Last Updated on May 27, 2020
For a lot of people, crypto knowledge begins and ends with Bitcoin. Little do they know that this coin is just the tip of the iceberg.
While Bitcoin was primarily designed as a substitute for an outdated financial system by creating a decentralized peer-to-peer network and blockchain-based transactions, it was just a matter of time before developers found a plethora of other use cases for this technology.
One such project is Ethereum, the second most popular cryptocurrency, abbreviated to ETH, and a leading platform for blockchain-based services.
Keep reading this guide as we’ll dissect all of Ethereum’s niche details for you!
What is Ethereum
Vitalik Buterin, a Russian-Canadian computer programmer, found about Bitcoin through his father, a computer scientist himself, but initially rejected the idea as an ambitious but fruitless project.
He revisited the invention shortly after, this time deciding to go deeper with his research on the mechanism and technology. One thing led to another and Vitalik ended up writing for leading Bitcoin magazines, which at the time was the only way he could earn BTC himself, as he didn’t have proper mining hardware.
His newly found interest made him travel around the world working on various crypto-related projects. In 2013, he introduced Ethereum to the world, by publishing a white paper in which he explains the details of his own project.
Vitalik was not so much interested in Bitcoin as a currency unit as he was absorbed by the potential of its proof of work-based blockchain. In the paper, he acknowledges this by saying that the attention of the crypto community has shifted to “how the blockchain concept can be used for more than just money” (p.1).
He mentions smart contracts as one of the future use cases, “systems which automatically move digital assets according to arbitrary pre-specified rules” (p.1). The vision of Ethereum, therefore, was to create a separate blockchain that has a built-in Turing-complete programming language used to create smart contracts that will then perform different functions for future decentralized technologies (p.1).
All this in just a few lines of computer code. In 2015, Ethereum, the first programmable blockchain, was finally launched.
How Does Ethereum Work?
The Ethereum blockchain works similarly to how Bitcoin works:
- The nodes receive incoming transactions.
- They store them in a block and prepare to perform proof of work.
- They solve a complex algorithmic problem using their computing power.
- The node that has the solution broadcasts it to the rest of the nodes and waits for their approval.
- If the solution is valid, the nodes accept it and move on to the next block of data.
From PoW to PoS
The proof of work (PoW) mentioned above refers to a type of consensus mechanism used by decentralized blockchains to validate transactions and mine blocks of data. The mechanism is a computational algorithm that has its own rules and applications.
PoW is by no means the only consensus mechanism, nor is it the best one out there. In fact, Ethereum is planning to switch from using PoW to using proof of stake (PoS) instead.
The reason behind this mining shift is that PoW becomes more and more exclusive. The better (read: the more expensive) the mining hardware is, the faster you’ll find the algorithmic solution. On top of that, PoW consumes a lot of energy.
So, how does PoS differ?
Instead of miners, a blockchain that uses PoS is run by validators who validate incoming transactions. The prerequisite to becoming a validator is to own that blockchain’s native cryptocurrency.
The validators put their coins “at stake” (there’s a required minimum) by locking them in a special wallet for a set period of time. This is done to make sure the validators are motivated to perform their work honestly because they risk losing their money.
PoS is more cost-effective as validators don’t mine coins themselves so there’s no need for enormous energy costs.
Ether vs. Gas
Another important segment of Ethereum is its two native tokens: Ether (ETH) and GAS.
ETH is the main cryptocurrency on Ethereum that has an intrinsic value and much the same features as Bitcoin. It can be bought, stored, and traded.
GAS is a utility token that calculates the amount of computational power needed to execute one of the services provided by Ethereum and charges for it. This can be a money transaction or something like a smart contract. In other words, on Ethereum, you pay a fee with GAS.
The Era of Smart Contracts
Smart contracts are self-executing contracts written in computer code that allow users to exchange anything of value. They’re cost-effective, cheaper, faster, reliable, and irreversible.
Normally, people would execute contracts with the help of an intermediary (a lawyer or a notary) and spend extra cash to pay for their services. Not to mention the inevitable delays and paperwork involved.
Now, the two parties agree on the conditions beforehand and record them on Ethereum’s blockchain in the form of a smart contract. The contract waits until all conditions have been met by both parties for it to execute itself.
These contracts will speed up the automatization of many sectors including property ownership, health care, business management, insurance, housing, supply chains, etc.
Ethereum users can also create decentralized applications (dApps).
What distinguishes them from regular applications is the fact that they’re blockchain-based, there’s no central authority, and all functions are executed via smart contract. Such an application lowers the operational costs and promises greater transparency.
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