Welcome to our What is Ethereum guide!
Ethereum is the 2nd biggest cryptocurrency by market capitalization. To clarify — Ethereum is the name of the network, Ether is the name of its cryptocurrency. You’ll hear the two names tossed about a lot in the crypto space, so it’s good we cross that bridge before we get started.
Note: ‘Market capitalization’ is the total value of all coins combined. So, for instance, Ethereum’s market capitalization is equal to the number of Ether coins in existence multiplied by the price of one Ether.
So, let’s get right into it!
What is Ethereum: The Basics
Right off the bat, let me throw you in at the deep end with a one-line description of Ethereum.
Ethereum is a programmable blockchain. In short: it introduced a programming language to blockchain technology.
Distributed Ledger Technology (DLT) is the underlying technology behind cryptocurrencies, and blockchain technology is the most common form of DLTs.
In 2009, we saw Bitcoin introduce the first of these with its blockchain used for decentralized digital money. The blockchain allows decentralized networks: rather than having one central point of authority and failure, networks could now be centreless. In 2015, we saw Ethereum join the market as a blockchain that could be programmed for purposes far beyond decentralized digital money.
This means that, for the first time, developers could build applications on blockchain technology without needing to create their own blockchain. It completely changed the game!
(For more on blockchain technology, see our Blockchain Explained guide.)
These applications are known as DApps, and they consist of components named smart contracts. These smart contracts are what developers build on Ethereum to create DApps. They were brought to the blockchain space by Ethereum, which rendered Ethereum incredibly unique and innovative at the time of launch.
More on these later, though.
You now know that Ethereum is essentially a development platform based on its own blockchain that applications can be operated on — it can be viewed as an operating system, like Windows or macOS.
Before we move on, let’s take a quick look at how this came to be.
What is Ethereum: The Story Behind It
As Bitcoin was making a name for itself in its tight-knit, underground community, a young blockchain prodigy was sat working away at his bedroom desk in Canada, planning something very, very special.
The aforementioned prodigy is, the Russian-Canadian, now-famous, Vitalik Buterin.
In 2011, aged just 17, Vitalik co-founded Bitcoin Magazine after becoming interested in Bitcoin and blockchain technology earlier in the year. He later went on to make suggestions to the Bitcoin development community, only to have his propositions rejected. Fear not, though, Vitalik’s ideas would later prove far from useless.
His vision was to have one core blockchain that allowed other applications to run on it, rather than each application needing its own blockchain.
In 2014, after visiting a range of different countries to meet developers who shared his love for programming, Vitalik finalized and published his idea in the form of a white paper. In 2015, after raising the required investment and developing the project with his co-founders, the blockchain went live.
What is Ethereum: The Features
Next in our What is Ethereum guide, we’ll detail Ethereum’s features.
As touched on earlier, Ethereum was an innovation unique to all other uses of blockchain at the time of its release. There were some features in particular that were completely new and had never been seen before in the blockchain space. There were also some that weren’t new.
Let’s take a look at them.
DApps (Distributed Applications)
Think of the applications you use on your phone, or on your computer. Now, think about the entities that control these apps.
For instance, if you were to sign up to eBay and input your personal data, such as telephone number and address, where would this information be stored? That’s right — it’d be stored on eBay’s servers.
This is what we call a centralized app. It’s centralized because there is one central point of authority and one central point of failure, which is eBay. This means that if eBay’s servers were to be compromised, all the data they store will be vulnerable. It also means that if their servers went down because of technical failure, no one would be able to use eBay.
If eBay was to run on Ethereum instead, this wouldn’t be the case. Ethereum is a blockchain and so it is run by a multitude of computer systems (nodes) spread out across the world, and to compromise it requires the ownership of 51% or more of the nodes. Therefore, if one or two of the nodes were hacked, the network itself would be unaffected. So, nobody would lose their data.
It also means that if one or two of the nodes shut down due to technical failure, the network would remain live and everyone would still be able to use eBay.
This is because Ethereum is decentralized, which is why we refer to apps on Ethereum (or other blockchains for that matter), as distributed/decentralized applications (DApps).
For more on DApps, see our What is a DApp guide.
