What is Ethereum and How Does the Blockchain Work?

In short Ethereum is an open-source technology platform. It supports its own native cryptocurrency called Ether or ETH. Additionally Ethereum allows developers to build blockchain based applications upon it.

Ethereum is the second most popular cryptocurrency after Bitcoin. In fact is has the second largest market cap out of all the cryptocurrencies.

Ethereum Pronunciation

How Does Ethereum Work?

Ethereum works using blockchain technology with the programming languages Solidity and Vyper. Blockchain was used successfully for Bitcoin. As a result blockchain was used as a basis for the Ethereum platform.

Blockchain works with blocks that contain a certain number of approved transactions that happened on the network. Transactions are approved by computers on the network once they reach consensus.

That is to say computers verify and agree all transactions are legitimate transactions before they get included in the chain. As a result this keeps the Ethereum ledger honest and robust against fraud.

Blockchains do triple entry accounting so there is certainty and transparency with the transactions that occurred on the network. The blocks included on the network are attached one after another to form a chain. Hence the name blockchain.

Since Ethereum is decentralised the technology operates relies on many computers. Additionally anyone may decide to pitch in and contribute to the network. However with Ethereum transitioning to proof-of-stake the criteria to contribute to the network will increase.

Ethereum vs Bitcoin

Even though both Bitcoin and Ethereum work with blockchain their blockchains are different. Not just from a technical point of view, but their blockchains also work differently.

The Differences and Similarities of Ethereum vs Bitcoin:

EthereumBitcoin
BlockchainYesYes
Programming languageSolidity and VyperC++
Supports DappsYesNo
Type of cryptoassetCrypto commodityCryptocurrency
Consensus protocolTransitioning from proof-of-work to proof-of-stakeProof-of-work
Transactions per second15-45 7
Monetary policyNo maximum cap in supply Max 21 million coins, deflationary

Bitcoin is purely a cryptocurrency. Likewise Ethereum has its own cryptocurrency called Ether that is natively supported on its platform. On the other hand Ethereum was created to have much more functionality.

Ethereum is actually what is called a crypto commodity. It is an innovation because it was the first of its kind. A crypto commodity is one of the four types of cryptoassets. A crypto commodity acts like a raw material like for example oil or sugar. This is because it is the basis for making other things with it. 

In fact Developers can use the Ethereum platform to build other blockchains called Dapps. DApps is short for decentralised apps and they use smart contracts for transactions. Dapps can offer cryptocurrencies or more complex services.

Consequently Ethereum’s innovation is going to bring about the next generation of the internet. So we will upgrade our internet from the internet of information to the internet of value. That is web 2.0 to web 3.0.

Ethereum Ecosystem

There is a whole ecosystem built with Dapps already on the Ethereum platform. It is part of what is called decentralised finance (DeFi).

DApps on Ethereum

ethereum-ecosystem

Sourced from The Moon Carl Twitter account

The Ethereum ecosystem grew very quickly and is still growing substantially. You can see the updated data on the amount of investment and the list of applications here on DeFi Pulse.

In short DeFi is trying to recreate all the financial services we have in our banking system and more. In fact Ether tokens are used for exchanging cryptocurrencies, staking, NFTs (nonfungible tokens), playing games, the metaverse and more.

Advantages of the Network

The main benefit of Ethereum is that it is decentralised and replaces central authorities. This is because many thousands of computers maintain the network.

Additionally the network is highly secure because each computer has a copy of the blockchain. So if one or many more computers suddenly stop contributing there are many other computers that can continue working.

Secondly with all the use cases for smart contracts they have the ability to disrupt a wide array of industries. Mainly because they remove the need for third party intermediaries. So two parties can interact directly with each other peer-to-peer.

Most importantly no one can edit a smart contract after the parties involved finalise it. As a result it puts everyone’s minds to rest knowing that it is secure. In fact there is a lot of investment being poured into creating applications on the Ethereum platform for this reason.

Ethereum Use Cases

As mentioned Dapps work with smart contracts. Smart contracts are a misnomer because they are not smart and they are not contracts. They are code used to make logic or coded rules to verify. Additionally they securely execute agreed upon business deals.

