What is Ethereum?
Ethereum is often described as technology that allows for open access to digital money and services for everyone. Built by the community, it is a peer-to-peer blockchain network that allows you to move money, make transactions, access financial services — all without a central intermediary.
Ethereum’s yellow paper was first published in 2013, then described as a next-generation distributed cryptographic ledger that is designed to allow users to encode advanced transaction types, smart contracts and decentralized applications into the blockchain.
Since then, Ethereum has gone through several iterations as a continuously improving piece of technology, but much of its core tenets remain unchanged.
Like Bitcoin, Ethereum is a blockchain, a peer-to-peer network of computers called nodes interconnected in a decentralized manner with no central authority.
However, unlike Bitcoin, Ethereum has a useful advantage. It is programmable, just a like a computer. It has smart contracts built into the network which gives developers the ability to build applications or run logic-apps over the blockchain.
Because it is programmable, it is able to do much more than what Bitcoin can do, which is often just used for payments. It can be used by developers to create blockchain-based decentralized applications known as dApps, or NFTs, which represent a piece of unique, non-fungible asset with provable ownership.
How does Ethereum work?
Ethereum is a blockchain network which organizes transaction data into blocks. For example, if you send money to a friend over Ethereum, that transaction data is added to a block and is waiting to be processed by a miner on the network.
When the block is verified and successfully mined or processed, it gets added to a chain of other blocks, by referencing the parent block, thus forming a blockchain — literally, a chain of verified blocks. With this chain of blocks that’s cryptographically linked to another block on the chain, the data in a block cannot be changed unless someone changes all blocks that comes after it.
The ordering mechanism is known as the consensus model, which describes how each computer or node on the network agrees which block is added to the chain and the blockchain as a whole.
It’s very similar to maintaining the latest version of your Excel file with your colleagues — how does everyone agree on the same source of truth?
The consensus mechanism provided by Ethereum is called proof-of-work, which means, in order for someone to propose new blocks to be added onto the blockchain, it first needs to do some work. The work it does is technically a difficult software puzzle that requires a lot of computing power to solve it. The process of solving the cryptographic puzzle is called mining.
By solving the puzzle through trial and error, you’ve proven to have done the work using computing power, and you’re rewarded with cryptocurrency known as Ether (ETH).
What is Ether (ETH)?
Ether, or ETH, is the native cryptocurrency of the Ethereum network. It is used to pay for computing power on the network, which creates an incentive for miners to come onboard and verify transactions that are incoming.
When a user attempts to make a transaction on Ethereum, it needs to offer some ETH as a bounty to network participants to verify the transaction. This ETH is rewarded to the miner that successfully mines the block to verify the transaction.
Because miners are incentivized to mine blocks with higher bounties, transactions with high ETH bounties are often mined first. This may often lead to a price bidding war for ETH, especially during times when the demand for block space goes up.
ETH is often seen as currency because it is used to pay for blockchain transactions over the Ethereum network. However, its utility doesn’t stop there. ETH will soon be used to validate and propose blocks on the Ethereum network once Ethereum moves to a proof-of-stake network in the future.
Besides those use cases, ETH is a good form of collateral in DeFi applications. For example, ETH can be used as collateral in a lending market like Aave or Compound. It can also be used to generate DAI on MakerDAO, a stablecoin pegged to the USD.
How is ETH produced and destroyed?
ETH is primarily produced through block rewards for mining new Ethereum transactions. This fee is paid to the miner who successfully solves the cryptographic puzzle explained above.
ETH is also destroyed on every transaction through the process of burning, which is the phenomenon of permanently removing ETH from circulation.
When users make transactions over Ethereum, they pay in ETH, determined by the gas fee set by the network. Some percentage of this ETH that is used for transactions is burned.
When demand for the blockchain network is high, the gas fee for transactions go up, and causes more ETH to be burned. When more ETH is burned (new transactions) than issued (new blocks), the net supply of ETH goes down.
Gwei and Wei
Ethereum is denominated in Gwei and Wei. Wei is the smallest possible amount of ETH that can technically exist.
- 1 Wei = 1/10⁸ ETH
- 1 Gwei = 1/10⁹ ETH
What are smart contracts?
We mentioned earlier that Ethereum is a programmable blockchain enabled by smart contracts.
A smart contract is similar to a computer program, except that the program runs on the Ethereum blockchain. It is a collection of functions and state that is deployed at a specific address on the blockchain.
A smart contract is not controlled by a user. Instead, they are deployed onto the network and then run as programmed. A user can interact with the smart contract and execute functions as defined in the smart contract, which enforce them via code.
A smart contract is often described as a digital vending machine. With the right inputs, a certain output is guaranteed. There is no need for a vendor employee to collect cash and dispense a bottled drink, the machine does all the work.
Because smart contracts are code, they need to be written, using a programming language like Solidity or Vyper, and then compiled and deployed onto the Ethereum virtual machine.
Once deployed onto the blockchain, they are permanently stored there and cannot be reversed. This feature makes certain smart contracts immutable, i.e. they cannot be changed, which prevents unauthorized modifications to the smart contract. It brings code is law to the highest level.
We’ve just described the basics of Ethereum and ETH, alongside some of its core technology such as smart contracts and gas.
This is simply the start of the rabbit hole, and obviously, the concept of Ethereum goes much deeper than this introduction. We hope that it gives you a nice quick overview about what Ethereum is about.