Ethereum: A Comprehensive Guide
By now Ethereum is the second largest name in cryptocurrency behind Bitcoin and has gained a lot of traction from the blockchain communities as an instrumental blockchain to support further development projects.
Ethereum gained momentum in 2017, seeing its coin (ETH) price go up about 11,000% from $8 per ETH on January 1, 2017, to $900 by the end of the year. This has caused Ethereum to attract a lot of attention from new cryptocurrency buyers and blockchain programmers alike.
The draw behind Ethereum is that it basically enables and supports the development of dozens of new cryptocurrencies to solve various problems using its native blockchain protocol. This has led some in the cryptocurrency communities to dub it Blockchain 2.0.
While the experienced blockchain community is probably familiar with Ethereum, those that are new to the game and less tech-savvy are probably wondering what makes Ethereum so popular. This comprehensive guide will go through the fundamentals of Ethereum and help you understand what’s under the curtain for this major cryptocurrency.
Ethereum vs. Bitcoin
Since most beginning crypto investors and traders are moderately familiar with Bitcoin and how blockchain works, it can be helpful to compare a cryptocurrency to the way Bitcoin works.
To start with the similarities, both Bitcoin and Ethereum operate on distributed blockchain networks. Both are decentralized and have no central authority or central point of control. For each blockchain, miners support the network by verifying transactions to earn either Bitcoin or Ethereum as block rewards. Furthermore, both Bitcoin and Ethereum represent cryptocurrencies that are heavily traded on the crypto markets.
However, there are differences between the two. Ethereum’s co-founder Gavin Wood explains the high-level difference: “Bitcoin is first and foremost a currency; this is one particular application of a blockchain. However, it is far from the only application. Take a past example of a similar situation, e-mail is one particular use of the internet, and for sure helped popularise it, but there are many others.”
So basically, Ethereum is using blockchain technology for a different purpose than Bitcoin. Bitcoin uses the blockchain ledger to keep a permanent history of digital currency ownership, enabling an innovative method for peer-to-peer currency transactions.
Ethereum leverages the blockchain for running the programming code of an application. Developers utilize the Ethereum blockchain to built and support separate blockchains, so the Ethereum blockchain and Ether coins are used for paying transaction fees on the network.
What is Ethereum?
So what really is Ethereum?
Ethereum uses the blockchain to store application code and smart contracts rather than have the sole purpose be for recording transactional information. So instead of a decentralized platform for financial transactions, Ethereum is a decentralized platform where applications can be built.
So what this means for developers creating new blockchain applications is that instead of building their platform and blockchain network from scratch, they can use the framework and Ethereum network to support their application.
Ethereum provides value in a couple of primary ways. First is this notion of building decentralized applications on the Ethereum blockchain using their native programming language called Solidity. Under that framework, there are now hundreds of new businesses being built around decentralized applications developed on the Ethereum network.
The trend is that developers will leverage Ethereum to build their blockchain application, and issue a new cryptocurrency associated with their application. Most blockchain companies release these coins through an Initial Coin Offering (ICO) where they typically raise funds in Ethereum and issue their tokens through the blockchain. The tokens that generated on the Ethereum blockchain are called ERC20 tokens.
Now that Ethereum has gained incredible traction for developers, there’s a growing list of well over 1,300 decentralized applications (dapps) built on Ethereum’s blockchain. We’ll go into some popular examples in more detail below, but running so many dapps on their network has its pros and cons, and sometimes there can be too much traffic that’s congesting the network. One notorious example was late last year when Cryptokitties quickly became massively popular and caused major slowdowns on the Ethereum network.
What is Ether?
The other primary way that Ethereum provides value to its blockchain network is through their token economics and how Ether coins are used in the system.
The Ethereum blockchain is a platform that intends to serve as a decentralized app store. This type of network platform needs a way to support the computational resources it takes to run a program of the app on the network. This is why Ether has value in the system.
Any decentralized applications operating on the Ethereum network needs to spend Ether coins to perform transactions on the blockchain. With so many applications and blockchain businesses running on Ethereum, this creates a lot of demand for Ether.
Additionally, when investors are looking to buy new tokens from an ICO, they often make that purchase using Ether coins. Another driver for the Ether coin’s value is that whenever investors or traders are buying and selling ERC20 coins using the Ethereum blockchain, they need to pay the transaction fee in Ether.
