What is Ethereum and How Does It Work?

Back to BlogSEPTEMBER 26, 2023

What is Ethereum and How Does It Work?

What is Ethereum?

Decentralized apps, or those that are not under the jurisdiction of one single entity, may be developed and deployed using Ethereum, a blockchain-based computing platform. You may create decentralized applications in which the people have the power to make decisions.

Ether and Ethereum: What's the Difference?

With Ether, you may conduct validate transactions, invest, or utilize it as a store of wealth. The blockchain network on which Ether is stored and traded is called Ethereum. In addition to ETH, this network provides a number of additional services, as was already indicated.

According to Boaz Avital, head of product at Anchorage, "These are often simple movements of money, but they may also be complicated transactions that do anything from swapping assets to seeking out loans to buying a piece of digital art." The Ethereum network is used to handle and safeguard the transactions.

The Ethereum network supports both data storage and decentralized applications. Instead of hosting their apps on a server managed by Google (GOOGL) or Amazon (AMZN), where the data is controlled by one company, users may host their apps on the Ethereum blockchain. Since no single organization is in charge of everything, users of the app have full access to it and control over the personal information that is collected about them.

Self-executing contracts, also known as "smart contracts," are among the most exciting applications of Ethereum. A future delivery of products or services is agreed upon by two parties, just as in any other contract. Lawyers are not required, unlike traditional contracts: The contract is encoded on the Ethereum blockchain by the parties. It self-executes and delivers Ether to the relevant party once the contract's requirements are satisfied.

How Does Ethereum Work?

The decentralized nature of the ETH network, which is made up of nodes spread across thousands of computers globally, makes Ethereum very resistant to assaults and ensures that it will continue to function even if some nodes go offline.

Every node on the Ethereum network has a copy of the Ethereum Virtual Machine (EVM), which runs as a single decentralized system and is used to validate and update network interactions.

On the Ethereum network, transactions are referred to as interactions and are recorded in blockchain blocks that have been verified by miners using a proof of work consensus algorithm. For their computational labor in locating distinctive codes for each block, miners are compensated in ETH.

As with Bitcoin, verified blocks serve as an immutable database of all network transactions, and Ethereum transactions are also publicly visible on the blockchain.

Users are required to pay transaction fees known as "gas" to encourage mining and maintain network security. Miners are compensated in ETH for verifying transactions. Gas prices serve as a cap to stop network spam and regulate the quantity of activities per transaction.

Due to its function as a utility token rather than a store of currency, ETH has an endless supply. In the proof-of-stake consensus process, fresh ETH will continue to circulate thanks to miner incentives and staking rewards.

Due to miners prioritizing transactions with larger gas costs during times of network congestion, Ethereum gas prices may be high as users compete to have their transactions processed first.

Network congestion is a significant issue that is being addressed with Ethereum 2.0, a complete overhaul to the Ethereum network.

Ethereum can only be used using cryptocurrency stored in a wallet. The wallet serves as a gateway to the Ethereum foundation, where users may engage in a number of anonymous activities including completing payments, playing games, and transferring funds without worrying about outside parties seeing or benefitting from their data.

The decentralized structure of Ethereum and its use of cryptocurrencies allow for nondiscriminatory access to decentralized apps (DApps), giving users autonomy over their activities and advancing Ethereum's goal of becoming online 3.0, the next generation of online interaction.

Ethereum Features

Now, let's have a closer look at the ETH features you should know about. Below, we'll provide you with a detailed description of each point, including features of Ether, smart contracts, and Ethereum Virtual Machine, as well as compare peculiarities of the pair "smart contracts vs. traditional contract systems". To have a full understanding of any topic in the crypto world, including one connected with the Ethereum ecosystem, it's essential to know all the features and distinctions of the network, so be attentive and pay special attention to this section.

Ether

The cryptocurrency used by Ethereum is called ETH. It serves as the network's fuel. It is used to cover the transaction fees and computational costs associated with every transaction carried out on the Ethereum network. Ether is a peer-to-peer currency, similar to Bitcoins. Ether may be used to purchase gas, which is required to process every transaction completed on the Ethereum network, in addition to paying for transactions.

Additionally, you will require gas in order to launch a contract on Ethereum, and you must pay for that gas in Ether. Gas is the sum that a user pays to perform a transaction on Ethereum. Decentralized apps, smart contracts, and routine peer-to-peer payments may all be created with Ether.

Smart Contracts

The guide should be used to learn more about smart contracts as they are changing the way that traditional contracts work. Simple computer code known as a "smart contract" facilitates the exchange of any asset between two parties. It's possible that you'd like to trade cash, stocks, real estate, or any other form of digital asset. Anyone using the Ethereum network can create these contracts. Most of the terms and circumstances of the contract are mutually agreed upon by the parties (peers).