It is smart contracts that made building on Ethereum so appealing to developers.
They are a decentralized tool offering self-executed actions in response to certain clauses being met, enabling applications that have no downtime and are immune to third-party interference. They are essentially agreements that are written in code, and therefore unbreakable.
They would be breakable if they were only running on one computer, as you could just damage the hard drive to void the contract, but as they are running on a blockchain in Ethereum’s case, they are in fact unbreakable.
Although they are very useful for payment systems, it is not their only use case. Smart contracts can be used for all instances of transactions and exchanges of data — any representation of value can be automated.
This is why the possibilities with building on Ethereum are endless.
We can realise the abundance of uses that smart contracts make possible by imagining the ways they can change various industries. Think of real estate, for example:
By creating a simple smart-contract escrow, the sale/purchase of a house can be operated in a safe, fair, trustless manner, without the expense of a third party. This can be done peer-to-peer, cross-border, with no issues regarding trust. It is revolutionary.
This is how that’d look:
- Rick lives in the U.K. and wants to sell his house. He creates an Ethereum token that legally represents ownership of his house.
- He creates a smart contract that states IF 100 ETH is sent to the smart contract, THEN his house token will be sent to the address that sent the 100 ETH.
- James (who lives in Australia) wants to buy Rick’s house and so he sends 100 ETH to the smart contract. The smart contract
instantly executes its terms and sends the house token to James, and the 100 ETH to Rick.
- James did not have to worry about sending 100 ETH to the smart contract, because he knew that the smart contract is just code on the blockchain and that nobody has control over it, so he had nobody he needed to trust.
- As he is in Australia and Rick’s house is in the U.K., this transaction would normally take numerous days to complete and require multiple third parties (such as banks and brokers) as well as expensive conversion fees, transaction fees, and broker fees. Instead, it is instant and virtually free.The only fee he must pay is to the Ethereum blockchain, as the nodes that run the blockchain must pay their electricity bills. The fee is minuscule, though, often amounting to less than 20 cents.
PoW (Proof of Work)
Every blockchain uses a consensus mechanism. This is the method the nodes use to come to group agreements and validate transactions.
Ethereum uses the same consensus mechanism that Bitcoin uses — Proof of Work (PoW). As Ethereum was released in 2015, the team behind Ethereum now see it as a little outdated. This is largely down to the scalability issues it presents and the fact it uses enormous amounts of electricity.
You see, in a blockchain, all transactions are grouped into blocks. Each block contains a certain amount of transactions, and the nodes in the network validate one block at once. Then, they move on to the next block.
To validate a block, they must solve a complex math problem.
The problem with PoW is it requires all nodes to attempt to validate the same block at the same time, rewarding the quickest node with some of its native currency. For instance, Ethereum nodes are rewarded with Ether.
As all nodes are working at the same time on the same block, but only one is truly needed to solve the problem and validate the transactions, there is an unnecessary large amount of electricity wasted.
It also limits the network scalability, as Ethereum is only able to achieve 7-14 transactions per second. This isn’t enough when compared with VISA, who run around 30,000 transactions per second.
NEO, a newer blockchain platform that DApps can be built on, can perform up to 10,000 transactions per second.
(Don’t worry too much, though, hang in for the Future of Ethereum section!)
Each transaction on the Ethereum network normally takes just a few seconds, with most coming in under 20 seconds at the latest. This is much faster than Bitcoin, which normally takes around 10 minutes or longer.
Ethereum transactions also tend to be much cheaper than Bitcoin transactions, although Bitcoin’s costs have improved lately (Q2 2018). Ethereum transactions are fueled by ‘gas’, which is a division of Ether. The user can change the price of gas; the higher they set it, the more of a priority their transaction becomes.
The gas is given to the nodes on the network that validate transactions, as it is part of their reward for contributing their computing power (which demands electricity).
If you want a ballpark figure: Ethereum transactions can cost as little as a few cents.
Initial Coin Offerings (ICOs) are crowdsale events hosted via smart contracts on a blockchain. Their name is similar to IPOs (Initial Public Offering), which is a traditional financial event in which a company stock is issued for the first time to the public.
