While cryptocurrencies haven’t yet made fiat money obsolete, they’re slowly taking over as a legal tender for online transactions. These digital currencies are fast becoming an alternative for transactions by the government, big organizations, and financial institutions.
However, even with the proliferation of cryptocurrencies, some people are still wary of indulging in them because they lack knowledge about their basic concepts. This article will teach you all you need to know about cryptocurrencies—with a focus on Ethereum—in understandable terms.
What Is a Cryptocurrency?
Let’s start with the big picture before we answer the question, “What is Ethereum?” Essentially, a cryptocurrency is a digital currency designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, create additional units, and verify the transfer of assets.
Before 2008, when Satoshi Nakamoto announced the creation of the first and still the most important cryptocurrency (Bitcoin), there had been attempts to build a digital cash system with decentralized entities, but they all failed. The difference in Satoshi’s creation was that he decided to build a peer-to-peer network without a central entity. This decision birthed cryptocurrency.
To understand the Ethereum blockchain, we’ll first discuss the blockchain Satoshi Nakamoto introduced for Bitcoin in 2008. The blockchain is a public ledger containing an increasing list of records linked by cryptography, containing a cryptographic hash of the previously recorded blocks, a timestamp, and transaction data. It records transactions between two parties and prevents the permanent modification of data.
It’s managed by a peer-to-peer network where interconnected nodes share resources amongst each other without the use of a central administration. Therefore, the data in a block can’t be altered without altering all the blocks that follow. This invention solved the double spending problem previous digital currencies suffered.
Before we dive further into Ethereum, we’ll look at the three types of blockchain.
- Public Blockchain: It is accessible to anyone with an internet connection, without restrictions, for making transactions or becoming a validator.
- Private Blockchain: It’s a private blockchain that’s restricted to only those with access. Whether as a participant or validator, one is not permitted to join unless invited by network administrators.
- Consortium Blockchain: This is usually a bridge between a private and public blockchain. It is semi-decentralized and permission based, too.
What Is Ethereum?
Ethereum is an open-source blockchain computing network that allows smart contracts to be performed. Ethereum is also the name of the startup behind the Ethereum tokens used as a means of exchange. Its blockchain is used by developers to build decentralized applications.
Its website is www.Ethereum.org, and it was founded by Vitalik Buterin in July 2014. Having a maximum supply of 98 million Ethereum tokens, Ethereum is currently the cryptocurrency with the second highest market capital after Bitcoin.
Before the inception of Ethereum, it was quite difficult to build blockchain applications, as it required having knowledge in coding, cryptography, mathematics, and so on. But with the provisions of the Ethereum blockchain, applications (known as DApps, or decentralized applications), which had been previously termed impossible, are being developed even faster than before.
For a better understanding of just what is Ethereum, its mission and vision is “to promote and support the Ethereum platform and base layer research, development, and education to bring decentralized protocols and tools to the world that empower developers to produce next-generation decentralized applications and together build a more globally accessible, freer, and more trustworthy internet.”
On the internet, transaction details are often stored in clouds or servers of host companies. Therefore, it’s possible for unauthenticated sources to hack these third parties and have access to your information without your consent. Ethereum tries to decentralize the internet and return control of your information to you. Instead of storing your data with third parties, Ethereum stores your data on the blockchain.
In the Ethereum blockchain, miners work to earn Ether (this is further discussed as you continue reading). Ether is a tradable cryptocurrency, but besides that, it is also used to pay for transactions and services on the Ethereum network. A token known as gas is also used to pay miners for transactions. Every smart contract is sent along with a certain amount of gas to make miners include it in their blockchain.
What Is Ether?
Ether is a digital currency used to run applications and monetize work in the Ethereum blockchain. It is the underlying token that powers the blockchain. Unlike Bitcoin, Ether is not a unit of currency to be traded on a peer-to-peer payment network. Ether can be used to decentralize, secure, and trade anything. The value of Ether appreciates and can also be traded on public markets.
