How it works

What Is Ethereum

By July 11, 2017 No Comments

The invention of Bitcoin and blockchain technology was quickly followed by other cryptocurrencies and platforms that claimed to be better.

Like with anything that is introduced for the very first time — it takes the time to perfect it and polish it as a ready product.

One of the most exciting offsprings of Nakamoto’s development is Ethereum, which is often misunderstood as a yet another cryptocurrency.

So what is Ethereum and what makes is so different?

The truth is, Ethereum borrowed a lot from Bitcoin but instead of focusing on just digital currency, it created a whole new spectrum of… Being the world’s largest computer.

Ethereum Explained

According to the Ethereum website and its creator, Vitalik Buterin:

‘Ethereum is a decentralised platform that runs smart contracts.’

But from my experience, the easiest way of understanding Ethereum is first to understand how the internet works.

Nowadays, the Internet comes with even more conveniences that in the past. Our passwords, credit card details, documents, and pretty much most of life, are stored in clouds and servers owned by Google, Facebook etc.

So we submit our data to all these servers, we put our trust in security, and we cannot imagine how our life could look like without them.

However, there’s one major drawback in the system — anyone can access the information you store on a third-party server. From hackers to government and police. Thus, your files automatically become vulnerable to leaks, theft and cyber attacks.

So when you think about it, the Internet became more and more centralised over the years, with significant companies overtaking the most prominent aspects of it.

And that contradicts the original idea behind the Internet, which was supposed to create a world-wide-web, easily accessible to everyone.

Therefore new tools have sprung, all with an idea to decentralise the internet and bring it back to its roots.
One of the newest technologies to join this movement is Ethereum.

In a similar way to Bitcoin aiming to disrupt online banking, Ethereum wants to replace internet third parties.

Ethereum is like a ‘World Computer’

The founder of Ethereum, Vitalik Buterin, wants Ethereum to be a ‘World Computer’ — a decentralised and democratic network that would replace the existing client-server model.

The vision is that Ethereum would return the control over data to its owner and the creative rights of its author. Each time you make changes to any of your notes, documents or files, every node on the network would adjust accordingly.

Ethereum, just like Bitcoin, is built on a blockchain technology.

But the difference is in Bitcoin being a digital currency and allowing to transfer money from one person to another. Ethereum, on the other hand, is like digital money but highly programmable.

Money could be sent automatically from one person to another if certain conditions are met. For instance, if you want to purchase a house from another person. Traditionally, there are multiple parties involved in the process, lawyers, bankers etc.

Making the process unbearably expensive and slow.

With Ethereum, a piece of code could automatically transfer the home ownership to the buyer and the funds to the seller. After two parties reaching an agreement, there wouldn’t be a need for a third party to execute it on their behalf.

This process brings us to a yet another benefit of Ethereum — smart contracts.

What Are Smart Contracts

What-are-Etehreum-smart-contracts

Smart contracts are the essential part of Ethereum network. When someone wants to get a particular task done, they initiate a smart contract with one or more people.

It’s a series of instructions, written using a programming language. If the first set of instructions is done, it will execute another function, and it will keep on going until the end of the contract is reached. None of the steps can work until the previous one has been executed.

A traditional contract outlines the terms of a relationship between two parties, while a smart contract enforces the ties with a cryptographic code.

To make it easier to understand, think of a vending machine and the steps you would have to take:

#1 You put some money into the vending machine.
#2 You choose the item you want, and you press the button.
#3 The item comes out, and you collect it.

All the steps are directly linked to the previous step and triggered automatically, as soon as the last step is executed. You also solely work with just vending machine, there isn’t a person, or a function, that has to come in between you and what you requested from the device.

How would it work in the Ethereum network? Let’s have a look at the vending machine again:

#1 You give the vending machine money, and it gets recorded by all the nodes in the Ethereum network. All the transactions are automatically updated.
#2 You choose the item you want, you press the corresponding button, and a record of that gets updated in the Ethereum network and public ledger.
#3 The item comes out, you collect it, and all the nodes and ledgers record the transaction.

Every transaction that goes through the Ethereum network gets recorded and updated in the system. Thus, it keeps everyone involved with the contract and makes everyone accountable for their actions.

Bitcoin was the first one to support smart contracts in a sense that the network can transfer the value from one person to another. And the nodes validate the transaction only if certain conditions are met.

Except, Bitcoin is limited only to a currency exchange – while Ethereum allows developers to program their smart contracts.

How do they do that?

How Does Ethereum Work

how does ethereum workNow, that you know what Ethereum is and what is capable of, let’s have a look at what happens backstage.

Ethereum borrowed a lot from Bitcoin’s protocol and the blockchain design but tweaked in a way so it can support applications beyond transferring money.

The goal of creating a different programming language for Ethereum is to allow more flexibility for developers. Thanks to that, they can develop applications or agreements that have additional steps and new rules can be introduced in the process.

The Ethereum’s Blockchain

Ethereum is based on blockchain technology, just like Bitcoin. Ethereum’s network is a publicly shared record of the entire transaction history, kept by all the nodes.

The big difference is that nodes also store the most recent state of each transaction, as opposed to just the record of the transaction happening in the past.

It includes keeping track of the current state, user’s information, balance and the smart contract code.

If you look at how Bitcoin transactions work, every time a transaction is made, the network passes on the right amount to a receiver and gives back the change to a sender. Similar to how paper money work.

To make further transactions, Bitcoin networks add up all your records and classifies them as ‘spent’ or ‘unspent’.

Ethereum, on the other hand, uses accounts, which store your Ether tokens and can be sent to another account.

What Is Ether

Bitcoin vs EthereumLike with most blockchain technology platforms, nobody owns Ethereum network. But, the system is not supported for free.