So once the parties honour the terms of the contract the smart contract automatically self-executes. In fact there are many use cases for a huge variety of industries. Companies are able to use smart contracts to increase efficiency and reduce costs.  

It eliminates the need in certain cases for:

  • brokers
  • escrow agents
  • governmental agencies
  • notaries or lawyers

Instead of these roles, developers that understand the Ethereum programming languages will directly code contracts.

Disadvantages of the Network

Ethereum has a lot going for it. It is revolutionary because it was the first blockchain to include smart contracts. However one drawback is that it does not support interoperability.

Interoperability is becoming really important within the cryptocurrency industry. This is because without it the different blockchains such as Bitcoin, Ethereum, Dash etc. will remain separate. These blockchains cannot interact with each other.

In fact Ethereum itself and its Dapps cannot interact with blockchains both outside and inside its ecosystem. To clarify this will end up fragmenting the whole cryptocurrency space.

On the other hand some new crypto commodities have all the functionality Ethereum has. However they also have interoperability. They have the ability to communicate between the Dapps on their own network and others outside their network. That includes interacting with Bitcoin and Ethereum. To clarify they create bridges to talk to other blockchains. Some examples include Comsos and Polkadot.

Another drawback Ethereum has is scalability. It has a limited amount of transactions it can process per second. Moreover because sometimes there are many transaction requests fees on the network are high. One competitor crypto that attempts to solve this issue is EOS, and you can read a detailed comparison of EOS vs Ethereum.

However the Ethereum developers are working to fix scalability. There is a much anticipated upgrade to the network called Ethereum 2.0.

Ethereum 2.0 Upgrade

Developers are going to upgrade the Ethereum platform for a couple of reasons. Firstly to improve scalability. Secondly to transition Ethereum to proof-of-stake for consensus. As a result these changes will drastically reduce the fees on the network. The upgrade is called Ethereum 2.0.

Scalability

To clarify scalability refers to scaling up the ability of the platform so that it can handle more requests. This is because Ethereum ran into problems with the popular NFT collectibles called CryptoKitties.

There were many requests for the network to process CryptoKittie sales in 2019. So much so that Ethereum could not handle the sudden surge in demand to cater for that many requests. As a result it created a huge backlog on the Ethereum network and the gas fees skyrocketed. At that point Ethereum put off quite a lot of users from the network.

what-is-ethereum-cryptokitties

Sourced from CryptoKitties.co

Moreover for blockchain networks to become mainstream they need to process a lot more transactions. In fact blockchains are compared to Visa which processes an average of 1,700 transactions per second (tps) without a hitch. However Visa can handle up to 65,000 tps.

As a result Ethereum 2.0 is going to introduce sharding. So instead of Ethereum having one chain in the blockchain it is going to have multiple chains. The primary chain is called either the main chain or the beacon chain. The other chains are called shard chains. They will help to share the requests that come through on the network.

beacon-shard-chains-illustration

Shard chains will run in parallel to the beacon chain. Each shard chain will only need to process the transactions of that shard, but they will sync with the beacon chain. As a result they are updated with all the relevant data they need to process transactions.

Ethereum Transactions Per Second

With the introduction of sharding for the Ethereum 2.0 upgrade the platform will scale up. As a result it will go from handling 15-45 tps to a phenomenal 100,000 tps.

Ethereum Proof of Stake

Ethereum is transitioning from a Proof-of-work consensus mechanism to proof of stake. This is because proof-of-work consumes a lot of energy due to mining. Additionally running costs for miners is expensive because of the equipment they need.

On the other hand proof-of-stake requires much less energy and costs less to run the network. In proof-of-stake miners are replaced by validators. All validators need to do to run the network is stake 32 Ether tokens to validate transactions on the network.

As a result it makes the network much more environmentally friendly.

Ethereum 2.0 Releases

The Ethereum 2.0 upgrade has a lot of work involved. In fact developers are doing the updates in stages.

Ethereum 2.0 featureDate of release
Beacon chainReleased 1st December 2021
The Merge of the beacon chain to the mainnet. Proof-of-stake will get activatedEstimated 2022
Shard chainsEstimated 2023

Ethereum Gas Fees

Whenever you interact with the Ethereum blockchain you have to pay a fee known as a gas fee. Like for example if you send Ether to make a payment or if you mint an NFT. Gas fees are paid in the Ether units called Gwei.

