What Is Ethereum And How It Works? – Beginners Guide

Date:

May 30, 2018

ethereum token

Interested in investing in Ethereum? This guide describes the basics of Ether and Ethereum as we are going to examine how Ethereum gained its value thanks to the use of blockchain technology which spurred thousands of companies and applications earning billions of dollars.

When Bitcoin was invented in 2009, it was dismissed by many as a way for criminals to send fake digital money that didn’t have any value. In less than 9 years it went from “scam” to a disruptive technology that can change the way banks and foreign exchanges exist, and can even create a potential for one worldwide currency “to rule them all”. Ethereum is still a new technology but it’s the one that aims to change the world.

There are over 1,000 cryptocurrencies that currently exist around the world, so to make right decisions those looking to invest in cryptocurrencies should choose wisely and understand everything they can if you will be going to be putting real money into the blockchain. You need to understand that neither Bitcoin nor Ether can exist as a coin in your hand. All of the currencies exist in the virtual field of mathematics as balances are changing from public to private “keys” which are essentially cryptocurrency account numbers.

Before we move any further, let’s agree on some of the main questions: you should understand that the difference between Ether and Ethereum can cause a lot of confusion. The first one is the token that is circulating inside the platform with the possibility of trading on a variety of cryptocurrency exchanges. The latter is the global network, or a platform, which helps to build thousands of applications and services. Miners who keep the network running and solve the transactions are rewarded with Ether for their efforts. Ether is similar to a fuel that powers the whole system. So when someone says they own several Ethereums, in fact, they own several Ethers.

What is Ethereum?

ethereum

Ethereum blockchain is a decentralized system open to anyone interested in developing an application on it so anyone can design programmable functions for executing transactions. This inherent functionality gives Ether a tangible value while also lowering risks since users can exercise a certain degree of control over the currency’s wellbeing.

Bitcoin created what can be called “blockchain 1.0”. The new capabilities that Ethereum introduced are known as “blockchain 2.0”.

Ethereum is considered by governments and corporations as a far more superior technology compared to Bitcoin. Large companies including Microsoft, IBM, MasterCard, BP, Deloitte, to name just a few are working to implement Ethereum to their processes and scale their blockchain to the new level.

The History

The creation of Ethereum started after Bitcoin gained some traction. It was unveiled by 19-year-old Russian Canadian programmer Vitalik Buterin who described principles and attributes of the new currency in the white paper in 2014. The project clearly differentiated from Bitcoin as it was presented not as a new cryptocurrency but rather a platform for creating decentralized applications. To make this possible, the white paper explained, the platform must be designed using a completely new programming language. That’s when Buterin decided to use Turing language to change the way that apps are created. His invention brought him the World Technology Award for the creation of Ethereum, as well as worldwide recognition of Buterin’s technological prowess.

After presenting his white paper Buterin received $100,000 grant from Thiel Institute, dropped from school and led the development team at Ethereum.

The development of Ethereum was funded by a successful crowdfunding campaign and the goals were met at the first run in August 2014 raising nearly 12 million tokens. This allowed starting building the infrastructure for the new platform. Just a year later in 2015, the new blockchain has been released in Canada and then worldwide. By this time, the blockchain is becoming a more widely used term in the business world, and the Ethereum community has started to grow.

Before Ethereum, when people couldn’t overcome limitations of Bitcoin, they had to invent new cryptocurrencies, or altcoins, to achieve results that Bitcoin couldn’t deliver simply because of its nature. Bitcoin wasn’t written in Turing and therefore cannot perform many functions or serve as the basis for smart contracts for this reason.

Although Ethereum is decentralized, there’s a major company that serves as a platform for its development with headquarters in Switzerland. Canton Zug is dubbed as “Swiss crypto valley” as it becomes a global cryptocurrency hub. Ethereum Switzerland GmbH is playing a vital role in making Ether progress possible.

In addition to that, the Ethereum Foundation (Ethereum Stiftung), also based in Switzerland, helps produce and maintain the collective use of Ether coins. Vitalik Buterin is the lead of the research team in the Ethereum Foundation, working to produce the next vision of Ethereum and ensure the success of thousands of decentralized applications (dApps).

Ethereum Tokens

what is ethereum

The value token of Ethereum is Ether or Ether coin. Similar to Bitcoin, it’s purpose is to facilitate transactions, but it also has other uses. The main benefit of being able to accommodate microtransactions (payments with a tiny fraction of Ether). The Ether currency can be held in your wallet and traded on the Ethereum network. There is no government or any other institution backing of the value of Ether, as with any other cryptocurrency, and its monetary value depends on how much value people agree to put in it.

