What is Ethereum?
What is Ethereum?
Established in 2015, Ethereum is the second-largest cryptocurrency by market capitalization following Bitcoin. However, unlike Bitcoin, its objective was not solely to serve as a form of digital currency. The founders of Ethereum aimed to create a novel global computing platform that combines the security and openness of blockchains together with its ability to support a wide range of applications.
The Ethereum blockchain currently hosts a wide range of applications, including financial tools, games, and complex databases. Its potential for future adaptation is virtually unlimited, with developers being able to innovate and explore new possibilities on its platform every day. According to the Ethereum Foundation, a nonprofit organisation, Ethereum has the capability to encode, decentralise, secure, and trade almost anything.
Much like Bitcoin, Ethereum has gained popularity as both an investment asset and a method of wealth preservation. It allows individuals to transmit or receive value directly, bypassing the need for intermediaries.
The Ethereum blockchain provides a platform for developers to create and operate a wide variety of applications, ranging from games to advanced decentralised financial instruments. These applications function without the need for traditional banking or other intermediaries.
Ethereum-based applications are built using "smart contracts", which are digital agreements that establish the terms of a transaction between parties. Unlike conventional contracts, smart contracts automatically execute when the predefined conditions are met, without requiring the involved parties to have knowledge of each other or involving intermediaries.
Similar to Bitcoin, Ethereum is an open-source project that is not owned or operated by a single entity. Anyone with an internet connection can run an Ethereum node or interact with the network.
Just as Bitcoin's decentralised blockchain allows individuals from anywhere in the world to send or receive money without a bank intermediary, smart contracts running on Ethereum's decentralised blockchain enable developers to build complex applications that operate as programmed without being affected by downtime, censorship, fraud, or interference from third parties.
Some popular innovations on Ethereum include stablecoins (such as DAI, which is pegged to the value of the US dollar through smart contracts), decentralised finance applications (collectively known as DeFi), and other decentralised applications (Dapps).
What’s the difference between Ethereum, Ether, and ETH?
Ethereum refers to the network itself, while "Ether" is the native cryptocurrency token used within the Ethereum network. However, in everyday usage, most people commonly refer to the token as "ETH" or simply "Ethereum." Similar to Bitcoin, ETH can be used for sending, receiving, and storing value. However, it also serves a distinct purpose within the Ethereum network. Since users pay fees in ETH to execute smart contracts, it can be likened to the fuel that keeps the entire system operational, which is why these fees are referred to as "gas."
If Bitcoin is often referred to as “digital gold”, ETH can be thought of as the equivalent of “digital oil”.
Is Ethereum secure?
Similar to Bitcoin, ETH is protected and secured by the Ethereum blockchain. The Ethereum network relies on an extensive amount of computational power, provided by the computers participating in the network, to authenticate and secure each transaction. This collective computing power makes it extremely challenging for any external party to disrupt or tamper with transactions on the Ethereum blockchain.
The inherent principles of cryptocurrencies contribute to their security. The permissionless nature of these systems allows anyone to participate, while the open-source nature of their core software enables numerous computer scientists and cryptographers to scrutinise and evaluate the security aspects of the networks.
However, when it comes to applications running on the Ethereum blockchain, their level of security is contingent upon the efforts made by their developers. For instance, the code of these applications can contain bugs that may potentially lead to the loss of funds. Although the source code of these applications is also visible to the public, their user bases are typically smaller compared to the overall Ethereum network, which means there are fewer individuals closely examining their security. Therefore, it is crucial to conduct thorough research on any decentralised application that you plan to use .
Currently, the Ethereum protocol is undergoing updates designed to enhance its speed and security. For more information, you can refer to the Ethereum 2.0 section below.
To achieve its capabilities, Ethereum employs a "virtual machine," which acts as a global computer consisting of multiple individual computers running the Ethereum software. Participants in the network invest in hardware and electricity to maintain the operation of these computers. To cover these costs, the Ethereum network utilises its own cryptocurrency similar to Bitcoin, known as Ether (ETH).
ETH plays a vital role in sustaining the network's functioning. When interacting with the Ethereum network, users employ ETH to pay for the execution of smart contracts. The fees paid in ETH are referred to as "gas.“
Gas fees vary depending on the network's activity level. In December 2020, the rollout of Ethereum 2.0 commenced. This new version of the Ethereum blockchain aims to enhance efficiency and is scheduled to transition gradually over the next two years.
What is Ethereum 2.0?
Ethereum 2.0, also known as ETH2, represents a significant upgrade to the Ethereum network. Its purpose is to facilitate the growth of the Ethereum network whilst enhancing security, speed, and efficiency.
