org’s information, the costs for a single transaction are around 0.000001$, which means they are almost free.