What is Ethereum and how does it work?

Key Takeaways

• Ethereum is the second-largest cryptocurrency in the world and beneath it is the biggest blockchain ecosystem with the highest number of users and developers. It goes beyond Bitcoin’s idea of digital currency and store of value, allowing for a multitude of new applications.
• Conceived by Vitalik Buterin and launched in 2015, the network was developed to enable decentralized applications. It has seen significant growth, including the creation of ERC token standards and major upgrades like The Merge and Dencun.
• Ethereum supports its vast ecosystem through blockchain technology, the proof-of-stake consensus mechanism, the Ethereum Virtual Machine, smart contracts, and decentralized applications, providing a versatile environment for innovation in all areas.
• With an impressive roadmap, a vibrant community and a dedicated team of developers, Ethereum is as popular as ever and its native ETH is still the most widely used digital asset.

What is Ethereum?

Ethereum is a peer-to-peer decentralized global blockchain platform that supports secure transfers and a wide array of applications. 

Vitalik Buterin, a programmer and writer who was deeply involved in the Bitcoin community, was the driving force behind Ethereum. He co-founded Bitcoin Magazine in 2011 and believed blockchain technology could be used to enable decentralized applications. In late 2013, Buterin released a whitepaper proposing Ethereum, a decentralized, open-source programmable blockchain. The project gained significant attention and support from the crypto community. In January 2014, Buterin and co-founders Gavin Wood, Charles Hoskinson, Anthony Di Iorio, and Joseph Lubin began working on Ethereum. The development was funded through a public crowd sale of Ether (ETH), raising more than $18 million.

Fast Fact

Vitalik Buterin’s main inspiration to create Ethereum came as a direct result of Blizzard Entertainment nerfing his World of Warcraft character. For him this was a clear demonstration of the horrors of centralization.

The Ethereum network went live on 30 July 2015, introducing smart contracts to the crypto universe. Since its launch, the network has served as a foundation for Web3, DeFi and the Metaverse. In more recent times, the network has been undergoind some noteworthy upgrades aimed at tackling scalability, with The Merge and Dencun. With more significant upgrades on its extended roadmap, Ethereum’s plans are long-term and it looks like it’s here to stay.

How does Ethereum work?

The Ethereum blockchain is programmable, meaning developers can build applications on top of it. It supports an extensive ecosystem of applications and services. Beyond blockchain, Ethereum uses a variety of technologies to create a secure environment for innovation. These include the proof-of-stake consensus mechanism, EVM, smart contracts, and decentralized applications. Let’s look at each one in more detail.

Proof-of-stake consensus mechanism

Each public blockchain uses a consensus mechanism, a system that ensures the veracity of all the data added to the network. Since the famous Merge in 2022, Ethereum has used the proof-of-stake consensus mechanism, which uses staked crypto to secure the blockchain from tampering.

• Validators

Validators are network participants who validate new blocks of transactions and add them to the blockchain. In return, they receive rewards, which come from transaction fees charged by the network. Validators’ rewards are proportional to the amount of ETH they’ve staked in the system.

• Staked ETH

To become a validator, you don’t need special equipment or a mining rig. The process is not energy intensive. However you do need to be able to stake (lock up) 32 ETH on the network as collateral. The network uses this staked ETH to deter validators from malicious or inefficient behavior. This is what keeps the network secure and operating smoothly.

If you don’t have 32 ETH to hand, you can’t become an Ethereum validator, but you can still earn rewards indirectly by joining a staking pool.

• Slashing

If a validator node tries to verify a false transaction or is not consistently “online” to contribute to the process, the protocol deducts some of their ETH. This is known as slashing, and it enables the network to remain decentralized while guaranteeing accuracy and security.

Ethereum Virtual Machine (EVM)

EVM is a core part of the Ethereum ecosytem. It’s a virtual computing environment that enables smart contracts and decentralized applications to be deployed to the blockchain. In other words, EVM is what makes Ethereum programmable.

It allows for a pool of thousands of interconnected cloud machines worldwide to work together, making the Ethereum network robust, resilient, and highly secure.

Every computation on the EVM requires gas, paid for by the transacting individual. For example, if you were to sign a smart contract using your crypto wallet, you’d be charged gas for tha transaction. This reflects the computational effort needed to execute operations. 

Smart contracts

Smart contracts are digital contracts stored on the blockchain that execute automatically when certain predetermined criteria are met. They’re the lifeblood of Ethereum and despite their name, they don’t contain any legal terminology, just code. Many of the actions users take on Ethereum include a smart contract. They  enable trusted transactions and agreements to be executed between separate, anonymous parties without requiring a central authority, legal system, or external enforcement mechanism. 