The network needs ‘ether’ — a unique code that can be used for the computational resources needed to run an application or a program.

Just like Bitcoin, it’s a form of a digital asset that doesn’t require a third party to process or approve a transaction.

The difference between Ether and Bitcoin is that the former doesn’t act as a virtual currency. It provides ‘fuel’ (otherwise known as ‘gas’) for the network’s applications.

The Ethereum transaction fees are calculated based on how much ‘gas’ (Ether) the action requires. Each step costs a certain amount that is based on how much much power a computer would have to use to execute it and how long would it take.

So you don’t use Ether as a method of payment, like Bitcoin, but you use it to pay for any actions or contracts that you want to proceed with on the Ethereum network.

Therefore, Ether doesn’t have a limit — so far 18mln of Ether is produced every year, and five new tokens are mined roughly every 12 seconds.

What Is Ethereum Mining

Nowadays, Ethereum’s mining process is almost the same as Bitcoin’s. For each transaction, miners use computers to quickly solve a mathematical algorithm and confirm a transaction as legitimate.

Miners run the blocks’ data through a unique hash value, which returns as a long and complicated combination of letters and numbers.

The lucky miner who finds the hash that matches a current transaction is awarded Ether and will broadcast the block to the network for each node to validate, update the record and keep in the ledger.

The entire process is called ‘proof-of-work’ and is designed to prevent hacking attacks and double spending.

Approximately every 12–15 seconds a miner finds a block. If miners start to solve the puzzle quicker or slower, the algorithm will automatically adjust the difficulty level, so the process doesn’t take longer than 12s.

Bitcoin miners use ASICs to mine new bitcoins, which is the only profitable way of mining bitcoins nowadays. However, they’re costly and there isn’t an equivalent for Ether.

Ethereum is also trying to move away from a ‘proof-of-work’ to a ‘proof-of-stake’. What does it mean?

Instead of using miners and the current algorithm, developers are trying to invent a process in which the owners of tokens secure the networks. The process would be less expensive and would use significantly fewer resources.

What Is an Ethereum Token?

What is ethereum token

The main difference between Ethereum and any other cryptocurrency is that it’s not just a currency — it’s a network and environment.

Anyone can benefit from the blockchain technology and build their decentralised applications (DAPPS) through smart contracts.

DAPPS are all decentralised, and they aren’t owned by an individual but by people. You can use Ether in exchange to buy DAPPS tokens.

There are two types of available tokens:

  • Usage Tokens — they act like a native currency in their respective DAPPS; they have a monetary value but don’t give you any privileges or rights within the network itself
  • Work Tokens — they identify you as a shareholder in the DAPP; they give you rights to vote on the direction and funding of particular DAPPs

By now you must be wondering why do we need tokens and why we cannot just pay with Ether? That was one of my first questions as well.

Let’s bring another situation from real life to draw a better picture. When you go to a festival, most of the time, you have to exchange your money for a certain amount of tokens to be able to pay for drinks and food inside the venue.

The idea behind it is to make the process smoother and to keep the cash in one place.

Similarly, Ethereum creates a seamless and smooth network, in which tokens are used to power the ‘world computer’. Ether is hardcoded and used as a cryptocurrency, while a token is a smart contract running at the top of the Ethereum blockchain.

How Can We Use The Ethereum Network

The potential of Ethereum is incredible and almost endless. Just think about numerous applications that act as a third party to connect you with others (Uber, Spotify, Airbnb). The Ethereum network could replace a vast majority of them and make them decentralised.

Decentralised applications can completely remove the middleman and reduce the costs for users. Decentralised nature also eliminates a single point of failure or control. This makes it almost impossible for internal attacks or outside hackers to infiltrate the network.

Areas where you can use Ethereum:

Identity

When you create an account on Facebook or LinkedIn, you automatically create your digital identity. However, it’s not you who’s in control of the data. You submit it to a third party — a centralised authority.

Applications created via Ethereum network allow you to be in full control of your data and the risk of anyone hacking into your account is minuscule.

The only issue with having Social Media platforms that don’t have any authority is the lack of censorship. If there isn’t anyone who has an ownership of the particular network, there also isn’t any censorship, and all content would be allowed.

Rights Management

The decentralised network also opens up large doors of transparency for multiple industries. Ethereum encourages a creation of right management platforms, through which investors or artists can share funds.

Artists could directly go to people who are interested in their products, and they wouldn’t have to through management companies or third party applications. Instead of waiting for royalties and giving a chunk of them away, the entire income would go to them directly.

Raising Capital

One of the primary use for Ethereum is decentralised fundraising network. Notably, for risky investments, crowdfunding is what can drive the next invention.

Ethereum itself was founded by a crowdfund, which raised $18 mln. By using Ethereum tokens, people can invest in the future applications as well as businesses.

The Future Of Ethereum

The future of Ethereum

To understand Ethereum’s potential, it’s crucial to understand the distinction between Ethereum and cryptocurrencies.

It doesn’t just offer a way of exchanging currency, but it creates a new era for the internet, perhaps even a Web 3.0.

Naturally, the public has been sceptical about Ethereum as much as about blockchain technology. It would not only change the way we use the internet, but it would also have an enormous impact on our everyday life.

If you were wondering what Ethereum is and how different is it to Bitcoin, then hopefully this has unwinded all the queries that you might have had.

The question is no longer what will happen if we implement Ethereum to our lives, but when are we going to do that.

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Megan Frydel

Author Megan Frydel

Megan is a self-thought blockchain enthusiast. She enjoys combining finance with technology, from a less-techy perspective. BiteMyCoin is her most recent project underneath the umbrella of an international digital marketing agency ANCHOVY.

More posts by Megan Frydel

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