Ethereum is a major player in the cryptocurrency market, with a huge first-mover advantage in processing complex transactions. If you are investing in crypto or thinking about buying, you probably already have this cryptocurrency on your radar. And if it isn't, well, it should be... Here's a little guide on what Ethereum is and how it works.
The history of the origin of Ethereum
Vitalik Buterin wrote the Ethereum whitepaper in 2013. He was only 19 years old at the time, but the Russian-born Canadian was thinking big. At the 2014 North American Bitcoin Conference in Miami, Buterin compared Ethereum to Bitcoin with an analogy. Bitcoin is like the “simple mail transfer protocol” (SMTP), which allows you to send and receive email. Ethereum is like the programming language of the Internet (javascript), which developers use to create a variety of Internet applications (for example, Facebook, Gmail, and cryptocurrency wallets). In other words, Ethereum is a platform for cryptoinnovation.
Why Ethereum is such an innovative technology7
Ethereum was the first cryptographic protocol to use smart contracts. They are programmable rules that developers can upload to the Ethereum blockchain. Like regular Ethereum users, smart contracts have their own wallet addresses. That's important to understand: we can send tokens directly to other users or send them to smart contract addresses, which have conditional payment rules attached to them.
Diagram showing the basic idea behind Ethereum smart contracts.
Smart contracts open up an immense range of cryptographic possibilities. In 2017, new blockchain projects raised billions in initial coin offerings (ICOs) through Ethereum smart contracts. If we wanted to purchase the X token, we would simply send ETH to a smart contract address before the ICO launch. Then, on the day of the project launch, the smart contract would send the X token back to our Ethereum wallet, based on the rules programmed into the smart contract. The market then crashed in 2018, but ICOs proved to be a major turning point: smart contacts could execute complex transactions on the Ethereum blockchain without going through a financial intermediary. As time went by, Ethereum's capabilities began to grow...
How Ethereum decentralized applications (dapps) work
Online banking, social media, gaming and investment apps work seamlessly on smartphones. If Ethereum were our phone, we could think of its applications as decentralized applications (dapps). Ethereum is a protocol1 layer«, which means that developers can create all types of dapps to run on the network. Additionally, these dapps can have their own native “ERC-20” tokens, which they can send, receive, and store securely on the Ethereum blockchain. Here are some examples of dapps running on Ethereum:
- Compound– A decentralized finance (DeFi) protocol where you can earn interest on your crypto by locking it into Ethereum smart contracts.
- Uniswap– A DeFi exchange where you can trade cryptocurrencies and deposit cryptocurrency collateral into smart contracts to provide liquidity to other traders, depositing some of your trading fees in the process.
- Dappradar– A crypto wallet that connects your PC or mobile device to the Ethereum network, allowing you to securely send, receive, and store all types of tokens on the blockchain.
How it works with NFTs
We can create and exchange “ERC-721” tokens on Ethereum, more commonly known as non-fungible tokens (NFT). These have value because they are unique and cannot be copied or cloned. Cryptopunks, Bored Apes y meebits They are some of the most valued collections.
NFTs from the CryptoPunks collection. Source: Opensea.io
Rare JPEGs have caught the attention of collectors, but there is much more we can do with NFTs on Ethereum. We can play NFT games on dapps, like Alien Worlds, Sorare Fantasy Football o Axie Infinity. Each game has different rules, but the general goal is to play, have fun, and collect NFTs in the game, with their ownership record updated on Ethereum. We can also buy parcels of digital NFT land on Ethereum-based projects like The Sandbox y Decentraland. In these “metaverse” worlds, we can interact with other people through our digital avatar. And if we have NFT land, we can build on it (just like with regular land) to further monetize our investment.
And of course, there is ETH
With so many interesting things being built on the Ethereum blockchain, we might be wondering what that could mean for the long-term value of Ethereum. Ethereum, the native token of Ethereum. Let's go back to the smartphone analogy: our phone is more useful (and more valuable to us) when it runs more apps. Ethereum is a base layer blockchain, and its network value grows as more dapps and NFTs are built on top of it. Since ETH is the “fuel” of the Ethereum network (users need it to pay transaction costs to miners for Ethereum transactions), demand for ETH increases as the network grows.