Base Fee

A while back Ethereum had a network update called EIP-1559. This update affected a couple of things. Firstly it affected the fees structure of gas fees. As a result today there is a base fee which is the minimum fee required to process your transaction.

How the Base Fee Works

The base fee can increase or decrease by 12.5%. An increase in the base fee happens when a block on the chain is between 50% – 100% full. On the other hand if a block is under 50% then the base fee will go down.

So say for example there are a lot of requests on the network. If there are enough transaction to fill a whole block, the nodes will create a block at once. However because the block is 100% full it will increase the base fee. In a way the fee helps to regulate demand and hence requests on the network.

Tips

Additionally you can top up the base fee yourself by giving a tip. The scope of this is to incentivise the nodes to process your transaction quicker. So if you need a fast response from the network you can send a tip.

Ethereum Max Supply of Ether Tokens

Another thing that the EIP-1559 upgrade changed is the supply of Ether on the network. In fact the Ethereum network has no fixed supply.

EIP-1559 on the network burns a portion of Ether token for every transaction. However the nodes receive Ether tokens for including new blocks in the blockchain.

To clarify Ethereum burns all the base fees. However the nodes can keep the tips and any additional Ether they receive from the blocks. Plus the new Ether tokens produced for including new blocks.

Ether units

Similarly to Bitcoin, Ether has its own denominations for the units that come behind the dot point. In sovereign or fiat currencies like the dollar or euro they are called cents. In this case Ether has many more than 2 – it has 18.

With this many units they have all been given a name to keep things easy for reference. The smallest unit of Ether is called Wei. You can read more about Ether units here on this page.

How Easy is it to Adopt Ethereum

The Enterprise Ethereum Alliance EEA was set up for this reason. Its role is to help organisations to use the Ethereum technology and adapt it into their business operations.

Board member of this organisation include individuals from large firms. For example Accenture, Intel, J. P. Morgan, Microsoft, Santander and others.

History

Ethereum was developed by Vitalik Buterin. He laid out the concept of Ethereum in a whitepaper in 2013. His ambition was to create a platform that had additional functionality to what Bitcoin offered. This is because Bitcoin only operates as a medium of exchange.

Ethereum was established as a non-profit whose initial founders were Vitalik Buterin himself, Mihai Alisie, Amir Chetrit, Anthony Di Lorio and Chales Hoskinson. Additional individuals joined later to help with founding the Ethereum project; Joseph Lubin, Jeffrey Wilcke and Gavin Wood joined the ranks.

Development for the cryptocurrency was crowdfunded. They raised money by the purchase of Ethereum tokens with Bitcoin. Ethereum eventually launch on 30th July 2015 with 72 million coins already in circulation.

Other Articles In This Section
What is Ethereum? An introduction to a major cryptocurrency.
Ethereum units. Breaking down the denominations of ETH.
How to buy ETH. Guide to buying and where to buy.

Frequently Asked Questions

Is Ether and Ethereum the same?

Ethereum is the network platform. Ether is the native token or cryptocurrency on Ethereum.

Can you mine Ethereum?

You can mine Ethereum until it transitions to proof-of-stake sometime in 2022. The Ethereum developers have not provided an exact date of the release for this change.

What is the Ethereum max supply?

Ethereum has no fixed supply and it is constantly changing. This is because the network burns a portion of Ethereum tokens every time there is a transaction. However new Ether tokens are produced as a block reward for including new blocks on the chain.

Why are Ethereum fees so high?

The fees go up and down depending on the demand of the network. If there are a lot of requests on the network the gas fees go up. However with the Ethereum 2.0 upgrade fees will come down drastically.

What is Ethereum gas?

The gas fees are the fees you need to pay whenever you do something on the Ethereum network. Whether that is sending ETH, buying or selling ETH, minting NFTs or creating a smart contract.

When does Ethereum 2.0 come out?

Ethereum 2.0 is being rolled out in stages. The beacon chain launched on 1st December 2021. However the beacon chain will merge on the mainnet sometime in 2022. Whereas the shard chains will get released some time in 2023.
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