ICOs don’t share many similarities to IPOs other than the name, and the fact they issue something for the first time. The item being issued in an ICO is a token. In Ethereum’s case, it is a token. These tokens are created in Ethereum smart contracts and sold to raise funds for new projects.
Let’s imagine that you wanted to start your own DApp. To develop it and have it adopted by the public, you’re going to need money. You’re going to need money to hire programmers (most likely), hire a legal team, attend networking events, market your application, and much more.
So, how do you get this money?
One option is an ICO, which was introduced to the blockchain space by Ethereum.
You develop a token smart contract, which automatically transfers your tokens to any legitimate purchasers when they transfer cryptocurrency funds to the smart contract. Your token could have a purpose on your application once its developed, although some don’t.
When the ICO is over (because you reached your time limit, or you sold all the tokens you had available), you receive your funds and can start developing your project. Investors will typically buy tokens from ICOs because they speculate that the price will rise in the future, although some investors purchase because of the features the token enables on the application. While others may purchase just because they want to see the application funded and created.
That’s ICOs in a nutshell. They were introduced by Ethereum, but other blockchains are starting to host them now, too. The mass majority are still hosted on Ethereum, though. To learn more, read our What is an ICO guide.
The Future of Ethereum
Yes, it’s true. As you just discovered, Ethereum is starting to feel its age. Fear not, though, Vitalik and the team have plans to solve this.
The future of Ethereum is widely believed to depend on the success of various required upgrades regarding scalability. I’m afraid 7-14 tx/s just doesn’t quite cut it anymore. The team know this, though, and have conjured up a few different solutions, which we’re expecting to see implemented this year.
PoS (Proof of Stake)
First of all, Ethereum is set to switch from PoW to PoS.
PoS (Proof of Stake) is a consensus mechanism that gained significant popularity in 2017 as a greener, more scalable alternative to Proof of Work.
The main difference between the two is that PoS only assigns one node per block, which means far less electricity is used per block. Rather than all of the nodes competing and racing against each other to be the first to validate the block, they each take their turn, and are selected in a fair manner.
Check out our Proof of Stake guide to learn more.
Secondly, Ethereum is introducing Sharding. This is an upgrade that will see the blockchain partitioned into lots of different segments. The nodes store their assigned part of the blockchain, which means each node is not required to store and update the entire blockchain, but just a part of it.
See our Sharding guide to learn more.
Raiden Network & Plasma
The third solution is named Raiden Network, and the fourth solution is known as Plasma. These two solutions both introduce new layers to the Ethereum blockchain. The Ethereum blockchain currently consists of a single layer, but with the implementation of Raiden and Plasma, Ethereum would have additional layers to scale the number of transactions it can process per second.
By introducing either of these solutions, the network would be able to handle many more transactions per second.
The Conclusion (Advantages & Disadvantages)
Yes, Ethereum was completely unique at its time of launch, but times have changed. It now has a fair amount of competition, and because Ethereum was the first of its kind, all of its competitors are newer than it. This means that there are now some disadvantages to using Ethereum over some of the other blockchain platforms available.
Let’s sum its pros and cons with a few brief points.
- Original/first mover
- Huge community
- Secure, decentralized, cheap and relatively fast
- Data can be stored securely
- Apps can enjoy zero downtime
- Cross-border payments are efficient on Ethereum — no third parties are required
- Widely adopted: Ethereum has more DApps built on it and more ICOs hosted on it than any other network
- Credible team who are working proactively to resolve any issues faced by Ethereum
- Still uses Proof-of-Work consensus
- Scalability issues: low number of transactions per second
- Newer blockchains use different consensus mechanisms that are much more scalable
So, what is Ethereum? If you remember, I threw a sentence in at the beginning that summarizes Ethereum in just one line: Ethereum is a programmable blockchain. That should make more sense to you now than it did at the start of this guide.
Anyway, that’s all for now; I hope you enjoyed our What is Ethereum guide. After reading it, have you formed your own opinion on Ethereum? If so, let us know!
We’d also be keen to hear about what you’re planning to do regarding Ethereum. Are you just a supporter? Are you going to invest? Or are you in fact looking to create your own DApp on Ethereum?
We’re all ears.
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