So every transaction on the Ethereum blockchain requires some Ether fees to reward the miners that are verifying the transaction. Ether is often referred to as the cryptocurrency that’s used as ‘gas’ to operate smart contracts and ‘fuel’ the Ethereum network. It’s similar to other cryptos like Bitcoin because a decentralized, open network of users controls Ether tokens.
So if a user is looking to make changes to an app on the Ethereum blockchain, they pay a transaction fee in Ether to compensate the network that is supporting the platform and processing the change on the blockchain. The amount of Ether it will take to complete a transaction on the blockchain is determined based on the required computing power and length of time to process.
How does Ethereum mining works?
Ethereum’s blockchain is based on Bitcoin’s protocol and design, meaning that it uses a Proof-of-Work (PoW) method of mining and supporting the network.
PoW is a technique that many of the first blockchain networks use to support the system by making it difficult, costly, and time-consuming to create a new block of data, but very easy for anyone else to take and verify that data. Effectively it makes it increasingly hard for the nodes on the network to run the computations and create new blocks of data and receive block rewards.
Ethereum uses the same PoW model as Bitcoin but developed the platform in a way so it can support much more than just asset transaction. For the nodes on the Ethereum network, this means they are responsible for maintaining the updated version of the Ethereum blockchain ledger, which tracks current information and status for each smart contract on the network, all the smart contract code and where it’s stored, and each user’s balance.
When new transactions are made using the Ethereum blockchain, that data is grouped by nodes or miners on the network to form a block of data, then chained together with the other blocks on the ledger to create the blockchain. To bundle together a group of transactions, miners use their computing power to solve the computational challenge as quickly as possible to be the block creator and receive the reward.
The trick with PoW mining systems, like Ethereum’s, is that the more powerful a computer, the better chance it has of solving the mathematical challenge quickest and being chosen for the new block. A lot of miners around the world compete for block creation and validation on the Ethereum blockchain network because Ethereum’s coin has been rising in value and every time they add a block to the chain new Ether tokens are generated and awarded to the miner.
This makes miners the backbone of the Ethereum network, along with most other blockchain networks, and especially those that use a PoW mining model to support the network.
Who is Vitalik Buterin?
Vitalik Buterin has gained a lot of fame and popularity for his status as the guy behind Ethereum. As the story goes, Vitalik was a programmer from Toronto who was introduced to Bitcoin in 2011 and saw the immense potential of blockchain technology.
That same year, Vitalik started Bitcoin Magazine which served as an online media platform for information on blockchain and cryptocurrencies. But along the way, he saw the possibilities for blockchain technology past merely creating the perfect ledger of transactions. He dreamt of the idea behind Ethereum that would send blockchain far past the financial use cases of Bitcoin and other digital currencies.
Vitalik released the Ethereum white paper in 2013 that described his proposed blockchain platform designed to support any type of decentralized application that developers could think of building.
To get funding for the project’s development, Vitalik and the other co-founders launched an ICO to raise funds in 2014. Participants in the ICO bought Ether coins to support the development. In total, they raised more than $18 million and released the first version of the platform about a year later in 2015.
What are smart contracts?
While Bitcoin is aiming to unlock new opportunities in the global financial networks, Ethereum is looking to do the same with the global computational networks using smart contracts. Smart contracts are scripts of code that deploy on the Ethereum blockchain.
Developers create this type of contract on the Ethereum blockchain using a language called ‘Turing complete’ and providing a set of instructions to be computationally carried out. Smart contracts can set parameters so that any funds deposited into an account can only be withdrawn when all parties involved agree by consensus.
Another practical example of the use of smart contracts is if two people are trying to carry out an agreement. If someone is renting a car, the contact can outline that the digital keys will be automatically released once payment is received. The smart contracts sort of work on an ‘if-then’ approach, so if the renter doesn’t pay the agreed price, the keys aren’t released, and the network automatically generates a refund.
Smart contracts are simply programs on the blockchain that are executed according to how the programmer developed them. Smart contracts can also act as records or registries and digitally store membership details or identification information on the blockchain.
Here are some of the key benefits of using smart contracts:
Autonomy: Smart contracts don’t rely on third-party confirmation to execute the agreement. This reduces the danger of the contract being manipulated by a third party because the network manages execution of the contract instead of other parties who might have a bias or implement the contracts with errors.
Backup: The blockchain is designed to be distributed across the network to ensure that the document is duplicated many times over, so there is no risk of losing it through one central point of failure.
Speed: Smart contracts use software code to automate tasks, which streamlines efficiency and helps companies implement faster agreements. Using smart contracts helps automate several key parts of an agreement process and make for quick, reliable transactions.
