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Ethereum: What It Is, How It Works, and How to Use It

Ethereum: What It Is, How It Works, and How to Use It

What is Ethereum?

Ethereum is a global, decentralized software platform powered by blockchain technology. Its native cryptocurrency is called ether (ETH).

This platform is available for anyone who wants to create secure digital technologies. Not only does it have a token designed to pay for work done in support of the blockchain, but it can also be used to pay for tangible goods and services if accepted.

Ethereum is designed to be scalable, programmable, secure, and decentralized. This blockchain is highly appreciated by developers and companies creating technologies based on it. Thanks to Ethereum, many industries can change their way of operating, and even everyday life can be influenced.

The platform natively supports smart contracts, an essential tool behind decentralized applications. Smart contracts are used in combination with blockchain technology in many decentralized finance applications and other applications.

To learn more about Ethereum, the ETH token, and how they are integral to non-fungible tokens, decentralized finance, decentralized autonomous organizations, and the metaverse, keep yourself informed!

KEY CONCEPTS

  • Ethereum is a blockchain-based platform known primarily for its cryptocurrency, ether (ETH).
  • The blockchain technology powering Ethereum allows for the creation and secure maintenance of public digital records.
  • Bitcoin and Ethereum have many similarities but different long-term visions and limitations.
  • Since September 2022, Ethereum has transitioned from proof of work to proof of stake.
  • Ethereum is the foundation for many emerging technological innovations based on blockchain.

How Does Ethereum Work?

In 2014, Vitalik Buterin published a white paper to introduce Ethereum, the platform he helped create. The following year, together with Joe Lubin, founder of the blockchain software company ConsenSys, they launched the Ethereum platform.

The founders of Ethereum were among the first to understand the full potential of blockchain technology, not limiting themselves to offering only a secure virtual payment method.

Since Ethereum's launch, ether, the cryptocurrency associated with the platform, has been remarkably successful and has positioned itself as the second-largest cryptocurrency by market value, surpassed only by Bitcoin.

Blockchain Technology

Ethereum, along with other cryptocurrencies, makes use of blockchain technology. This technology can be imagined as a long chain of blocks, where each block contains information that is added to with each new block and new data. An identical copy of the blockchain is distributed throughout the network.

The validity of the blockchain is confirmed by a network of automated programs that reach consensus on the truthfulness of transaction-related information. Without consensus being reached, no changes can be made to the blockchain, making it highly secure.

Consensus is achieved through an algorithm called a consensus mechanism. Ethereum uses the proof-of-stake algorithm, where a network of participants called validators creates new blocks and collaborates to verify the information contained in the blocks. The blocks contain information about the state of the blockchain, a list of attestations (a validator's signature and vote on the validity of the block), transactions, and more.

Since mid-September 2022, Ethereum has officially adopted a proof-of-stake algorithm, which is more cost-effective and environmentally friendly compared to the proof-of-work model.

Proof-of-Stake Mechanism

Proof-of-Stake is a consensus algorithm that differs from Proof-of-Work in that it does not require the use of large amounts of electrical energy to validate blockchain blocks. It uses a finalization protocol called Casper-FFG and the LMD Ghost algorithm, combined into a consensus mechanism called Gasper, which monitors consensus and defines how validators receive rewards for their work or are punished for their dishonesty.

Each individual validator must stake a total of 32 ETH to activate their validation capability. People can stake smaller amounts of ETH, but to do so, they are required to join a validation pool and share any rewards. When a validator creates a new block, they must attest that the information contained in the block is valid. This happens in a process called attestation, during which the block is broadcasted to other validators, called the committee, who verify it and vote on its validity.

Validators acting dishonestly are punished in the Proof-of-Stake system. In fact, Gasper identifies which blocks to accept and reject based on the validators' votes. This way, validators attempting to attack the network are identified and removed. They face a punishment that involves burning the staked ETH and removing it from the network. "Burning" refers to sending the cryptocurrency to a wallet that does not have the keys, resulting in its removal from circulation.

Wallets

Ethereum holders use digital wallets to store their cryptocurrency. A digital wallet is an interface that allows access to the ether stored on the blockchain. The wallet has an address similar to an email address, where users can receive and send ether as if they were email messages.