How Does the Ethereum Blockchain Work?
Ether allows smart contracts to run. It provides the incentives for nodes to validate blocks on the Ethereum blockchain, which contains code for smart contracts. Every time a block is validated, Ether is created and added to the successful node. A new block is propagated every 15–17 seconds. The Ethereum network rewards nodes that proffer correct solutions to a block without being included in the network. Ether is a disinflationary currency, as the inflation rate decreases every year.
What Is a Smart Contract?
A smart contract is a computer procedure that facilitates or enforces the performance of a contract online. In 1994, smart contracts were first proposed by Nick Szabo. Smart contracts promote credible transactions by eliminating interceptions from internet third parties.
The aim of smart contracts is to provide high-end security and reduce the TX fees associated with cryptocurrency transactions. This contract is made possible on the Ethereum blockchain.
An Ethereum wallet, otherwise known as EtherWallet (www.myetherwallet.com), is a free, open source, client-side interface where users are allowed to directly interact with the blockchain while in full control of their currencies and private keys. The upside is that you are the only one in control of your funds and keys—you do not rely on any exchange to transfer your funds for you. But the downside is that when you lose access to your Ethereum wallet, you lose your funds and private keys. No one else has them, and no one can recover them for you.
However, when using an exchange like Coinbase, an account is created for you, and your funds and private keys are stored for you on their account in the blockchain. Your login details give you access to their server to track how much of your currencies are with them. If you lose your login password, you can use the traditional “password reset” option to change your password. Note that if the exchange loses all ETH, you also lose yours.
To ensure your private keys are safe, do not enter it on random sites and do not save it on cloud storage or email it to anyone. Always ensure you’re on the legitimate website. Don’t allow remote access software like Team Viewer on your mobile or computer.
How to Buy Ethereum
Although the cryptocurrency market value is rising, it’s extremely volatile. This means it fluctuates wildly and is a very risky investment; hence, it’s advisable to start with low amounts that you can part with. However, when you’re ready, the first step is to download the Coinbase app (it’s available for Android and iPhones), create a Coinbase account, log in, tap the Buy button to add a payment account, and buy Ethereum. Note that there’s a limited amount of Ethereum you can buy in one week and that ETH today is at $198.37 with 102,154,600 ETH in circulation.
Potential Uses for ETH
Ethereum is an asset to the world when it comes to the security of digital information. Government authorities can use it to store confidential security information, and the absence of a central administration makes it difficult for unauthorized sources to break into it.
Healthcare centers around the world can use the Ethereum blockchain to store, access, and share patient’s records. This way, a patient can access his hospital records even if he has relocated from one country to another. Ethereum could also be used to record patterns in medical conditions and alert a person beforehand. This would significantly reduce mortality rates.
An Ethereum smart contract makes it possible for transactions to be made in full confidence. Anything of value can be traded on Ethereum. The IFFT logic inbuilt in Ethereum makes transactions more direct and cheaper.
Ethereum’s technology is endowed with the ability to make fast and safe transactions. It has made gambling easier and more like a transaction between friends, instead of a tedious process like traditional betting via bank transfers. Also, the option of anonymity makes it safer for people to gamble without the fear of having their identities revealed.
Bitcoin: A Short History and Market Analysis
To better answer, “What is Ethereum?” let’s look into its precursor, Bitcoin. Bitcoin is a digital currency that is decentralized (i.e., with no central administration), has no intermediaries, and can be transferred from one user to another on the Bitcoin peer-to-peer network.
History of Bitcoin
In October of 2008, just a couple months after registering bitcoin.org, Satoshi Nakamoto wrote a white paper detailing how a peer-to-peer network can be used to generate a digital cash system for online transactions not reliant on trust. The world’s first Bitcoin transaction happened on the 12th of January, 2009.