Smart contracts are still fairly new technology, but they have a vast range of application is the world’s voting systems, global supply chains, health and medical records, financial systems, and more.
What are decentralized apps?
So now we have a basic understanding of smart contracts and how they can be used in a blockchain network to create an innovative type of agreement. The Ethereum network uses these smart contracts in the development of decentralized applications on the blockchain.
Traditional applications are well-known to most users who download apps from the App Store on iPhone or Android. Apps allow users to perform unique functions like checking bank account balances, scrolling through a news feed of friend’s pictures, or even play their favorite card game.
Dapps follow the same concept. However, it runs on a platform supported by a network of nodes instead of a central group. This allows for several benefits and advantages over our traditional apps.
Tamper-Proof: Ethereum benefits from the properties of blockchain technology meaning that it’s resistant to third-party tampering. Dapps can deploy on the network without worry of an unauthorized third party hijacking control. Furthermore, the blockchain is built using a principle of consensus, so that all nodes and users of the network are required to agree on each change before it’s executed. This helps mitigate the potential fraud and corruption of the network.
Decentralized: The Ethereum platform also has the key blockchain principle of decentralization. There is no single point of failure for the network, meaning the applications hosted on the network never fail or go offline. This also has security implications that protect the network against possible hacking attempts.
Open Source: Users can look at the dapp’s source code on both the back end and front end. This means there is no code ‘hiding under the hood’ that’s running extra functions that may not be beneficial to the user.
No Downtime: Because dapps run on a network of nodes supporting the blockchain, there is no one point of failure that can take the entire application down and offline. That means the application’s service is always operating and functional, mitigating the risk of system crashes and failures.
Easy Implementation: Dapps built on the Ethereum blockchain provide a lot of value for developers because they don’t have to go out and build a blockchain application from scratch. Instead, the framework exists through the Ethereum protocol and helps save developers precious time and effort when trying to create a new application. Then to use the Ethereum’s decentralized network, the dapps directly pay the network transaction fees in Ether.
Which cryptocurrencies use Ethereum?
With all this talk about decentralized applications using the Ethereum blockchain, there are several notable examples of cryptocurrencies that have their underlying blockchains running on Ethereum.
Some of the cryptocurrencies you may have heard of, but it gives a proper scope of what types of applications can be built and operated on a decentralized blockchain platform like Ethereum.
Golem: Golem is a global decentralized supercomputer that combines the computing power of all machines on its network. Users of the Golem ecosystem can loan out spare and unused computer resources to others who need the additional power to perform complex computations and tasks. Using the same model that brought Uber and Airbnb success, this is a way to capitalize on unused resources to make some extra money.
Augur: Augur is a decentralized prediction market built on the Ethereum network. Using Augur’s prediction market, users can bet on outcomes of future events to receive monetary rewards and prizes. The less likely an event is to occur, the more significant potential reward users can earn predicting its success. Augur uses a method called “The Wisdom of the Crowd” from the various predictors on their platform to create predictive data in real time that can often have higher accuracy than leading experts on a particular subject.
Civic: Civic is an identity management service built on the blockchain that allows users to control protect the use of their identity. Each time you are required to prove your identity, you go through the same authentication process over and over. However, Civic’s ID management enables users to verify their identity data once and then reuse that authentication in other places that acknowledge Civic identification.
OmiseGo: OmiseGo, or OMG, acts as a decentralized blockchain gateway and platform for high-value transactions and settlements. Their goal is to solve inefficiencies within the financial systems to allow for lower cost and higher volume transactions, such as payments, payroll deposits, B2B commerce, asset management, supply chain activities, or loyalty programs.
Storj: Storj is an open source, decentralized solution for file storage that uses encryption and file sharing, along with their blockchain hash table to store files using their peer-to-peer network. Storj is using blockchain technology to make cloud storage faster and cheaper.
Are there disadvantages with Ethereum?
Ethereum has been a game-changing blockchain platform and led to a whole new direction and vision regarding blockchain use cases. However, like most things, there are pros and cons when it comes to Ethereum’s blockchain network.
So what are the potential disadvantages and downside of Ethereum and the future of its blockchain?
Well, just to give a little more credit, because Ethereum has been revolutionary in the blockchain community, they have secured the second spot among cryptocurrencies about the total market cap. Aside from the ultra-popular Bitcoin, Ethereum is the largest cryptocurrency in the space. They have a huge developer community, a massive and broad-reaching media and PR team, along with global distribution and a dispersed group of strong advocates.