Compared to any other fiat, or government-backed, currency, Ether has one significant difference: to use it, people must have access to the internet. Ether is accepted in much fewer places compared to dollars or euros. There are ongoing efforts, and not unsuccessful, to make cryptocurrencies the widely accepted payment currency, so we may soon be able to pay for coffee or hotels in Ethers just as in any other crypto coin, just by using your computer to make a transaction.

Ether is volatile by nature but it plays a crucial part in facilitating the functioning of Ethereum network. Ether goes one step beyond cryptocurrency as it not only used for investing but also by developers to pay fees incurred and other goods and services inside the network. It also enjoys a lot of media attention recently which makes it an attractive investment.

Ether vs Bitcoin

ethereum vs bitcoin

Although often compared, Ether and Bitcoin have very different purposes and capabilities. If Ether was indeed so advanced technologically, Bitcoin would soon become extinct. Yet, it’s not happening. Both currencies are based on the same principle, the blockchain, although both are built using different languages. Let’s discuss what’s different between them.

Bitcoin has a purely financial nature and its blockchain is designed to track the coins and facilitate Bitcoin transaction. Bitcoin blockchain offers just one application — the online peer-to-peer payment network that enables Bitcoin transactions to be completed. It’s a truly digital currency that operates all over the world. The Bitcoin blockchain has only one purpose — to confirm transactions and establish ownership of Bitcoins to be distributed.

Ethereum blockchain, on the other hand, has more applications. While it also has a currency, Ether, it’s the main function is to maintain the integrity of the blockchain which not only allows the circulation of Ethers but also supports different applications that can be developed on top of its blockchain. People can create new coins, found new virtual countries, raise funds via ICOs, and develop practical tools for various industries. This way, Ethereum has other uses that have nothing to do with cryptocurrencies. Also, this blockchain is far more superior compared to Bitcoin blockchain and its capabilities are only growing, while the number of Bitcoins is limited. Ethereum is expanding the use of blockchain technology taking it from financial area to many more industries and business uses. The only limit is in the developers’ imagination and their ability to detect the unfulfilled market niche.

This is Ethereum’s major advantage. Bitcoin became the first and hence the most popular digital currency that cannot be controlled by any government is innately hacker-proof and allows making payments without any third-party involvement. Ethereum does all this plus makes possible to mint new cryptocurrencies and develop new applications. It also allows miners to maintain the network and confirm transactions and get rewarded in Ethers.

The proof of this rising popularity is in the numbers. Ether grew in price by 2400% in 2015 and more than 5000% in 2017, figures previously unknown to currencies in the financial markets.

The Difference Between Ethereum and Ethereum Classic

ethereum classic 

Many people who are new to Ethereum don’t realize that there are two functioning versions of the platform. What’s the difference and why did it happen?

One of the first decentralized applications built on Ethereum was the DAO for the execution of smart contracts. The DAO was a success with its ICO raising more than 150 million tokens. However, the application was hacked and more than 50 millions of tokens were stolen. In an attempt to remediate the damages, the company decided to do a hard fork, or introduce a new blockchain that would invalidate the theft and essentially would bring the tokens back to DAO. But many participants didn’t agree to reverse the blockchain. During the hard work, all nodes have to install the new version of the blockchain, but some miners refused to do it and continued to support the old version of Ethereum which is now called Ethereum Classic.

These two versions are different in their operations. For example, Ethereum Classic introduced a limit on maximum amount of tokens to be generated over the lifetime of the platform — that’s not true in case of Ethereum. There are also plans for Ethereum to move to Proof of Stake while Ethereum Classic insists on Proof of Work. At the time of writing, the market cap of Ethereum Classic was $1 billion and Ethereum was worth $42 billion. Do the math.

Smart Contracts

smart contracts

Ethereum has one significant feature that puts it ahead of the competition: the smart contract.

The idea was to create small programs that would serve the same functions as paper contracts and would execute when certain conditions are met. Traditionally, a contract is drafted by a legal professional for a certain fee. Then it was usually left to the parties to ensure that causes and terms of the contract are met. Sometimes the parties, in the event of non-execution, would turn to the court or police, and the process would take a long time until resolution. For the smart contract, all you need is your computer.