The key feature of a smart contract is that once it has been performed, it cannot be modified, and that every transaction made on top of it is irrevocably recorded. Therefore, even if the smart contract is changed in the future, the transactions related to the original contract won't change; you cannot modify those transactions.

Any smart contract execution on Ethereum is decentralized since the smart contract verification is carried out by anonymous network participants without the requirement for a centralized authority.

Any asset or cash may be transferred on the Ethereum network securely and transparently, and the identities of the two parties are protected. When a transaction is completed correctly, the sender's and receiver's accounts are updated appropriately, building confidence between the parties.

Smart Contracts vs. Traditional Contract Systems

In traditional contract systems, you sign an agreement, then you employ a third party to carry it out because you have faith in them. The issue is that data manipulation is feasible in this kind of operation. The contract is written in code when using smart contracts.

The outcome is validated by the users of the Ethereum blockchain-based network rather than a centralized authority. The danger of any data tampering or alteration is eliminated once a contract is performed since the transaction is registered and cannot be changed or interfered with.

Consider the situation where Zack hired Elsa to create the website for his business and paid her $500 for the job. The smart contract's agreement is built by the developers using the Ethereum programming language.

Every condition (requirement) necessary to develop the website is present in the smart contract. The Ethereum Virtual Machine (EVM) is used to deploy the code after it has been written.

Using EVM, a smart contract may be executed. Each member of the network will have a copy of the contract once the code is installed on the EVM. Each node on the Ethereum network will assess and validate whEther Elsa's work has been completed in accordance with the coding criteria when she submits it to the Ethereum network for assessment.

The $500 contract will self-execute when the outcome has been accepted and validated, and Elsa will be paid in Ether. Elsa will be given $500 in Ether, and Zack's account will be promptly deducted.

The implementation of an Ethereum smart contract is demonstrated in the Ethereum tutorial video.

Ethereum Virtual Machine

EVM is intended to function as a runtime environment for assembling and implementing Ethereum-based smart contracts, as was previously explained in this Ethereum tutorial. The smart contract language, which is written in the Solidity programming language for Ethereum, is understood by EVM. In essence, you may install your stand-alone environment, which can serve as a testing and development environment, as EVM is run in a sandbox environment. Once you are pleased with the smart contract's performance and usefulness, you may deploy it on the Ethereum main network after testing it (using it) "n" times and confirming it.

Any coding language used in the smart contract is translated into bytecode that the EVM can comprehend. The EVM has the ability to read and run this bytecode. One of the most widely used languages for creating smart contracts is Solidity. As soon as your smart contract is created in Solidity, it is translated into bytecode and deployed on the EVM, providing security against hacker assaults.

Ethereum Mining

Mining is the process of building a new block of transactions to be added to the Ethereum blockchain. Ethereum 2.0 will switch to a proof-of-stake (PoS) blockchain from a Proof of Work one for scalability and a more ecologically friendly method.

The machines that run the Ethereum software are known as miners, and they utilize their time and processing power to execute transactions and build blocks. In decentralized systems like Ethereum, network members must make sure that everyone is in agreement on the order of transactions. This is made possible by miners, who create blocks by resolving difficult computational puzzles and defending the network from intruders.

Ethereum vs. Bitcoin

Although Bitcoin is the cryptocurrency that is most widely used, the Ethereum community wants to advance the project. The former is intended to be used as digital money, and it does it fairly successfully. However, Bitcoin has several drawbacks. Some people think that this Proof of Work network, which struggles to expand, is more of a store of value, akin to gold. Additionally, Bitcoin has a hard ceiling of 21 million coins, which strengthens that case.

However, Ethereum aims to replace the present internet infrastructure. Many procedures that currently call on middlemen, like utilizing an app store or consulting with fund managers, are going to be automated. Although it may be used to send money, ETH is most commonly used to communicate with the network.

A special ERC-20 token, interoperable with Ether, may be created for each DApp by developers using the Ethereum platform. All Ethereum-based tokens are therefore technically interoperable, despite the fact that the process isn't flawless. The network of Bitcoin is only for Bitcoin.

Ethereum Benefits

A big, current network. The advantages of Ethereum include a tried-and-true network that has been put to the test during years of operation and via the exchange of trillions of dollars in value. It boasts the biggest blockchain and cryptocurrency ecosystem, as well as a sizable and devoted worldwide community.
A large variety of functions. Ethereum can perform different types of financial transactions, carry out smart contracts, and store data for third-party applications in addition to being used as a digital currency.
Continual innovation. The enterprise Ethereum alliance is always searching for fresh approaches to enhance the network and create fresh decentralized applications. According to Avital, "Ethereum tends to be the most used blockchain network for novel and intriguing (and occasionally risky) decentralized apps because of its popularity."
Eliminates middlemen. With Ethereum's decentralized network, users will be able to do away with third-party intermediaries like banks that operate as middlemen in financial transactions, attorneys who draft and interpret contracts, and site hosting providers.