But the Ethereum blockchain has been running up against some of the same troubles as Bitcoin lately, and that’s the scalability issues.
What we mean by scalability issues is that in the current state of the Ethereum blockchain, it wouldn’t be able to support a large enterprise level dapp. The way it’s structured now, the platform can only support around 15 transactions per second on the blockchain, which as we know is shared among the entire network of dapps running on the platform. To put this in perspective, Visa alone processes tens of thousands of transactions per second.
So while Ethereum is supposed to act as an operating system for dapps to run on, the practical functionality is limited to larger entities and projects. You can think of it like Apple making an iPhone that isn’t able to make a call or have the phone app, or a Windows system that isn’t capable of running an Excel spreadsheet.
This is where that notion of network congestion really comes into play. The Cryptokitties example mentioned above is just one horror story of how something so trivial in the grand scheme of things can have a major ripple effect throughout the entire Ethereum network. You can think of the Ethereum network like a single lane highway with traffic jams along the way when what’s indeed needed is a major multi-lane interstate highway to allow larger enterprises to use the existing blockchain framework for their applications.
Even with the current unscalable model, people surrounding the Ethereum blockchain know these concerns. The scalability issues aren’t a huge secret, but the supporting community assumes that it will get fixed.
While the core Ethereum development team has been working hard to resolve the scalability concerns for a while now, they’ve provided multiple proposals to the community, and nothing has gained much traction. They haven’t been able to put together and agree on a concrete plan going forward to solve the core scalability problems.
One recent development towards scalability is Ethereum’s new proposed consensus mechanism called ‘Casper.’ The objective behind this proposal is to move Ethereum from a Proof-of-Work to a Proof-of-Stake model. We discussed how the PoW method of mining and supporting the network requires lots of computing power and this is the core reason behind the scalability issues.
All blockchains operating on some form of Proof-of-Work model will eventually run into issues with scaling the network once it reaches a certain usage point. However, moving to Proof-of-Stake (PoS) might be able to alleviate some of the scalability issues. PoS provides an alternative way to process transactions on the blockchain, allowing miners to earn block rewards based on the number of coins they hold. So the larger coin stake a node has, the better chance they have of mining the block and getting a more substantial reward.
The ongoing issue for Ethereum is that they don’t even have a unified direction for Casper or the implementation of a new consensus mechanism. There are competing versions from a couple of prominent Ethereum developers that are supported by various groups within the Ethereum community. And neither proposed solution has a roadmap of timelines outlined.
When it comes to the Ethereum blockchain, there is a good reason to be skeptical of the potential application. At the very least, expectations should be tempered about major organizations and enterprises jumping on the blockchain bandwagon and using the Ethereum platform. It could very well end up that Ethereum is a great platform for issuing ERC20 tokens and providing a launch pad for small-scale applications.
How to invest in Ethereum?
The most convenient way to invest into Ethereum and buy Ether tokens is through a crypto exchange. If you are brand new to the world of cryptocurrency, and you’re considering buying Ethereum, Binance is one of the easier exchanges to work with and will take fiat payment in exchange for Ether tokens.
There are plenty of other great crypto exchanges to use if you’re looking to buy Ethereum. A few other popular ones are:
How to store Ethereum?
If you’ve purchased Ethereum on one of the crypto exchanges above, you will want to properly store your Ethereum coins to keep them secure and off of the crypto exchange account. This means sending the Ethereum from your crypto exchange wallet to a separate crypto wallet you control.
The good news is there are plenty of crypto wallets that support Ethereum coins. Furthermore, if you start to take a more in-depth look at the applications built on the Ethereum platform, you might consider investing in those cryptocurrencies as well. Various crypto wallets support all Ethereum related tokens, called ERC20 tokens.
One great example is MyEtherWallet. Also commonly referred to as MEW, MyEtherWallet is a web interface that supports Ethereum and ERC20 token storage. Because Ethereum has over 1,300 applications running on the network, MEW makes it easy for users to store all related tokens and cryptocurrencies in one location and wallet.
Other wallets that support Ethereum are:
- Ledger Nano: Ledger nano is a hardware wallet that focuses on security, so beginners should be aware of the required two-factor authentication for an extra layer of security. This wallet stores your Ethereum, as well as other cryptocurrencies, on a small flash drive device.
- Trezor: Trezor is a hardware wallet and great for storing large amounts of cryptocurrency or Ethereum. The wallet interface is easy to use, and desktop versions are available too.