Smart contracts are versatile and can be used for different purposes, from collecting insurance premiums to paying for AI-powered services. They can enable the exchange of anything that has value, including money, real estate, shares, and information. Smart contracts are programmed, stored and managed in the blockchain. When the terms and conditions were outlined and the fee has been paid, the contract starts instantly. The contract’s code is programmed in such way that it automatically fulfills the causes and terms of the contract, without the need of a central authority to ensure the execution.

Thanks to Ethereum’s capability of supporting thousands of applications of all sizes, smart contracts are best to run on this blockchain. By eliminating the intermediary, smart contracts save money, time, and prevent a potential conflict of interests.

Here are just some of the examples of how we can use smart contracts:

  1. Voting during political elections: Smart contracts can ensure a secure voting system that cannot be manipulated or penetrated. There are two main advantages of using smart contracts for voting. One of them is the non-breaching security the blockchain provides. To hack the system, votes would have to be decoded (solved by cryptographic puzzles) and this requires massive amounts of computational power. Another benefit is the ease of voting online so more people could vote instead of taking time to go to the voting place.
  2. Smart contracts can be used in enterprises for communication and workflow control. Its streamlined nature would eliminate the need to wait for reviews and approvals.
  3. Smart contracts in real estate could reduce the time during renting process all around the world. For example, smart contracts could encode the deal in the blockchain and the record would stay there permanently without letting anyone tamper its clauses.
  4. Smart contracts could completely change the processes in healthcare. Blockchain could be used to securely store personal health records so only people with a special key would have access to them. Smart contracts could also facilitate medical insurance claims because all prescriptions and medical records would be stored in the blockchain. In the clinical trial area, smart contracts would ease up the patient recruiting and scientific data handling. Patient data could be shared easily only with specific people to protect the privacy of patients and reduce the amount of paperwork.

By replacing the judge and the court who are also prone to errors, DAO protects both the owner of the contract and the person who exercises it. Thanks to DAO you no longer have to waste money on lawyers and execution services. But at the same time, it’s vitally important to read the contract carefully before sending it to blockchain because once it’s verified it cannot be undone or modified. This system could easily evolve into a trustless legal system as Ethereum continues to grow and mature. Well, a lot of people would be happier if they didn’t have to deal with judges and lawyers to get their contracts done!

Solidity

ethereum dapps

Ethereum dApps and smart contracts are programmed using a specific language called Solidity. This language allows programmers to create ICOs, applications, games, and other exciting things living in Ethereum, running on blockchain and powered by smart contracts. You will also be able to create dApps using web3.js, audit and test smart contracts, and many more.

Solidity is very similar to JavaScript and PHP, so if you are familiar with these languages, you will find it easy. But Solidity is very limited in blockchain since you cannot store a lot of data in variables. The computing is also limited.

As we know, the smart contract is a piece of code that permanently lives in the blockchain. The good thing about it is that it cannot be changed, although it can be blocked to prevent its execution (for example, when all clauses have been executed or the situation has changed). Smart contract is created by a computer to control the execution. The process is simple: the developer is sending a transaction with the contract code compiled to bytecode to reduce its size. Since smart contracts cannot be changed or deleted, they are called immutable. With smart contracts, all parties agree not to trust third parties to force them to execute its clauses. With Solidity, smart contracts can be created easily and a lot cheaper than with a lawyer.

The Future of Ethereum

Someone has called Ethereum the new internet. The internet is a set of global protocols that power communication, content exchange, collaboration and business processes. With the development of services that merge finances and technology, the new cryptocurrency could soon become the Internet of Value while the internet would remain the Internet of Information. The goal of blockchain is to reduce barriers and centralization and to provide everyone equal rights to access and own the information, as well as establish trust and facilitate transactions without middlemen. People all around the world are considering cryptocurrencies to gain legitimate recognition. More tools are being developer allowing your computer to join the blockchain and earn income on distributed computing. Of course, more effort in regulating blockchain also needs to be made.

Today we can say with confidence that blockchain will soon occupy the same important place in our lives as the internet does today. The success of any particular cryptocurrency, be it Bitcoin or Ether, doesn’t make any difference because the main principle of blockchain is a lot bigger than any particular coin or another token of currency. Just look at the numbers:

  • In 2016, the blockchain technology attracted an investment of 1.6 billion
  • Dubai government announced that all their supply chains will run on blockchain by 2020
  • IBM is working on a new blockchain technology called Hyperledger
  • More than 50 major financial corporations worldwide are running blockchain labs — just months ago UBS and HSBC joined them. Still got questions?

Tell us about your experiences with Ethereum and let’s provide more answers for people to better understand cryptocurrencies.