What is Ethereum Explained With How it Works & its Purpose

What is Ethereum Explained With How it Works & its Purpose

Founded in 2015, Ethereum is a decentralized computing network and functions as the backbone for many applications, smart contracts, and other digital assets. Its own crypto, Ether, currently holds the title of the second most popular and biggest cryptocurrency by market capitalization globally. Ether makes up around 17% of the crypto market with a valuation above $160 billion. Ethereum provides a base for an array of opportunities in the world of digital assets. 

Just like space exploration is unlimited at the discretion of our imagination and knowledge, the uses of Ethereum and its new implications are also unlimited till the developers’ minds can wander. Fascinating, isn’t it? Let’s take you on an exciting journey to understand what is Ethereum, its purpose, and basically, everything you need to know about it!

What Is Ethereum (ETH)?

Ethereum was created to expand blockchain’s application beyond the decentralized monetary system (Bitcoin). In 2013, its co-founder Vitalik Buterin published a whitepaper on Ethereum and later, along with seven other co-founders, crowdfunded $18,439,086 in Ether (ETH) to build the network. Currently, there are more than 120 million ETH in circulation. 

Ethereum is based on the blockchain network, a decentralized public ledger. This public ledger records and verifies all transactions on the network. Being a distributed public ledger, all the participants have access to all the transactions conducted at any time on this network. There is no single authority; all the participants (computers maintaining the network) hold complete control over the platform.

Often people confuse Ethereum with Ether as people use the term interchangeably. So let us clear it up once and for all. 

Ether is the token of the Ethereum platform, which works similarly to other cryptos. You can exchange it for goods and services on the network. While Ethereum is the blockchain platform that helps developers build applications, smart contracts, software, and even other cryptos. 

Thus, Ether is the cryptocurrency, while Ethereum is a blockchain network behind that cryptocurrency. Well, that’s all on Ethereum! 

How Does Ethereum Work?

Ethereum is based on a distributed public ledger and runs on the computer system known as the Ethereum Virtual Machine (EVM). It is the primary software that facilitates the creation of smart contracts and dApps; it keeps track of the overall network. 

With its broader applications for smart contracts, Ethereum wins the title of the most preferred platform for building dApps. Decentralized applications, or dApps, are nothing but applications built on blockchain. These applications could be anything from a video conferencing app to a gaming app and more.

i) dApps are based on blockchain and require smart contracts for smoother functioning. Decentralized applications can be created for a myriad of industries, from finance to healthcare, etc. Ethereum facilitates the creation of smart contracts quickly and makes them more accessible– fulfilling the requirements for dApp creation.

ii) Additionally, the Ethereum platform helps these dApps reduce their programming time and rapidly monetize their platform with an already available large community within the ecosystem.

Validation of data on the Ethereum blockchain

Let’s come back to how Ethereum works. A copy of EVM exists on a global chain of computer networks maintaining the Ethereum blockchain. To insert or modify a transaction or set of data, it needs to be verified by all these computer nodes. The transactions on Ethereum exist as data blocks. Every Ethereum block consists of 64 digit code; you can think of it as a tag for that particular block making it easy to identify. 

To add a block, till now, miners had to compete to solve complex mathematical equations. The miner that solved the equation first got the chance to add the block to the blockchain and earned Ether in return. This process or consensus mechanism is called Proof of Work (PoW). However, with Ethereum 2.0, Proof of Stake (PoS) has replaced PoW, which we will cover soon. 

Miners also earn rewards from a portion of the fees the users pay to transact, called “Gas fees.” The Gas fees are based on the network’s busyness at that particular time–compare it with demand vs. supply; the higher the demand (demand of the network), the higher the prices, and vice versa. 

What Is Ethereum 2.0?

We just discussed how miners add a transaction to the Ethereum blockchain using Proof-of-Work. However, this mechanism has its shortfalls. 

For starters, it consumes a lot of energy and is quite expensive. Each miner had to solve complex equations that consumed high energy and resources, but only one would be successful, and the energy used by others would get wasted. 

