What is Ethereum?

The Beginner’s Guide


One of the most ambitious blockchain projects, Ethereum (ETH) seeks to use cryptocurrency to decentralize products and services in a wide range of use cases beyond money. 

If Bitcoin seeks to serve as a digital gold, Ethereum has taken a different approach, generalizing so its users can create any number of custom assets and programs governing their operation.

This has led to (perhaps imperfect) comparisons that Bitcoin is more like email (a very powerful, special-use tool), whereas Ethereum has more in common with the web browser (its goal being to enable programs users can interact with and create).

This analogy is effective in communicating Ethereum’s scope, as its team would create its own virtual machine and scripting language (needed to execute its programs), raise funding through the sale of its own new money (ether) and introduce a concept called “state” to cryptocurrency. 

Put simply, Ethereum tracks changes (transactions confirmed on the blockchain) as well as potential changes yet to occur (state), a difference that gets to the heart of its vision. 

On Ethereum, these multi-step computing functions are called “smart contracts.” Larger constructions of many smart contracts, in turn, are called decentralized applications (dapps). 

While primitive today, there is a belief such programs could one day be used to create software that mimics the behavior of some of the world’s largest internet companies. 

Amazon, as an example, can be thought of as a kind of state service that connects buyers using a simple web interface to a massive, ever-updating inventory stored on databases. In this case, a for-profit company plays the role of middleman and technology steward. 

Ethereum, in this way, can be viewed as an early attempt to use cryptocurrencies to create competitive markets governing different parts of these now-monopolistic services.

As of 2020, Ethereum’s developers are in the early stages of delivering on this idea, and are preparing an overhaul of its core code called “Ethereum 2.0” that will usher in new changes.

What is Ethereum?


Who created Ethereum?

Ethereum was the brainchild of then 20-year-old Russian-Canadian Vitalik Buterin. 

According to Buterin, he was inspired to create Ethereum after realizing it might be possible to apply Bitcoin’s design more broadly to mitigate the “horrors” of centralized web services. 

In a famous example, Buterin cited slights suffered playing the popular online game World of Warcraft, as developers at the time could make arbitrary changes despite the wishes of users. 

Buterin would later receive a Thiel Fellowship to pursue Ethereum full time, and set to work creating a non-profit to help launch the project. In early 2014, the Ethereum Foundation sold 72 million ETH in an online crowdsale, which generated roughly $18 million in funding for the effort. 

Ethereum would go on to attract a passionate community of users, many of whom continue to spearhead its development today. 

Other notable community figures include: 

  • Gavin Wood – Author of the Ethereum yellow paper specifying its virtual machine

  • Jeff Wilke – Creator of the first Ethereum software implementation 

  • Joseph Lubin – Founder of Consensys, a major ethereum investment incubator 

  • Vlad Zamfir – Cryptographer focused on protocol development and game theory.

A more extensive list of founders and contributors can be found on Ethereum’s Wikipedia.

How does Ethereum work?


It can be said there are always two Ethereums, Ethereum as it works today and the Ethereum the developers hope to one day complete when they finish their roadmap. 

So, while Ethereum has accomplished much since its 2015 launch, it’s important to remember that not all of its proposed features have been implemented.

Ethereum Blockchain

Today, Ethereum uses proof-of-work mining (in which computers burn energy to solve puzzles needed to create blocks) to power its blockchain. (Miners batch transactions into new blocks roughly every 12 seconds).

Developers write programs (smart contracts) in Solidity or Vyper, the project’s programming languages, and then deploy this code on the Ethereum blockchain. 

All nodes (computers running the software) maintain a copy of the Ethereum Virtual Machine (EVM), a compiler that translates the smart contracts written in Solidity and Vyper and executes their changes in transactions on the blockchain. 

In 2016, a group of Ethereum users rejected a proposed code update, choosing to continue running older code. As a result, a new cryptocurrency called Ethereum Classic was created.

Proof-of-Stake

With the transition to Ethereum 2.0, Ethereum plans to alter its core operating system, migrating to a system called proof-of-stake (PoS). 

Under a proof-of-stake model, any user who owns a minimum of 32 ETH could lock those funds in a contract, which then would earn rewards for solving computations needed to add new blocks to the blockchain. 

More details on this transition can be found in a 2020 Kraken Intelligence report.


Why does ETH have value?

The main cryptocurrency powering Ethereum is called ether, a portion of which is minted in every block and distributed to miners. 

Notably, Ethereum does not place a limit on the amount of ether that can be minted. Rather, the supply of ether is programmed to increase 4.5% each year, with 2 ETH now minted each block. 

This reward has been decreased twice in the network’s history, and was originally set at 5 ETH. 

Changes to the monetary policy are generally proposed by developers. Nodes and miners running the software can then accept or decline to upgrade their software to accept the change. 

Miners also earn ETH in the form of fees for computations processed by the network. Fees are not paid in ETH, but rather paid in “gas,” a special computational unit. 

The more complex the computation, the more gas a given program will require. 

This means that any applications or protocols operating on top of Ethereum must continually purchase and spend ether, creating a continued demand for the asset.

Why use Ethereum?


At a time when many cryptocurrencies have struggled to generate a single use case, Ethereum is perhaps unique in that it has passed through several distinct phases of strong demand. 

Private blockchains 

Among the first to embrace Ethereum were major banks and institutions, who took advantage of its open-source code to create proof-of-concepts and R&D initiatives in 2015 and 2016.

Those that didn’t copy the Ethereum code were often inspired by its approach, including the Linux Foundation’s Hyperledger and R3’s Corda, projects that copied parts of its architecture but discarded the idea they needed a new cryptocurrency.

Major banks and corporations would eventually back Ethereum more directly by creating the Enterprise Ethereum Alliance, a non-profit whose aim at its creation in 2017 was to bridge the many private bank blockchains with the main Ethereum blockchain. 

ICOs

Entrepreneurs would later flock to Ethereum in 2017 with the thesis that its platform could be used for fundraising by creating new cryptocurrencies and selling them to global consumers in what came to be called “initial coin offerings” (ICOs). 

ICOs took advantage of the ability Ethereum gave developers to create new crypto assets on top of its blockchain, using token standards without creating a new codebase from scratch.

Enterprising projects that now have their own live blockchains and cryptocurrencies (like Tron and OmiseGo) would launch as tokens on ethereum, later delivering new technology.

DeFi

The most recent wave of innovation on the network, decentralized finance (DeFi) has found entrepreneurs using Ethereum to create protocols that replicate traditional financial services.

These have included projects like MakerDAO, which designed a protocol that decentralizes the management of a cryptocurrency pegged to the U.S. dollar. Other DeFi projects have sought to automate and decentralize financial services like lending and borrowing.

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