Cryptoeconomics — Part II: Monetary aspects of the Stellar Consensus Protocol and its steps towards decentralization
In my previous blog “Bitcoin, Stellar and the current financial system”, I provided a brief introduction to the history of money and how it led to the creation of cryptocurrencies. This time we will discuss the monetary aspects of the Stellar Network, and its roll in the development of a new decentralized economy, which together with Bitcoin and other DLT technologies, might bring to reality Hayek’s vision for a free market of money.
Due to the invention of new technologies that are challenging the financial status quo, governments are starting to analyze and implement different strategies that allow them to somehow regulate and keep up with these new developments. In the US, for example, Bitcoin and similar cryptocurrencies are regulated as both “currency” and as a “security”, having the SEC as the leading actor in the industry.
However, on May 9, 2019, the US representative Brad Sherman, called for an introduction of a bill that would “outlaw cryptocurrencies purchases by Americans”, during his declaration he mentioned that “…the advantages it has over Sovereign currency is solely to aid in the disempowerment of the US in the rule of law…”. This powerful statement clearly shows that cryptocurrencies and distributed ledger technologies have the potential to disrupt the traditional financial institutions, and even though it is unlikely that a bill of that nature gets approved, the initiative has uncovered something that was previously thought as unthinkable; freedom equality and privacy for financial transactions.
On the other hand, it seems that the EU has a different approach; on 10th of April 2018, 26 members the European Union (plus Norway and Liechtenstein) recently agreed to sign a Declaration aim to cooperate in the establishment of a European Blockchain Services Infrastructure (EBSI) that will support the delivery of cross-border digital public services, with the highest standards of security and privacy.
Without a doubt, only time will tell which will be the winning approach, however, I would like to share a thought by Friedrich Hayek in his book “The Denationalization of Money”.
“The further pursuit of the suggestion that government should
be deprived of its monopoly of the issue of money opened the
most fascinating theoretical vistas and showed the possibility
of arrangements which have never been considered. As soon
as one succeeds in freeing oneself of the universally but tacitly
accepted creed that a country must be supplied by its government with its own distinctive and exclusive currency, all sorts
ofinteresting questions arise which have never been examined.”
In order for the success of a Cryptoeconomic system, a consensus is key, and it will reign all the actions that are going to take place. The consensus is a group decision-making process in which participants of a system agree to support (or to vote) a decision in the best interest of the whole.
Proof of Work (POW)
The underlying consensus mechanism in which Bitcoin operates is called Proof-of-work (PoW), this consensus mechanism secures all transactions in the Bitcoin network and was the inspiration for the development of Stellar.
The way it works is that users create cryptographically secure transactions and broadcast them to the network. Miners collect as many transactions as they can and fit them into a block, and then they have to solve highly complex mathematical algorithms which allows them to verify each block and move it to the list of historic blocks. This is key in order to make sure that there are not invalid or fraudulent transactions.
The Stellar Consensus Protocol (SCP)
The Stellar Consensus Protocol is a decentralized global consensus, differentiates itself from the other consensus mechanisms (POW and POS) because the nodes which validate the transactions work without mining, this should count as a plus for the voices that call for more environment-friendly technologies. Each validator or node defines sets of other nodes that it needs to agree with.
These sets are called quorum slices and when you look at the quorum slices of all validator nodes they define a global network of trust relationships between these nodes. Here you will find an article that SatoshiPay released explaining this in detail.
In the whitepaper called Stellar Consensus Protocol: A Federated Model for Internet-level Consensus developed, which was designed by David Mazieres and Jed McCaleb, is a model for achieving decentralized consensus while preserving the traditional benefits of the Byzantine agreement and solving the double spending problem. It focuses on helping enabled distributed systems to achieve consensus with efficiency, standard cryptographic security, and flexibility in designating trusted participants. Stellar is a great example of an efficient decentralized consensus protocol allowing each operation to cost only 0.00001 XLM (100 “Stroops”) per transaction.
The SCP has four pillars:
Decentralized control: Where anyone is able to participate and no central authority dictates whose approval is required for consensus.
Low latency: Nodes can reach consensus at reasonable timescales.
Flexible trust: Users have the freedom to trust any combination of parties they see fit.
Asymptotic security: Safety rests on digital signatures and hash families whose parameters can realistically be tuned to protect against adversaries with unimaginably vast computing power.
Incentive mechanisms
One of the incentives that Stellar implemented is an inflation rate of 1% annually. This means that holders of XLM receive a return of 1% yearly according to the number of Lumens that each wallet possesses. 100 Billion Lumens were created in 2014, however, due to inflation, according to https://coinmarketcap.com, there are almost 105 Billion Lumens. Each Lumen equals one vote and 0.05% of the existing lumens is the minimum amount of votes needed to take part in the inflation pool. However, due to criticisms about the centralized nature of the inflation, this incentive mechanism is currently being reviewed by the Stellar Development Foundation in order to allow a more optimal way to incentivize the use of the protocol and enable a more aggressive network effect.
Technologies such as Bitcoin and specially Stellar, which enable the tokenization of any kind of asset and fiat currency in a cheap and efficient way, will not only have to be thought as a mere decentralized technology enabler but also as a decentralized policy maker. This constitutes a huge responsibility for network developers to implement better crypto-economic strategies and incentives that not only allow sustainable growth of the networks but also consider the moral repercussions in networks that humans interact with.
Further reading
Stellar network: growth and decentralisation
Link: https://medium.com/@SatoshiPay/stellar-network-growth-and-decentralisation-e99c52ade798
Friedrich Hayek — The Denationalization of Money
Link: https://mises-media.s3.amazonaws.com/Denationalisation%20of%20Money%20The%20Argument%20Refined_5.pdf
European countries join Blockchain Partnership
Link: https://ec.europa.eu/digital-single-market/en/blockchain-technologies
