There are many types of digital currencies or cryptocurrencies. Ethereum is a type of digital currency or cryptocurrency that exists only online. As of October 2021, Ethereum is the second-largest cryptocurrency, trailing only Bitcoin, which has become synonymous with the term “crypto.”
From those who believe it will be the next payment system to those who believe it is a speculative bubble, cryptocurrency has generated a lot of debate. How Ethereum works is explained here.
Table of Contents
What does Ethereum stand for?
In the last few years, there have been tens of thousands of new cryptocurrencies launched. On January 1, 2015, Ethereum was launched by its eight co-founders. Ethereum is the name of the cryptocurrency and platform, while ether is the name of the individual unit (2 ether, 17 ether, etc.)
The currency of Ethereum is managed and tracked by a decentralised computer network, or distributed ledger, known as a blockchain. Think of the blockchain as a record of every transaction that has ever occurred in a cryptocurrency. The integrity of the data is ensured by the network’s computers verifying the transactions.
The appeal of Ethereum and other cryptocurrencies is due to this decentralised network. Without a central bank, the currency is essentially self-governed, and users can exchange money without having to go through a bank. Even if a transaction is publicly available on the blockchain, Ethereum still allows users to transact virtually anonymously.
A more useful way of thinking about crypto is to think of it as a token that can be spent on an Ethereum-based platform for a specific purpose rather than currency. These include functions such as transferring money or purchasing and selling goods. Other apps and smart contracts could also be built on the Ethereum platform, which has a lot more capabilities than Bitcoin.
Ethereum’s Origins
In the past, Ethereum wasn’t the second most popular blockchain project. The project was co-created by Vitalik Buterin to address the shortcomings of Bitcoin. Decentralized applications can be built with Ethereum’s smart contracts, which were first published in a white paper by Buterin in 2013. Platforms were not interoperable in the blockchain space, despite the fact that DApp development was already taking place there. Buterin wanted Ethereum to serve as a bridge between the two. The only way to keep DApps popular, according to him, was to standardise on how they run and interact.
Ethereum 1.0 was born as a result. The App Store is a place where thousands of different applications can be found, all adhering to the same set of guidelines. This is the only set of rules that is hardcoded into the network and enforced autonomously by DApps. No one person or group is in charge of making and enforcing the rules, as Apple has done in the past. To the contrary, community members wield authority.
Of course, putting together a network like this isn’t going to be cheap. Because of this, Buterin and his co-founders, Gavin Wood, Jeffrey Wilcke, Charles Hoskinson, Mihai Alisie, Anthony Di Iorio, and Amir Chetrit, raised $18,439,086 in Ether through a token presale to help fund Ethereum’s ongoing and future development.
The group also established the Ethereum Foundation in Switzerland, which has the goal of ensuring the network’s long-term viability and growth. Several co-founders left after Buterin announced that the foundation would be run as a nonprofit.
Over time, Ethereum was inundated with decentralised ideas from developers. A democratic group of DAO users was formed in 2016 to vote on proposed network changes and enhancements. A smart contract underpinned the organisation, eliminating the need for a CEO with control over Ethereum. As a result, changes had to be approved by a two-thirds majority to be implemented.
However, a security flaw allowed an unknown hacker to steal $40 million from The DAO’s assets. As a means of reversing the theft, the DAO decided to “hard fork” Ethereum, which meant departing from the old network and switching to a new protocol. The original Ethereum network is now known as Ethereum Classic, while this new fork has retained the name Ethereum.
How does Ethereum work?
The Ethereum network, like Bitcoin’s, is made up of thousands of computers around the world, rather than a single centralised server. Since the network is no longer centralised, it is now highly resistant to attacks. This makes the network virtually unbreakable. When a single computer goes down, the network as a whole will continue to function.
One decentralised computer system called the Ethereum Virtual Machine (EVM) powers the entire Ethereum network (EVM). Because each node has a copy of the computer, any changes must be verified before they can be made to anyone else’s copy.
Transactions on the Ethereum blockchain are referred to as “network interactions” and are stored in blocks. Before a block can be added to the blockchain, it must first be verified by the network’s miners. Proof-of-work (PoW) consensus mining is used to verify transactions. A 64-digit code is assigned to each block to identify it. This code can only be found by miners using the most powerful computers in the world. Because of this, miners receive ETH in exchange for the use of their computer power.
In addition, all Ethereum transactions are open to the public, just like those of Bitcoin. Blocks that have been mined are broadcast to the entire network, confirming the change and adding the blocks to each individual’s copy of the ledger. A perfect record of all network transactions can be found in confirmed blocks, which cannot be tampered with.