Ether is not actually stored within the wallet, but the wallet itself contains private keys that act as passwords when making a transaction. Each ether holder receives a private key for each unit owned, and this key is required to access their cryptocurrency. This is why it is crucial to discuss key security and how to properly store them.

The Historic Split

A notable event in Ethereum's history was the hard fork, or split, of Ethereum and Ethereum Classic. In 2016, a group of network participants gained control of the majority of the Ethereum blockchain to steal over $50 million worth of ether, which had been raised for a project called The DAO.

The success of the heist was attributed to the involvement of a third-party developer in the new project. The majority of the Ethereum community chose to undo the theft by invalidating the existing Ethereum blockchain and approving a blockchain with a revised history.

However, a fraction of the community chose to maintain the original version of the Ethereum blockchain. That unmodified version of Ethereum permanently split off and became the cryptocurrency Ethereum Classic (ETC).

Ethereum vs. Bitcoin

Ethereum is often compared to Bitcoin but has significant differences. Its developers describe it as "the world's programmable blockchain," an electronic and programmable network with many applications. In contrast, Bitcoin was created solely to support the cryptocurrency Bitcoin.

The maximum number of Bitcoins that can be created is 21 million, while the quantity of Ethereum is unlimited, although block processing time limits the amount of ether that can be minted each year. Currently, the number of circulating Ethereum coins exceeds 122 million.

Another significant difference between Ethereum and Bitcoin concerns the treatment of transaction processing fees. In the Ethereum network, these fees, known as gas, are paid by the participants in the transactions themselves, while in the Bitcoin network, fees are absorbed by the broader Bitcoin network.

Since September 2022, Ethereum has been using a proof-of-stake consensus mechanism, while Bitcoin uses proof-of-work, which requires miners to compete for rewards.

The Future of Ethereum

Ethereum's transition to the proof-of-stake protocol, which allows users to validate transactions and create new ETH based on the amount of ether they hold, is part of a major upgrade to the Ethereum platform. Previously known as Eth2, this upgrade is now simply called Ethereum. However, Ethereum now has two layers. The first layer is the execution layer, where transactions and validations take place. The second layer is the consensus layer, where attestations and the consensus chain are maintained.

The upgrade has increased Ethereum's network capacity to support its growth, ultimately helping to address the chronic network congestion issues that have led to increased gas fees.

To address scalability, Ethereum is continuing the development of "sharding." Sharding will divide the Ethereum database across its network. This idea is similar to cloud computing, where many computers handle the workload to reduce computation time. These smaller database sections will be called shards, and the shards will be managed by those who have staked ETH. Shards will allow multiple validators to work simultaneously, reducing the time required to reach consensus through a process called sharding consensus.

Sharding is expected to be implemented by 2023.

Use in Gaming

Ethereum is also finding application in gaming and virtual reality. Decentraland is a virtual world that uses the Ethereum blockchain to protect the objects contained within that world. Land, avatars, wearable items, buildings, and environments are all tokenized through the blockchain to establish ownership.

Axie Infinity is another game that utilizes blockchain technology and has its own cryptocurrency called Smooth Love Potion (SLP), used for rewards and transactions within the game.

Non-Fungible Tokens

In the early months of 2021, non-fungible tokens (NFTs) gained significant popularity. NFTs are tokenized digital objects created using the Ethereum platform. In practice, tokenization allows for the assignment of a specific digital token to a digital asset, identifying and storing it on the blockchain.

This establishes ownership of the object, as encrypted data stores the owner's wallet address. The NFT can be traded or sold like any other transaction on the blockchain, and ownership is securely transferred through network verification.

NFTs can be developed for any type of digital asset. For example, sports fans can purchase so-called fan tokens of their favorite athletes, which can be treated like trading cards. Some of these NFTs represent images similar to trading cards, while others are videos of memorable or historic moments in the athlete's career.

Development of DAOs

Decentralized Autonomous Organizations (DAOs), which represent a collaborative method for making decisions within a distributed network, are being developed.

For example, imagine creating a venture capital fund and raising money through a fundraising campaign, but wanting decision-making to be decentralized and distributions to be automatic and transparent.

A DAO could use smart contracts and applications to collect votes from fund members and invest in companies based on the majority of the group's votes, then automatically distribute any returns. Transactions could be viewed by all parties involved, and there would be no involvement of third parties in fund management.