To eliminate this competition and higher energy consumption, recently, in mid-September, Ethereum 2.0 finally rolled out.

How does this change things?

It is like the rebirth of Ethereum with better features. Ethereum 2.0 uses Proof-of-Stake (PoS) mechanism to validate the transactions and add new data blocks.

This mechanism chooses a validator instead of miners to validate the blocks. Validators are selected based on the Ether they stake. The chosen validator adds the transaction, and others attest to it.

All the Ethereum transactions now use the Proof-of-Stake consensus mechanism, saving resources and, most importantly, electricity. 

Ethereum 2.0 is also likely to positively impact existing and new smart contracts and dApps built on this platform. Also, with Ethereum 2.0, the scalability of this platform will also increase, attracting more developers and start-ups to join this ecosystem and innovate new applications. 

What Are the Features of Ethereum?

Now that we know what Ethereum is and how it works, let’s touch on its features.

1. Ether

Ether is the native cryptocurrency of the Ethereum blockchain. Validators earn Ether when they validate and add new transactions on the platform. Ether is also used to pay for services on the Ethereum blockchain.

2. Ethereum virtual machine (EVM)

EVM is like a supercomputer system that enables functionalities like smart contracts and dApp creation on the Ethereum blockchain. It works as an encyclopedia for Ethereum transactions. A copy of this decentralized ledger exists with the chain of computer nodes operating the Ethereum blockchain. EVM ensures that the deployment of different functionalities is seamless on the Ethereum blockchain network, and users enjoy a smooth experience.

3. Smart contracts

Smart contracts are upgraded versions of traditional contracts. Developers create them to transact various assets, such as money, property, shares, etc., between two parties in a secure and digital format without any intermediary. Smart contracts automatically execute themselves once predefined conditions are met. Ethereum is the leading blockchain infrastructure for smart contracts. 

4. Decentralized autonomous organizations (DAOs)

DAOs are decentralized organizations built on blockchain. Unlike traditional organizations, DAOs lack hierarchy, and no single entity dictates its working; all the members of a DAO make decisions together. The decision-making process is based on decentralized voting systems, making it unbiased. Smart contracts ensure the smooth functioning of DAOs.

Some examples of DAOs include Uniswap, MakerDAO, etc.

5. Decentralized applications (dApps)

DApps, also written as Dapp, DAPP, etc., are usually built on Ethereum. It works similarly to other web-based apps, but the differentiation is in the usage of decentralized databases for storing and accessing data. It stores users’ data on a decentralized ledger instead of a developing company’s centralized network. 

How Is New Ethereum Produced?

Staking produces new Ether. In PoW, miners used to solve complex mathematical problems to mine new ETH; in PoS, validators stake their ETH to validate transactions and thus create new ETH.

Bitcoin has a lifetime cap of 21 million coins, with the last Bitcoin probably getting mined in the next century. However, there is no such cap for ETH, but there is an annual cap of 18 million. 

How Does Ethereum Have Value?

Ethereum’s value depends on two factors. 

  • The market value of Ether (ETH) fluctuates based on its demand and supply. The higher the demand, the higher its value, and vice versa. 
  • Secondly, the applications on Ethereum also drive ETH’s value. For example, you can use the Ethereum blockchain for creating decentralized apps, smart contacts, and other cryptos such as stablecoin, etc. With Ethereum becoming a popular network for building new innovations, it has had a positive impact on its native cryptocurrency.

What Are the Advantages and Disadvantages of Ethereum?

To know the ins and outs of Ethereum, you also need to know how Ethereum benefits and where it lacks. 

Advantages of Ethereum

1. A strong blockchain network

Ethereum is the most popular network for developing new innovations in this space. It has transparency and trust that users and developers can count on. Out of 4073 total dApps, developers built 2970 dApps using the Ethereum network, stating its credibility and popularity. Also, currently, its crypto, ETH, accounts for around 17% of the total market cap. 