Where does the ETH that miners are paid come from? The user who initiates the transaction must pay a fee known as “gas” for each transaction. Incentivizing future mining and ensuring network security are the primary goals of this fee. Users are limited in the number of actions they can take during a single transaction by the amount of gas they have available. It’s also there to keep network spam at bay.
Because ETH is more of a convenience token than a store of value, there is no limit to the number of coins that can be created using it. Once the network transitions to proof-of-stake, Ether will also enter circulation in the form of staking rewards (PoS). Ethereum’s value should never fall to the point where it is no longer usable, as long as demand remains high.
Ethereum gas fees, depending on network activity, can be prohibitively expensive for some users. That’s because a block has a limited capacity for gas, and the amount available depends on the type and amount of transactions. Consequently, miners will prioritise transactions that have the highest gas fees, resulting in a race to validate transactions first. As a result of this competition, fees rise and the network becomes congested at peak times.
Even though network congestion is a major issue, Ethereum 2.0 — a complete overhaul that will be discussed separately — is working to address it.
It is necessary to have a wallet in order to use Ethereum. This wallet serves as a gateway to the Ethereum ecosystem, allowing users to access DApps. From there, anyone can purchase items, play games, lend money and do all sorts of activities just as they do on the traditional internet. Despite this, the traditional web is free to users because they’re handing over personal data. Centralized entities running websites then sell that data to make money.
Cryptocurrency takes the place of data here, meaning users are free to browse and interact anonymously. As a result, the use of DApps is open to everyone. There are no lending or banking DApps that can deny anyone based on their race or financial situation. A “suspicious transaction” cannot be blocked by an intermediary. It’s for this reason that many people consider Ethereum to be Web 3.0 — the next step in web-based interaction.
What is the purpose of Ethereum?
There are numerous applications that can be powered by Ethereum, each offering a different set of capabilities:
Currency
If the digital currency is accepted as payment, you can send and receive ether using a cryptocurrency wallet. Using a digital wallet such as Coinbase, you can theoretically reduce the risk of hackers accessing your coins.
Smart contracts
The execution of a smart contract is triggered by the fulfilment of one or more conditions spelled out in the contract.
Dapps are short for “digital applications”
Play games, invest, send money, track an investment portfolio and more with Ethereum-powered digital apps.
Non-fungible tokens
Artists and others can use smart contracts to directly sell their work to buyers using these tokens, which are powered by Ethereum.
Decentralized finance
People who use Ethereum may be able to avoid having their money or other assets controlled by a centralised authority. If you think of Ethereum as a token that powers various apps rather than a cryptocurrency that allows users to transfer money to each other, you may be more accurate.
What is the origin of ether coins?
There were approximately 118 million ether in circulation as of October 2021. There is a yearly cap on the total number of coins that can be “mined.” Bitcoin, on the other hand, has a cap on the number of coins that can be mined, and the difficulty of new issuance increases each year. The issuance of Dogecoin, on the other hand, is completely unrestricted.
The computers on the network “mine” Ether and other cryptocurrencies. Coins and fractions of coins can be unlocked by performing mathematical calculations.
However, this set-up is undergoing a transformation. To create new coins and verify transactions, the blockchains of Bitcoin and Ethereum both rely on a technique known as “proof of work.” It’s a costly, time-consuming, and energy-intensive process that can cause network congestion. Because of this decision by Ethereum’s creators, they’ve decided to implement a “proof of stake” system, which they’ve dubbed Ethereum 2.0.
To generate new coins, miners have to work harder under the new system. As a result, those who hold the currency are essentially “staking” it and validating transactions. Verifying transactions that do not follow Ethereum’s rules may result in a loss of stake.
It’s expected that the switchover and the “burning” of transaction fees will lead to a deflationary spiral, which will cause the crypto to soar.
The advantages of using Ethereum
Open, flexible, and suitable for cooperation between multiple parties are some of the characteristics of Ethereum. As a data coordination tool, Ethereum is similar to a distributed ledger, but its unique architecture also provides a wide range of benefits for businesses. If you’d like to learn more about the differences between blockchain and distributed ledger technologies, our Protocol Business Architect Brent Xu has written a two-part comparison. Enterprise Ethereum currently has the following capabilities:
Coordinating the flow of information
With Ethereum’s decentralised architecture, users no longer have to rely on a single entity to administer the network and mediate transactions.
Data coordination
It is easier to deploy and manage private blockchain networks using an all-in-one service like Hyperledger Besu rather than coding a blockchain implementation from scratch.