As of early 2021, Ethereum 2.0 and Ethereum 1.0 coexist in parallel. However, eventually, the original Ethereum blockchain will merge with the ETH2 blockchain. If you hold ETH, you won't need to take any action, as your holdings on the Ethereum 1.0 blockchain will automatically transition to the ETH2 blockchain. The transition to ETH2 began in December 2020 and is anticipated to unfold over a two-year period.
Why is Ethereum 2.0 necessary?
Moving a popular cryptocurrency to a new platform is a complex task, but for Ethereum to scale and progress, this upgrade is crucial. The current Proof of Work (PoW) consensus mechanism employed by the Ethereum 1.0 blockchain to verify transactions results in bottlenecks, increased fees, and significant resource usage, particularly in terms of electricity consumption.
What is Proof of Work?
In cryptocurrency networks, the challenge is to prevent double-spending without relying on a central authority like Visa or PayPal. This is achieved through a consensus mechanism. When Ethereum 1.0 was launched, it adopted the Proof of Work (PoW) consensus mechanism pioneered by Bitcoin. PoW involves virtual "miners" worldwide who compete to solve computationally intensive mathematical puzzles.
The first miner to solve the puzzle is rewarded with a predetermined amount of ETH and is responsible for updating the blockchain with the latest verified transactions. This process occurs approximately every 30 seconds, compared with Bitcoin's 10-minute time frame. However, as network traffic on Ethereum has increased, the limitations of PoW have resulted in bottlenecks, causing unpredictable spikes in transaction fees.
What is staking?
Recognising the limitations of PoW, Ethereum's founders devised a distinct solution for Ethereum 2.0 that would enable the network to handle thousands of transactions per second more efficiently.
Ethereum 2.0 introduces a new consensus mechanism known as Proof of Stake (PoS), which is faster, less resource-intensive, and theoretically more secure. The overall outcome is similar to that of PoW: a participant within the network is selected to verify the latest transactions, update the blockchain, and earn ETH as a reward.
Instead of relying on a network of miners competing to solve a puzzle, PoS relies on a strong network of participants who have a genuine stake in the success of the system.
The participants in PoS are known as validators. Instead of contributing processing power like miners, validators contribute their ETH to a "staking pool."
Participating in the staking process involves contributing ETH to the staking pool. By staking ETH, participants have the opportunity to earn rewards that are proportional to the size of your stake.
The network determines a winner based on the amount of ETH each validator has staked in the pool and the duration for which they have held it. This rewards the participants who have made the highest level of investment.
Once the winner has validated the latest block of transactions, other validators can confirm the accuracy of the block by providing their verification. When a specified number of these attestations are received, the network proceeds to update the blockchain.
All validators who have actively participated in the process receives rewards in ETH. The network distributes these rewards proportionally among the validators based on the size of their stake.
What is a Smart Contract?
The concept of smart contracts was initially introduced in the 1990s by Nick Szabo, a computer scientist and lawyer. Szabo famously drew a comparison between a smart contract and a vending machine. To illustrate, envision a vending machine that sells cans of soda for 25 cents each. If you insert a dollar bill into the machine and choose a soda, the machine is designed to either dispense your chosen drink along with 75 cents in change or, if your selection is sold out, prompt you to make an alternative choice or refund your dollar. This scenario serves as a simple example of a smart contract. Similar to how a vending machine automates a sale without requiring human intervention, smart contracts have the capability to automate a wide range of exchanges.
History of Ethereum
At the age of 19, Vitalik Buterin, a computer programmer and co-founder of Bitcoin Magazine, published a whitepaper introducing a revolutionary idea. His proposal outlined the development of a versatile blockchain that could accommodate almost any type of transaction.
The teenager from Toronto, along with a team of co-founders that included Gavin Wood, initiated a crowdfunding campaign for the development of the Ethereum protocol. Through the sale of pre-launch tokens, they successfully raised $18 million in funding.
In July, the initial public version of the Ethereum blockchain was launched, marking a significant milestone. This release enabled the implementation of smart contract functionality on the Ethereum blockchain, initiating its gradual rollout.
A group of hackers managed to exploit a software vulnerability, leading to the theft of approximately $50 million from a Decentralised Autonomous Organisation (DAO) venture fund, which operated using smart contracts.
Following the incident, the Ethereum community engaged in a contentious vote, eventually deciding to revise the Ethereum protocol. The proposed revision aimed to restore the stolen funds. As a result, the Ethereum blockchain underwent a hard fork, splitting into two separate blockchains. This led to the formation of two distinct communities: one supporting the revised Ethereum blockchain, now known as Ethereum, and another maintaining the original Ethereum blockchain, referred to as Ethereum Classic.