Ethereum Disadvantages

Growing transactional expenses. The rising demand for Ethereum has increased transaction fees. Transaction costs on Ethereum, sometimes referred to as "gas," can vary and be highly expensive. That's excellent if you're making money as a miner, but it's not as advantageous if you're attempting to use the network. Ethereum forces participants to pay the fee, in contrast to Bitcoin, where the network rewards transaction verifiers.
Risk of inflation in cryptocurrencies. Although Ethereum has a yearly cap of 18 million Ether released, there is no cap on the total amount of tokens that might ever be created. Because Bitcoin has a fixed lifespan restriction on the quantity of coins, this might mean that Ethereum functions more like cash and may not value as much as Bitcoin as an investment.
Engineers have a steep education curve. As they switch from centralized processing to decentralized networks, developers may find it challenging to learn Ethereum.

What is Ethereum 2.0?

Proof of stake replaced proof-of-work as the consensus algorithm on Ethereum 2.0's blockchain in 2022. The necessity for miners, who use expensive crypto mining equipment and use a lot of energy to execute validations, was phased away as a result.

The method of verifying Ethereum transactions is now done through staking rather than mining, which entails securing a set quantity of crypto. Up to 99.9% of Ethereum 2.0's carbon impact was eliminated.

How to Buy Ethereum

A bank or an online brokerage like Vanguard or Fidelity won't let you acquire cryptocurrency. You must instead make use of a crypto trading platform. There are several cryptocurrency exchanges accessible, with dashboards that range from basic to complex for experienced traders. Before registering, it's a good idea to conduct some research on the various platforms because they have varying price structures, security features, and other features.

You'll almost probably need to provide some personal information and have your identity validated in order to register an account with a cryptocurrency exchange. After that, you may add money to your account by logging it in using a private key and linking a debit card or bank account. Depending on the option you select, fees may change.

As with any investment account, funding your account does not mean you have purchased Ethereum, and you don't want your unspent money to sit there. To invest at this time, you must first buy Ethereum.

Following the filling of your account, you can exchange your US dollars for Ethereum. Simply enter the amount of dollars you wish to exchange for Ether. You may be purchasing shares of a single Ethereum currency, depending on Ethereum's price and how much you choose to purchase. Your purchase will be shown as a share of the total amount of Ether coins.

If you simply have a little amount of cryptocurrency, it's simpler to leave it in your exchange account. A digital wallet, however, can offer additional security if you choose to move your assets to a more secure location for storage. There are many different kinds of digital wallets, each with a different amount of security, like a paper wallet or a mobile wallet.

Should You Buy Ethereum?

Bitcoin/Ethereum are comparable in terms of value, and ETH is the second-most valued cryptocurrency by market capitalization. Like any investment, it's feasible that Ethereum's increased risk will also lead to larger returns. In any case, Ethereum has progressed past the proof-of-concept stage, making the year 2009 irrelevant, and investors who haven't considered this type of investment yet should do so right soon.

Before investing a sizable percentage of your retirement funds in Ethereum or any other cryptocurrency due to the instability and volatility of the cryptocurrency market, you should do your own study. It would be beneficial to take this into consideration as a fast-growing alternative in a diversified portfolio. Obviously, never take a risk with money that you cannot afford to lose.

The Future of Ethereum

The Ethereum blockchain has been more well-known in recent months as a result of the development of several NFTs and decentralized finance initiatives. Advocates claim that the advent of new apps like these, which are among the first to operate on a public blockchain, has already resulted in a significant network effect, as greater activity draws more and more developers to Ethereum.

However, there are still fundamental questions over whEther Ethereum, which is behind schedule due to a complex series of technological upgrades, will be able to compete with more agile rivals and whEther any consensus on its long-term role will emerge as the cryptocurrency industry expands.

As a result of Ethereum's long-term significance, investors like Garg warn that the cryptocurrency markets may be due for a turnaround, with Bitcoin returning to uncontested supremacy.

FAQ

Still have any questions about the Ethereum network? If so, we recommend you to take a closer look at the FAQ list below – there, you'll definitely find the answers to all the outstanding issues.

How much is 1 Ethereum coin?

The exchange rate of 1 ETH to USD is 1957.79.

Why is Ethereum so valuable?

Ethereum is significant because it provides a decentralized platform for smart contract execution, which has many uses and the ability to spur innovation across many sectors.

How does Ethereum make you money?

With Ethereum, you might potentially earn money by participating in decentralized finance (DeFi) protocols, purchasing Ether and profiting from price growth, creating and deploying your own apps on the Ethereum network, and more.

Who owns most Ethereum?

It is challenging to identify a single owner that has the most Ethereum since Ethereum is dispersed across many different people and organizations.

Is ETH a good investment?

The answer to the question will depend on an individual's circumstances, risk tolerance, and market conditions. It is crucial to conduct thorough research and get professional guidance before making any financial decisions.