2. An array of functionalities and innovations

Ethereum is the base for smart contracts, decentralized apps, digital assets, and much more. The imagination of developers is the only thing limiting its functions and use cases. There are many innovations yet to occur, especially now that Ethereum 2.0 has rolled out. 

3. It is secure and saves time

All cryptos are based on the fundamental idea of providing the needed security and decentralization to users. Ethereum, too, is secure, with its overall structure being permissionless and open-source. Numerous cryptographers and computer scientists have already tested it for safety. Ethereum eliminates the need for intermediaries and saves users time and effort to develop various applications, including smart contracts and dApps. 

Disadvantages of Ethereum

1. Higher charges for transactions

Remember we talked about the transaction fee called ‘Gas’? The gas charges are based on the demand of the Ethereum network. With its increased popularity, the Ethereum platform is gaining wider use, leading to higher demand and higher gas fees. This can be a challenge for users as their cost rises; however, with Ethereum 2.0 and the use of PoS, we can expect some reduction in gas fees. 

2. Less value compared to Bitcoin

Bitcoin has a definite number of 21 million coins that miners can mint in its lifetime, which creates scarcity and results in its higher value. However, there is no such lifetime cap on Ethereum. Because users can mint them in unlimited numbers, there are chances of Ethereum not appreciating in the same manner as Bitcoin.

3. Issue of scalability

While Ethereum has gained a lot of traction, it has also caused scalability issues. For example, transaction per second (TPS) on Ethereum is only 30, resulting in delayed and limited transactions. Thus lagging in providing firm support to dApp developers. However, the good news is that numerous developers are already heading in the direction of resolving this shortfall, and we can expect to see some concrete results soon. 

How to Store Ethereum Securely?

You can store ETH in three ways. 

1. Hardware wallets

This is a cold storage wallet. These are not connected to the internet. Here you store ETH in USB devices, and thus, it is quite secure. However, storing these USB devices is more crucial as once lost, you lose your Ether.  

2. Desktop and mobile wallets

As the name suggests, you store a desktop wallet on a desktop, and a mobile wallet on a smartphone. There are two types under these wallets. Custodial and non-custodial wallets. The first relies on a third party to save the private key, while the latter does not. Because third-party platforms are vulnerable to hacking, non-custodial wallets work better and offer a higher level of safety. 

3. Web wallets

These types of wallets store private keys online. Because someone can hack online accounts or storage if not secured properly, this method is the least safe to store your Ether. 

Ethereum Vs. Bitcoin

While Ethereum and Bitcoin are both virtual assets and a store of value, their functionalities differ.

BitcoinEthereum 
Popularity Bitcoin is the first cryptocurrency that started in 2008. It is the biggest crypto by market cap and popularity. Ethereum was founded in 2015. Its crypto, Ether, is the second biggest crypto in terms of market cap and popularity. 
Coins Mining Bitcoin cannot be in infinite numbers. The cap is 21 million, after which no new Bitcoins would be created. There is no cap on the number of ETH that could ever exist. However, for each year, there is a cap of 18 million. 
Usability Bitcoin is a payment token and a store of value. ETH is used as a mode of payment within the Ethereum ecosystem. It also facilitates the building of DApps, smart contacts, digital assets, etc., on the Ethereum blockchain network.
Speed of Transaction The Bitcoin network adds a new block once every 10 minutes. Compared to Bitcoin, the transaction speed of Ethereum is extremely quick. New blocks are added every 12 seconds. 

Real-World Use Cases of Ethereum 

You can find real-world use cases of Ethereum below. 

1. Banking

Ethereum is a boon for the banking and finance industry, with the innovation of decentralized finance or DeFi Apps. DeFiapps are based on Ethereum’s distributed ledger, which makes it challenging for hackers to steal or tamper with the data of consumers. It also makes payment processing faster.

Given its broader and safer scalability, even central banks have started to implement blockchain. For example, to launch its own CBDC, the Norwegian central bank recently launched an open-source prototype code that is based on Ethereum.