- Exodus: Exodus is a great desktop wallet and supports Ethereum along with many other coins. The user interface is great for new users, and they have a simple guide explaining how to back-up their wallet. One neat feature is in-wallet trading to convert between the variously supported cryptocurrencies.
- Jaxx: Jaxx is a crypto wallet that was created by Ethereum’s co-founder Anthony Diiorio in 2014, and supports Ethereum and a wide range of other cryptos. Jaxx is available in the desktop version, mobile application, and as a web browser extension.
Is Ethereum the right investment for you?
We’ve made it through a lot of information detailing Ethereum, its blockchain, its cryptocurrency, and how it all works together. By now you get the basics of how Ethereum is blockchain platform that enables other blockchain projects to become a reality.
It could be argued that without Ethereum, there wouldn’t be the incredible amount of cryptocurrencies on the market today. The enablement of creating ERC20 tokens has allowed new blockchain businesses to pop up and get a running start using the existing infrastructure through Ethereum.
Of course, the ramifications of this approach are two-fold: plenty of innovative and exciting projects are being built and launched through the Ethereum platform, but there is also the potential for bad actors to easily and quickly develop and release ERC20 tokens that have no purpose other than to attract dumb money from novice cryptocurrency traders. That’s why it’s so important to understand the business and use cases behind the tokens you purchase, especially for ERC20 tokens.
When it comes to Ethereum and Ether coins as a potential cryptocurrency for your portfolio, there are several factors to consider. While this isn’t investment advice for investors or traders, several factors that should impact your investing decision.
The first is that Ether coins have purpose and functionality within the Ethereum ecosystem and blockchain network. As mentioned above, Ether is like the gas that fuels the system. All participants need to use Ether to use the underlying blockchain that supports all of the applications.
This gives Ether a lot of value because, without Ether, these other applications wouldn’t be able to function. So it’s easy to see one area of defined value for owning Ethereum based on the cryptocurrency’s necessity for other cryptos and blockchains to exist.
The flip side of that argument is that the Ethereum platform itself is limited, and might not be used at the same rate in the future for developing dapps. If larger organizations aren’t able to leverage the Ethereum framework, they will probably opt for another blockchain platform, or put in the effort and build their own.
There is a realistic chance that the development team isn’t able to figure out the scalability issues and the network congestion problems for Ethereum only get worse. Without solving scalability, the future of Ethereum’s potential is quite limited. We’ve already seen some blockchain projects opt to build elsewhere to avoid the congestion problems.
So potential investors that are considering buying Ethereum need to look at both sides of the coin here and decide if Ethereum is the right cryptocurrency investment.
Who are Ethereum’s competitors?
Also before buying into Ethereum, potential investors should look at the various competitors in the market that are vying for Ethereum’s place as a blockchain platform for decentralized applications. Several projects are trying to succeed where Ethereum falls short and innovate on the concept of Blockchain 2.0.
- NEO: NEO is often referred to as the Chinese Ethereum because they also offer a platform for smart contracts and applications to be built on the blockchain. NEO has gained a lot of momentum in China, and Chinese blockchain developers are using their platform for their new projects. NEO has more scalability than Ethereum and can process close to 1,000 transactions per second. They also support multiple programming languages like the popular C# and Java.
- EOS: EOS aims to combine the security aspects of Bitcoin and the dapp support of Ethereum to provide a more scalable platform. This includes features like shared databases, built-in authentication systems, account recovery mechanisms, and decentralized storage and hosting. Changes are facilitated through a community voting process to gain a network consensus.
- WAVES: Waves is another platform that allows developers to create tokens on the network for their application. The Waves platform has started to become recognized as one of the more accessible blockchain platforms for new businesses to launch an ICO or token. The Waves platform works on a Proof-of-Stake model where nodes with 10,000+ tokens are relied on to support the network.
Ethereum is a foundational blockchain platform that has set the stage for a lot of innovation in the cryptocurrency space. Vitalik and team took the concept of Bitcoin and applied it to a multitude of other use cases.
Now other blockchains have subsequently seen the problems with the Ethereum platform, and are trying to build upon its success and improve the value of their application-building protocol. It remains to be seen if these other blockchain platforms can upend Ethereum as the go-to platform for new dapps to be built.
But the limitations of Ethereum are well noted. There are plenty of other competitors in the marketplace. Ethereum’s development team is trying to maintain their top dog status, and for now, they are still dominating the marketplace for new applications. Ethereum probably had its best days behind it, but the good news for the blockchain industry is that innovation is happening all around and Ethereum serves as a great jumping pad for new platforms and applications alike.