As a tool to facilitate the execution of agreements, smart contracts have numerous applications across Web3 and beyond. These range from supply chain and e-commerce to finance, gaming, and beyond.

ERC token standard

ERC stands for Ethereum Request for Comment, which means a set of guidelines for creating smart contracts.

What makes ERC standards so important is that they set certain requirements for all participants. This makes the whole Ethereum system highly composable and interoperable. All the tokens speak the same language, and are compatible with the same protocols. For example, a DEX based on Ethereum will be able to exchange hundreds of different ERC20 tokens, thanks to the fact that all the tokens and the DEX itself are designed to communicate.

There are many ERC standards on the Ethereum network but the most popular ones are ERC-20 and ERC-721.

For example, Dogecoin is a fungible token following the ERC-20 standard. Almost every other meme coin on the Ethereum network is also adherent to ERC-20. So what is ERC-20 exactly? Simply put, it’s a list of requirements. From a technical perspective, an ERC-20 token must implement six primary functions:

• TotalSupply — Determines the total token supply of a specific ERC-20 token
• BalanceOf — Retrieves the token balance in an Ethereum wallet
• Transfer — Enables the user to transfer token ownership to another address
• TransferFrom — Similar to the Transfer function but allows contracts to transfer tokens on behalf of a user
• Approve — Sets a limit on the number of tokens a smart contract can withdraw
• Allowance — Allows external addresses to access and spend tokens from a specified balance

If a token has all of the requirements above, it follows the ERC-20 token standard. ERC-721 fulfills a similar function but for non-fungible tokens (NFTs). By using this standardizing approach, Ethereum sparked a thriving Web3 and DeFi universe.

Ethereum vs Bitcoin – what’s the difference?

Bitcoin and Ethereum are both giants n the world of crypto, but they serve distinct purposes and have fundamental differences.

Ethereum 2.0 and The Merge

The Ethereum blockchain is secured by the proof-of-stake consensus algorithm, but that wasn’t always the case. Before 15 September 2022, the Ethereum network, much like Bitcoin, was running on proof-of-work, which secures the blockchain using computational power. 

The Merge, which took years of preparation by Ethreum developers, switched the consensus mechanism from proof-of-work to proof-of-stake. This alternative system uses staked crypto instead of power to secure the network.

The Merge had two broad objectives: setting the stage for Ethereum to process transactions faster, and reducing the amount of energy consumed by the network.

Post Merge, Ethereum has reduce its power consumption by 99.99%, while so far remaining secure from attacks on the network.

Scalability is more of a long term goal. While the Merge itself didn’t directly change Ethereum’s transaction speed, transitioning to proof-of-stake laid the foundation for a range of scaling solutions (such as sharding) that will enable the network to accelerate over time.

Staking on Ethereum

After the successful completion of The Merge, proof-of-work became a thing of the past. Instead of miners, Ethereum now had validators and instead of mining, users were now staking. When it comes to staking, there are a few options available:

Solo staking

Solo staking is exactly what it sounds like. The requirement to create your own validator node stands at 32 ETH (that’s ~$114720 at current price) as the needed amount you must stake. If you choose to stake solo, you’ll need the hardware to run a node and the necessary knowledge to operate it properly.

Cloud staking

Somewhat similar to solo staking, with cloud staking you’ll still need that 32 ETH to create your validator. The difference here is that you delegate the keys to your node to a third party and it takes care of all the technical details for you in return for a monthly fee.

Staking pool

Pooled staking is another option if you don’t want to be a validator, but do want to earn rewards. Staking pools let you stake any amount of Ethereum to an already existing pool. You won’t have to worry about hardware or software requirements, as pool staking allows you to simply collect rewards. All for a small fee to the pool you’ve joined.

Benefits of Ethereum

Ethereum boasts numerous advantages, making it an appealing platform for developers and users:

• Large and robust network: the network has a well-established, globally-tested network with an extensive community. It features the largest developer community and one of the most comprehensive decentralized application ecosystems in the blockchain and cryptocurrency space.
• Programmability: Ethereum’s programmable nature attracts a large community of developers, fostering continuous improvement and innovation in the network and its applications.
• High liquidity: ass the most used cryptocurrency on the planet, Ethereum offers high liquidity. Its compatibility with a growing number of cryptocurrency exchanges, trading platforms, and brokerages facilitates easy trading.