2. Smart contracts

Ethereum network facilitates developers to create smart contracts. It also makes the overall process of creating, storing, signing, and transferring smart contracts across organizations and geographies very easy and quick. It saves time and removes the need for a third party. 

The popularity of smart contracts has seen a constant increase in recent years. In the first quarter of 2022, users created more than 1.45 million smart contracts on Ethereum compared to 1.16 million in the last quarter of 2021, which is an impressive 24.7% increase. 

3. Data storage 

Typically, large institutions and companies store their data on server farms. Server farms have hundreds of servers, storing data in larger volumes. And these farms have centralized servers, which means access and control of this data is limited to only a handful of individuals and computers. If someone destroys the computers or if they malfunction, the chances of them losing data are high. However, saving them on Ethereum removes this threat with its decentralized properties. 

4. Creating other digital assets

Ethereum already has its own crypto, Ether. However, many cryptocurrencies, including Tether (USDT), Stablecoin, Binance Coin, etc., are also built using the Ethereum platform. In addition, digital assets like Non-fungible Tokens (NFTs) also use the Ethereum blockchain network, broadening its use case in the digital assets industry.

How to Buy or Invest in Ethereum? 

We have talked enough about Ethereum’s meaning, purpose, and usage. Now let’s get to the point that you have the most interest in–how to buy ETH.

1. Online crypto platforms 

You need to open an account with a crypto platform to buy ETH. Once you have an active account, deposit money to start trading. 

2. Peer-to-peer exchange

This is not the preferred method to buy ETH for retail investors. However, if you know someone who wishes to sell their ETH, you can buy it from them. Once bought, you can store ETH in your crypto wallet, which is secure, with public and private keys. 

Note that investing in cryptocurrency has its own risk. 

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Is Ethereum a Good Investment?

In the last few years, ETH’s value has tremendously increased. When ETH’s initial coin offering took place in 2014, its value was $0.31. However, in May last year, its peak was $4,379. Its current value is around $1200. 

That said, we always suggest you do your own research, be aware of the risk factors, and check all the aspects before making an investment in any cryptocurrency, including ETH. 

Should You Invest in or Mine Ethereum?

Investing in and mining ETH are two polar opposite activities. 

In the first option, ETH is available on crypto platforms for you to invest in, just like stocks are available on the stock market platforms. 

On the other hand, mining ETH can be compared to creating it from scratch, which requires extensive energy and resources. You have to incur a lot of expenses with this method. Earlier, you had to run computer systems to solve mathematical equations once you became a miner. Now you need to hold a certain number of ETH in order to become a validator and earn rewards of new ETHs, which is quite challenging. 

From a business perspective, it may make sense, but as an investor, you do not want to exhaust so many resources and effort in mining when you can easily invest in it via a crypto platform.

The Bottom Line

With the upgrade, the future seems brighter for this blockchain network. Ethereum’s popularity has already been multifold in recent years, and its myriad uses prove the potential it has. The new, improved version will help developers across the globe to innovate and build new applications while being energy and cost-efficient.

FAQs 

1. What is Ethereum used for?

Ethereum works on its own distributed blockchain network. It is highly secure, and developers use it to build smart contracts, decentralized applications, and other digital assets. Ether (ETH) is the native cryptocurrency of the Ethereum network.

2. What is the difference between Bitcoin and Ethereum?

The main difference between Bitcoin and Ethereum is that while Bitcoin is a payment token, Ethereum, in addition to facilitating payments, enables the blockchain network to build an array of applications. Bitcoin has a lifetime cap of 21 million, while for ETH, there is no such cap (only the annual cap of 18 million.) Thus, both derive their value differently. 

3. Why is Ethereum so popular?

Ethereum, founded in 2015, provides a wide spectrum of applications, from creating new cryptos to building smart contracts to execute transactions without third parties. This functionality of Ethereum has helped it gain extensive popularity over the years. 

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