Networks that require user permission
It’s possible to build on public or private Ethereum networks with the ConsenSys Quorum open source protocol layer because it ensures that your solution meets all possible regulatory and security requirements.
Size of a network. The Ethereum mainnet proves that a network of hundreds of nodes and millions of users can work together seamlessly. The vast majority of competing enterprise blockchain networks consist of fewer than ten nodes, making it difficult to draw comparisons between them. For business consortiums that are bound to outgrow a small number of nodes, network size is critical.
Transactions that take place behind closed doors
In Ethereum, private consortia and private transaction layers can be used to achieve granularity in privacy. Private information is never made public on the ConsenSys Quorum network. Encrypted data is only shared with those who need it.
Performance and scalability
Consortium networks built on Ethereum can outperform the public mainnet and scale up to hundreds of transactions per second or more depending on network configuration and Proof of Authority consensus and custom block time and gas limit. Protocol-level solutions like sharding and off-chain, layer 2 scaling solutions such as Plasma and statechannels present opportunities for Ethereum to increase its throughput in the near future.
Confidence in system
Confidence in the integrity of the transaction record is provided by the blockchain’s consensus algorithm. Consensus mechanisms such as RAFT and IBFT for different enterprise network instances ensure immediate transaction finality and reduce the infrastructure required by the Proof of Work algorithm.
Incentive layer
A business network can use Ethereum’s cryptoeconomic layers to both punish nefarious activity and reward activities like verification and availability.
Tokenization
Businesses can tokenize any digitally registered asset on Ethereum. For example, by tokenizing assets, organisations can fractionalize previously monolithic assets (real estate), expand their product line, and open new incentive models (crowdsourced data management).
Standards
Ethereum is where the standards are. ERC20, ENS, ENS-based names, Swarm, and Whisper, as well as other decentralised storage and messaging protocols, keep the ecosystem from fragmenting. Enterprise Ethereum Alliance (EEA) Client Specification 1.0 defines the architectural components of compliant enterprise blockchain implementations for the EEE. A new version of the specification, version 2.0, will be released soon by the EEA.
Open source software and interoperability
The IT environment of a single vendor is not a constraint for Ethereum consortiums. Customers of Amazon Web Services, for example, can use Kaleido’s Blockchain Business Cloud to run private networks. Like the Java community’s spec-driven philosophy, the Ethereum ecosystem welcomes contributions to the codebase through Ethereum Improvement Proposals (EIPs) (EIPs).
Is it a good idea to invest in Ethereum?
Those who bought and held Ethereum for a long time have profited greatly from its recent rise. Instead of focusing on the price movements of the previous trading day, you should focus on understanding what you’re investing in. As a result, anyone purchasing Ethereum is doing so on the assumption that it has no real-world assets or cash flow to back it up.
There is a crucial distinction between stocks and cryptocurrency that may seem insignificant at first. Because a stock represents a small portion of a company, its value rises and falls with the health of that company. Over time, if the company’s profit grows, its stock is likely to follow suit. Ownership of the company’s assets and cash flow is vested in its shareholders.
When it comes to Ethereum and most cryptocurrencies, there is nothing to back them up. Because other investors believe they’ll be able to sell the cryptocoin for more money later on to someone else – what’s called the “greater fool theory” of investing – it’s only keeping the price from falling further. Ethereum and other cryptocurrencies are only going up because of speculation.
Is it better to invest in Ethereum or to mine it?
There are many popular trading platforms, like Robinhood or Binance.US, that allow you to buy and sell Ethereum for speculative purposes. You’ll have access to the market at all hours of the day and night, and there will be plenty of money to move around if you do. When you sell coins for more than you paid for them, you make money.
Think like a business owner if you’re considering mining Ethereum. In order to mine the cryptocurrency, you will need to invest a large amount of money in mining rigs, as well as spend a lot of money on electricity. You’ll need to do the math to determine if making the initial investment and maintaining your operation is worthwhile. Because you want to get coins worth more than the money you spent mining them. Miners need to make sure that the profit is still there in light of Ethereum’s new validation system.
Ethereum can be purchased for a fraction of the cost of mining it, making the process more convenient. Cryptocurrency mining has the potential to be profitable, but only time will tell. One option for speculators is to invest in the companies that may benefit from digital currency adoption, such as Ethereum.
If you’re trading cryptocurrencies like Ethereum, Bitcoin, or any other kind, you should be aware of the risks involved, including the loss of all of your initial investment. Cryptocurrency is volatile and has many risks, so investors should be cautious. Inexperienced gamblers should not risk more than they can afford to lose.