The Ethereum network has the highest number of active users and this tends to attract even more people. If a project wants to get noticed and leave a mark in the blockchain space, chances are it will launch on Ethereum.

Limitations of Ethereum

Despite its many benefits, Ethereum faces a few major challenges:

• Scalability: With increasing transaction volumes over the years, the network has faced limitations in speed and capacity. To tackle scalability issues, new solutions like Layer-2 blockchains and rollups have been developed.
• Transaction costs: The popularity and expansion of the Ethereum ecosystem have led to fluctuating gas fees, which can sometimes be expensive for users. There was a time when gas fees reached more than $100.
• Centralization and censorship: Critics argue that the transition from proof-of-work to proof-of-stake has introduced risks of centralization and increased potential for censorship within the Ethereum network.

Is Ethereum worth buying?

If you’re interested in the Ethereum ecosystem, you might be considering buying some of its native coin Ether (ETH).

On one hand, Ethereum has been the go-to blockchain platform for users and developers for years. The fact that it still holds the top spot is proof of the dedication of the team behind Ethereum. Many users theorize that “The Flippening” will occur at some point in the future. The Flippening is an event where ETH will surpass BTC in terms of market capitalization, earning the number one place among all cryptocurrencies. Currently, Ethereum has a market cap of over $400 billion and it’s seeing some competition from other top chains. With Ethereum ETFs about to be the next hot thing, it might be worth holding some ETH.

How to buy Ethereum (ETH)

You have two main options for making your purchase:

• Buy ETH on a centralized exchange
• Buy ETH through on-ramping apps like Moonpay, Coinify

Buy ETH via a CEX

The majority of people choose to purchase ETH on a centralized crypto exchange. If it’s your first time buying crypto, this is the best option for you. There are three main steps in the process:

1. Choose a CEX
2. Complete KYC
3. Buy your crypto

Once you’ve considered the best CEX option for you, you’ll start by completing the KYC process, providing ID and some personal data. Once that’s complete, you’ll be able to buy ETH with a credit/debit card, bank transfer, or another payment method. 

After buying your ETH, it’ll be available in your custodial exchange wallet. You can choose to keep it there or transfer it to a non-custodial wallet where you can own it directly.

Buy ETH using a crypto on-ramp app

Unlike BTC, ETH is much more accessible. Many crypto wallets have integrated an on-ramp option in their application, allowing users to buy ETH directly with a payment method of their choice. 

If you already have a crypto wallet, you can look for an option to purchase ETH directly from the app/extension. Keep in mind that many of these on-ramp services within wallet applications can still ask you to complete a KYC procedure (just like on a CEX). The big advantage here is that you’ll be saving on fees (and potentially time) if you prefer to keep your holdings in your own wallet.

1. Open your crypto wallet
2. Look for the on-ramp solution
3. Complete KYC if needed
4. Buy your crypto

Closing thoughts

Ethereum stands as a cornerstone in the world of blockchain technology, pioneering the way for a decentralized future. Its robust platform enables the development and execution of smart contracts and decentralized applications, transforming industries by enhancing security, transparency, and efficiency. As the second-largest cryptocurrency by market capitalization, Ethereum supports a vast ecosystem of innovative solutions in finance, real estate, gaming and fosters an inclusive global digital economy. With its continuous advancements and the ongoing transition to Ethereum 2.0, Ethereum’s significance is set to grow, solidifying its role as a key driver of technological progress and decentralized innovation in the modern world.

Frequently asked questions

What is Ethereum used for?

Ethereum allows developers to create and deploy smart contracts and decentralized applications powered by blockchain. To facilitate this, Ethereum includes its own programming language that operates on a decentralized blockchain secured by validators.

What is staking Ethereum?

Ethereum staking entails pledging Ether (ETH) as collateral to validate transactions on the Ethereum network. Doing so earns rewards in the form of ETH. You can stake Ethereum independently or via a third party, such as through a cloud service, a cryptocurrency exchange, or a staking pool.

What is Ethereum max supply?

The supply of a cryptocurrency denotes the total number of coins that have been, and will ever be, created. Ethereum has an unlimited supply, meaning it can produce an unlimited number of Ether. The circulating supply of ETH stands at 122,276,015.

What’s an Ethereum wallet?

An Ethereum wallet serves as a digital interface that allows you to manage your Ethereum-based assets, perform transactions. it also enables you to interact with decentralized applications on Ethereum or its Layer 2s.