The only major security flaw in the history of Bitcoin was discovered on August 6, 2010. Some users found that in an improper transaction verification they could bypass Bitcoin’s economic restrictions and create an indefinite number of Bitcoins. We’re noting this weakness because it’s worth comparing to Ethereum: because of it, two addresses on the Bitcoin network acquired over the 184 billion Bitcoins. The transaction was identified and erased, and Bitcoin upgraded to a more secure version. There hasn’t been any news of security breaches since then.
Because Bitcoin has no central administration, it is unrestricted. International payments can be easily carried out with Bitcoin because it isn’t country specific, thereby increasing Bitcoin’s market demand.
However, security issues and government regulations threaten its growth potential. For instance, it’s difficult for users to maintain records of all Bitcoin purchases made in a year as directed by the US Internal Revenue Service (IRS).
People can buy Bitcoins as investments, like one would buy shares. It can also be used in anonymous purchases, as buyer names aren’t disclosed in public ledgers (hence, Bitcoin could be used in shadier deals). Bitcoin has few or no transaction fees, which is advantageous to startups or small market enterprises who want to trade in Bitcoin.
Bitcoin vs Ethereum
Bitcoin may look similar to Ethereum, but the two differ in many ways. Ethereum is the world’s second largest cryptocurrency after Bitcoin. Since its inception in 2014, it has been constantly compared to other cryptocurrencies (like Bitcoin and Litecoin). It’s imperative that investors know the similarities and differences between the two.
The increased market capitalization experienced by Ethereum also puts it in constant comparison against other currencies, especially Bitcoin. However, the principles guiding the Ethereum blockchain reveal that Ethereum was not intended to compete with Bitcoin.
So what is the difference between Bitcoin and Ethereum? Both Ethereum and Bitcoin are digital currencies, but they differ according to their purpose of invention. While Bitcoin was created as an alternative to fiat money, Ethereum was developed as a platform to facilitate peer-to-peer contracts and applications via its own currency vehicle.
What is EVM in Ethereum?
The Ethereum blockchain has an inbuilt programming language that can be described as a globally executed virtual machine. The Ethereum Virtual Machine (EVM) can be seen as a large decentralized computer containing millions of accounts that have the ability to maintain an internal database, execute code, and communicate.
The two types of accounts existing on the Ethereum blockchain are externally owned accounts (EOA) and contracts. While externally owned accounts are controlled by a private key that gives you access to send Ether, contract accounts are controlled by codes.
Mining is how the total volume of digital tokens in a blockchain increases. It’s how transactions (known as blocks) are secured, verified, published, and propagated on the blockchain. The process of cryptocurrency mining helps to ensure that only valid transactions are recorded on the digital ledger. There are two ways to engage in Ethereum mining:
Proof of Work (PoW)
Before now, Ethereum used Proof of Work as a means of verifying transactions and adding them to the blockchain. Validators (also known as miners) are required to agree on the reliability of some data values.
Proof of Stake (PoS)
Unlike Proof of Work, Proof of Stake is more energy efficient in terms of power consumption, and you only need enough coins to stake, plus an internet connection to validate transactions on the network.
In Proof of Stake, validators secure new blocks before adding them to the Ethereum blockchain. Validation requires that all participants agree that certain nodes are eligible to be added to the network. In PoS, miners can participate in the mining process by staking a given amount of coins to validate a new block. In the process of doing this, your computer qualifies as a node. The number of coins you possess determines the number of transactions you can mine. The more coins, the higher your mining power.
Miners are often chosen by holders of Ethereum coin. The chosen miners then stake the required amount of coins using special staking wallets. The main task is the verification of transactions and security of the network.
Cryptocurrency is fast becoming an alternative currency, and although it is not yet widely accepted as a mode of payment for the purchase of goods and services, we expect technology compliant firms like Amazon and Facebook to incorporate them in the near future. Once more and more internet users can answer, “What is Ethereum?” we expect to see a more universal adoption of ETH and other cryptocurrencies.