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Cryptocurrency Explained: Ethereum

May 29th, 2024Joey PrebysJoey Prebys

*This article was originally published in November 2020

Main Points

  • Ethereum is a decentralized, open-source blockchain used to create decentralized applications (dApps) and contracts that self-execute (smart contracts). 

  • Ether (ETH) is Ethereum's native cryptocurrency token and in addition to being an investment vehicle and store of value, it is used to pay for services on the Ethereum network.

  • Ethereum is the world's second-largest cryptocurrency by market capitalization and is the most actively used blockchain in the world.

The introduction of Bitcoin was revolutionary because it woke people up to the idea that individuals can send or receive money without intermediaries. This idea led many to wonder if the control of money can be decentralized, then what else? Enter Ethereum.

What is Ethereum?

All cryptocurrencies use blockchain technology to create a system that makes decisions without the guidance of central authorities or intermediaries using cryptography, proof of work, and a decentralized network of computers.

The most popular cryptocurrency, Bitcoin, is limited by its design so that it can only carry out simple wealth transfers between one wallet to another. Ethereum, like Bitcoin, is a peer-to-peer digital currency that allows you to quickly send cryptocurrency to anyone in the world for a fee. Unlike Bitcoin, Ethereum uses a different implementation of blockchain technology that adds additional capabilities to its protocol, including the ability to use its blockchain to create decentralized applications.

Ethereum was proposed in 2013 and launched in 2014 by Vitalik Buterin, a Russian-Canadian programmer and co-founder of Bitcoin Magazine. With Ethereum, Buterin intended to create a truly decentralized Internet. In addition to being a cryptocurrency, it also provides a DIY platform for decentralized applications (dApps) - software programs that do not execute on any centralized machine.

How does Ethereum work?

Ethereum uses a network of computers to validate every action and maintain thousands of identical copies of the shared digital ledger. Adding to the ledger requires computing power, so the protocol selects validators to perform computations, and for the effort they're rewarded with eth. Only computers that have deposited a large amount of eth into holding - a process called "staking" - can participate in validation, and if they're dishonest their "staked" deposit will be destroyed. This system is called a "Proof of Stake" consensus mechanism.

Ethereum has a coding language, Solidity, that enables programmers to write decentralized applications (dApps) and smart contracts. Traditional apps rely on central authorities to store data and perform operations with that data. dApps use Ethereum's vast network of independent validators to hold data and perform computations in a robust, decentralized way. This ensures that a dApp can run even if some validators go offline.

Ethereum's greatest innovation is the smart contract. Think of smart contracts as a special type of dApp. They are self-executing contracts with the terms of the agreement between buyer and seller directly written into lines of code. The code controls the execution, and transactions are trackable and irreversible. Smart contracts permit transactions and agreements to be carried out among disparate, anonymous parties without needing a central authority, legal system, or external enforcement mechanism.

A smart contract on the Ethereum network is immutable, meaning no one can ever change it. Changing a contract without permission is virtually impossible because you would have to convince thousands of individual validators on the Ethereum network to accept a change to the ledger, and if that change is deemed fraudulent the validators who accept could lose their staked ether.

So in the real world, if you had a smart contract with your employer, you could stipulate how much money would be awarded for a certain number of hours worked. The smart contract could see when the employee clocks in and out, and automatically moves money from the employer's wallet to the employee's. If the employer's wallet runs low on money the smart contract can be programmed to alert both parties before the next pay period.

What is Ether (ETH)?

Ether is the native asset of the Ethereum blockchain. Think of it like how the US economy runs on dollars; Ethereum runs on ether (ETH). On Ethereum, computers work together to execute the code that powers dApps. Maintaining these powerful computers can be costly, so ETH is an incentive for people to run the protocol on their computer, similar to how Bitcoin miners get paid in BTC. Like BTC, you can use ETH as a form of digital payment or as an investment.

Anyone looking to build software on Ethereum has to pay for the computing power and space using ETH. This fee is determined by a built-in pricing system called gas. Gas refers to the price needed to process a transaction on Ethereum's blockchain successfully, considering the computational difficulty, bandwidth, and space required.

Learn more about gas fees here: Gas Fees FAQ

What Are Ethereum Tokens?

Among the most popular uses of the Ethereum blockchain are Ethereum based tokens. Ethereum tokens are digital assets built using the Ethereum blockchain. These tokens are often cryptocurrencies that do not have their own native blockchains. Instead, they benefit from Ethreum's existing infrastructure.

The Ethereum network can be used to create contracts that represent new digital assets. Ethereum tokens can represent anything from the United States Dollar, like USD Coin, to digital artworks like non-fungible tokens (NFTs).

Learn more about different Ethereum tokens here: Coin vs. Token: What’s the Difference?

Bitcoin and Ethereum are similar as they both provide decentralized and immutable transaction ledgers that use cryptography and blockchain hashing processes. However, the two are different in some fundamental ways:

  • Cryptographically, Bitcoin uses a hash function called SHA-256 to encrypt blocks, while Ethereum uses ethash

  • Bitcoin asks miners to complete complex math problems to validate transactions (proof of work consensus), while Ethereum's protocol chooses validators from a pool of nodes that staked a significant amount of ether (proof of stake consensus).

  • Bitcoin is used for financial transactions like purchasing goods and services. Ethererum can be used for financial transactions and also support dApps and smart contracts.

  • Currently, Bitcoin carries significantly more value per coin than Ethereum. 

  • Bitcoin was created to compete against gold and fiat currencies, while Ethereum was developed to be a platform that allows developers to build blockchain applications. 

  • Bitcoin transaction speed is counted in minutes, while Ethereum transactions take only seconds. 

  • The total amount of bitcoin to ever be created will be capped at 21 million, while there currently no cap in place for ether.

Why Buy Ethereum?

Ethereum has continuously maintained its place as the second-largest currency by market capitalization. With this level of popularity, many merchants that accept cryptocurrency include ETH in their payment options. 

When it comes to the Ethereum blockchain, there are endless possibilities with how it can be used and implemented. Already, Ethereum is the world's most actively used blockchain as it is the primary blockchain used for Decentralized Finance (DeFi) and NFTs.

Are you interested in buying into Ethereum? You can do so at a CoinFlip ATM near you or online through CoinFlip Preferred!

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