The ERC-20 standard is an established network protocol, which simplifies the process for developers to create compatible applications on the Ethereum blockchain. This standard defines a framework for creating assets or tokens on top of the Ethereum network.
A popular Ethereum-based application called CryptoKitties emerged, introducing a game where users can collect and trade digital cats. It quickly gained significant attention, leading to a craze in which rare digital cats sell for high prices, and even surpassed $200,000 at its peak.
The non-profit organisation Ethereum Enterprise Alliance was formed with the objective of developing practical applications for smart contract technology. Notable members of this alliance include JP Morgan, Samsung, Microsoft, and Mastercard.
MakerDAO, the pioneering decentralised finance (DeFi) protocol on the Ethereum blockchain, was launched. MakerDAO also introduced the first stablecoin based on Ethereum called DAI, which maintains its value against a pegged currency.
The price of ETH surpassed $100 USD for the first time, marking a significant milestone in its valuation.
DeFi, which seeks to revolutionise the financial services sector by offering faster, more cost-effective, and secure transactions, gained traction as notable platforms like the lending protocol Compound and decentralised exchange Uniswap are introduced.
The launch of the USDC stablecoin, supported by the collaborative efforts of Coinbase and Circle through the CENTRE Consortium, proved to be a significant development. Within its first year, the USDC stablecoin achieved an impressive milestone by reaching $1 billion in issued coins.
In January, the value of ETH surpassed $1,000 USD for the first time, signifying a notable achievement. However, the price subsequently experienced a decline and falls below $100 USD.
The Ethereum 2.0 upgrade was initiated in December, marking the beginning of a comprehensive transition from Ethereum 1.0 to Ethereum 2.0. This transition process is expected to span approximately two years until it reaches completion.
The initial phase of Ethereum 2.0 introduces the implementation of Proof of Stake as a new consensus mechanism. Meanwhile, Ethereum 1.0 continues to operate using Proof of Work as its consensus mechanism.
ETH hit a new all-time high above $1,700 in February.
How do you buy Ethereum?
Regardless of how you obtain your ETH, it is essential to grasp a few fundamental concepts. Each address within the Ethereum network is assigned a public key and a private key, and to effectively manage your cryptocurrency holdings, you will require a wallet.
Public Key : You can view your Ethereum public key as a digital equivalent of an email address. It serves as the destination where people can send you ETH and other Ethereum-based tokens, such as USDC and Dai. It is safe to share your public key with others for transactions and receiving funds.
Private Key : Consider your private key as the equivalent of a password. In general, it is advisable to refrain from sharing your private key with others. A private key is a lengthy combination of letters and numbers, and it can also be represented as a series of words known as a seed phrase. It is of utmost importance to securely manage and keep track of your private keys. Losing your private keys means permanently losing access to your Ether, as they are essential for accessing and controlling your cryptocurrency holdings.
Wallet : To safely store and protect your Ether, you will require a wallet. If you are new to Ethereum, the simplest choice is to create an account using the Hata app. This option involves utilising a "custodial wallet" where your private keys are stored and secured on your behalf. As you gain more experience and explore further, you might consider exploring alternative wallet options specifically designed for interacting with Decentralised Finance (DeFi) protocols such as Compound, a platform for lending and savings, or Uniswap, a decentralised exchange enabling cryptocurrency trading.
How does Ethereum have value?
Determining the value of Ethereum can be approached from different perspectives. At a basic level, Ethereum's value is determined by market forces, similar to other assets. It can be bought and sold using various currencies such as Bitcoin, Dollars, Euros, Yen, and others around the clock. The price of Ethereum can fluctuate on a daily basis based on the level of demand. Due to its status as an emerging technology, Ethereum's value is often more volatile compared to established currencies like the US dollar or established equities such as Fortune 500 stocks.
However, understanding why the market assigns a specific value to Ethereum is a more complex matter. For many investors, Ethereum's value is derived from its versatility as a platform for issuing stablecoins and hosting decentralised finance (DeFi) applications. This perception stems from the growing user base and the increasing transaction fees associated with these activities.
What’s next for Ethereum?
As of early 2021, Ethereum stands as the primary host for a significant majority of blockchain applications. It boasts a market capitalisation of nearly $200 billion, with over $55 billion locked in tokens on its blockchain. Ethereum has also become the preferred platform for popular stablecoins like USDC and USDT, mainly due to its network effects and widespread adoption.
However, a range of new smart contract blockchains has emerged as competitors in the field. While Ethereum currently holds a dominant position in the market, there is mounting pressure for it to successfully complete the transition to Ethereum 2.0. This transition is crucial for Ethereum to maintain its leadership and respond to the growing competition in the blockchain landscape.
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