Ethereum 1.0, proof of work and ETH mining⛏️
Like Bitcoin, Ethereum currently uses a proof-of-work (PoW) system to validate and secure its blockchain. Here, miners compete to solve complex cryptographic puzzles to attach each block of transactions to the blockchain. As a reward for solving the puzzle, the winning miner takes the newly created ethers, which are then added to the total coin supply. On top of that, miners also earn ether transaction fees for their hard work. Around 13.000 new ethers are mined every day. Since each Ethereum block takes about 13 seconds Upon mining, winning miners receive around two ETH per block.
Number of new ETH mined per day. Source: Glassnode.
Ethereum's PoW is extremely secure, but it also makes the network slow, expensive, and unscalable. It can only process about 30 transactions per second, much less than competing smart contract blockchains, Solana, which can handle up to 65,000 per second. In terms of ETH fees, each transaction will cost us about $15 on average, depending on the dollar price of ETH. That's even more than the transactions of Bitcoin, which generally cost between $1 and $5. As with Bitcoin, Ethereum fees increase with network usage. This is because too many transactions can cause network congestion, so users increase their fees so that miners process their transactions before everyone else. In times of high network demand, Ethereum fees have been above $50, making it really expensive for smaller transactions. But this is about to change: Buterin and the Ethereum developers are updating the blockchain, which promises to be more speed boat tourPlus cheapPlus safe and fairer energy efficient.
Ethereum 2.0 and the end of ETH mining
Ethereum is changing from a PoW to a blockchain proof of stake (PoS), which means there will be no more energy-consuming competitive ETH mining. With PoS, “validators” confirm transaction blocks according to the amount of ETH they stake, that is, the amount they offer as collateral. Validators generate commissions in exchange for each transaction they validate. This works a bit like the wheel of fortune, where a random calculation selects the winner. Validators with more ETH staked have a higher chance of winning on average. It is expected that the fusion (Merge) of Ethereum towards PoS will be completed sometime in 2022, although as early as December 2021, ETH holders began staking a minimum of 32 ETH in the «Beacon Chain«, a separate PoS blockchain that runs in parallel to the current PoW chain. Once the Beacon Chain merges with the PoW chain, the need for ETH miners will disappear, and only validators will keep the network in control.
ETH network update history: Source: AMB Crypto
Additionally, PoS means that Ethereum will consume a lot of less electricity. And validators, unlike miners, will not have to buy very expensive mining equipment or cover sky-high electricity bills. They will only have to put collateral in ETH. As a result, they will not need such high ETH rewards to incentivize them to validate and secure the blockchain. In other words, PoS will slow down the creation of new ETH, making ETH more of a commodity. little and probably more valuable in the next years. The PoS merger could also make Ethereum even more Safety. Think about it: we would need more than half of the total ETH locked to outbid the validating network, and that's just to commit a single transaction. We would have to be incredibly rich to do that, and even the juice wouldn't be worth the squeeze. A hacking attempt would probably not bear fruit either. Validators could lose their entire stake if they break the rules, and that threat should make Ethereum's validator network impenetrable. After the merger, Ethereum will be in the next 2.0 update: fragmentation (Sharding). Basically, that will split the chain into 64 parts to reduce network congestion. Let's think of this as a highway with more lanes to alleviate traffic. That should make Ethereum transactions much more Quick y lower transaction costs.
Why ether is like “digital oil”️
If Bitcoin is digital gold, ETH is digital oil: transaction fuel for the Ethereum machine. Ethereum transactions can be simple (i.e. sending ETH to someone else) or complex (e.g. creating an NFT or lending ERC-20 tokens to earn interest on crypto). As the first smart contract blockchain, Ethereum has a dominant market advantage over younger competitors like Solana, Avalanche y Fantom. Like Facebook or Google, Ethereum benefited from a growing network effect: the more people use it, the more people will adopt it. Combine that with the promises of Ethereum 2.0 and we have a good reason to consider holding Ethereum in our cryptocurrency portfolio for the long term.