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What Is Ethereum?

October 8, 2021

5m

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In this lesson, we will discover the rather intricate world of Ethereum. Being the second-largest cryptocurrency by market cap, Ethereum goes hand in hand when studying blockchain technology. It is as revolutionary as Bitcoin, and one cannot simply venture into crypto not knowing about Ethereum.

Not to mention, today’s importance of the DeFi sector places Ethereum and its subsequent features (smart contracts, dApps. gas, etc.) in a very high position. This means that understanding those terms represents an essential part of the crypto experience.

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What Is Ethereum?

Although complex, Ethereum can be summarized in only a few words: a smart contract ecosystem. Smart contracts are an emerging technology that enables users and developers alike to interact on a blockchain network in a decentralized manner without requiring trust. Having the ability to execute a transaction based on preimposed rules is what makes Ethereum so great, and it is a major reason why it competes with Bitcoin.

We call Ethereum an ecosystem because it truly is one at its heart. It is the de-facto environment for blockchain-based applications called dApps, through which users mostly utilize financial instruments. Some go as far as to refer to it as a decentralized version of the internet.

Exchanging value is Ethereum’s main use case, and it is done through the Ether (ETH) token. But as the network supports other projects, users can also exchange value via tokens based on the ERC-20 token standard.

Ethereum has been developed since 2013. It is backed by the blockchain industry’s greatest minds, and at its launch, the following co-founders were present: Vitalik Buterin, Anthony Di Lorio, Charles Hoskinson, Mihai Alisie, Amir Chetrit, Joseph Lubin, Gavin Wood, and Jeffrey Wilcke. While some are part of the project still to this day, others (such as Wood and Hoskinson) have left Ethereum to work on their own projects.

How Ethereum Works

Ethereum works essentially the same as any other blockchain network. The core difference is that the project hosts vast scripting abilities, which make smart contracts and other upgrades possible.

Ethereum currently has two networks: ETH1 and ETH2.

ETH1 is the original Proof-of-Work blockchain network that requires miners to validate new blocks before minting additional ETH tokens.

ETH2 (Ethereum 2.0) is a proof-of-stake network that requires users to stake (deposit) their assets in order to validate transactions and be eligible for block rewards. This network is a work in progress at the moment. After completion, it will completely replace ETH1.

Both live and breathe through smart contracts. For a more strict definition: a smart contract is a self-executable and autonomous collection of code that follows a set of agreements and rules. It works much like an ordinary contract, with the core difference being that it is digital and executes all mechanisms on its own.

This feature comes in handy because developers can use smart contracts to automate processes that they usually need to execute manually. For example, if a user wishes to withdraw assets from an exchange, the developer must process the withdrawal personally. With smart contracts, the withdrawal is fulfilled as soon as it is requested.

Ethereum’s smart contracts are important because they leave no room for intermediaries. The network behaves as if it is run by robots. There are no humans to maliciously interfere with transactions.

You may think that smart contracts are not a big deal, but the opposite is true. Let us take the lending protocol Compound as a clear example.

No big deal, you say? On the contrary, my friend, and here's why.

A smart contract makes it possible to completely remove intermediaries from transactions, whether they are financial or otherwise. Imagine wanting to borrow cash using cryptocurrency as collateral.

By using an Ethereum-based decentralized finance protocol like Compound, it is possible to create a loan request for a loan that specifies a 1 year repayment period, 50% LTV, and monthly installments. A borrower picks up your loan requests, and using the decentralized compound app, a smart contract is created with the specific loan details.

The smart contract then takes hold of your collateral and issues the loan, putting the agreement into action, and effectively going live. Should you violate any of the loan terms by not repaying on time or going below the 50% LTV ratio, the smart contract can dissolve the agreement in the case of the former or liquidate your collateral in the latter.

If by the end of the contract period everything has gone according to plan, the smart contract returns your collateral, and the lender receives their repayment plus interest.

Smart contracts enable true peer-to-peer transactions in matters beyond simply sending payments, as is the case with Bitcoin.

The Ethereum Token (ETH) and Ethereum 2.0 Explained

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Ether is a utility token used to transfer value and maintain the network by rewarding miners. Due to its tokenomics, ETH is both a digital asset and a digital currency.

ETH is governed and minted much in the same way as Bitcoin — by miners using specialized computer hardware to validate blocks.

All smart contracts are executed on the Ethereum Virtual Machine (EVM), and doing so requires gas. Gas is the fee paid to execute a smart contract, and it is denominated in gwei.

Complicated tasks naturally require more processing power, so they require more gas than a simpler task, like withdrawing tokens. As the demand for gas fluctuates, so too do gas prices - which in return increases ETH’s value.

Users can follow ETH gas prices at the ETH gas station. Besides tracking prices and charts, the platform also enables users to calculate the amount of ETH needed in a wallet to engage in a transaction.

How to Store Ethereum (ETH)

Storing Ethereum is different from storing Bitcoin.

The Ethereum network uses a token protocol standard called ERC-20 — so, to store ETH and any Ethereum-based tokens, users need an ERC-20 compatible wallet.

Because Ethereum offers ample opportunities to developers, most tokens at this point are ERC-20 tokens. The trend began in 2015 with the rise of initial coin offerings (ICOs), and it was later fueled in 2020 with the advent of decentralized finance (DeFi).

There are two options when storing Ethereum on a digital wallet:

  1. Ethereum Software Wallet — Software wallets are mobile app or desktop-based wallets that are ERC-20 friendly. They are generally secure as long as you side with a trusted Ethereum wallet and offer more flexibility in terms of a multitude of assets stored than hardware wallets.
  2. Ethereum Hardware Wallet — If security is what you seek, then look no further than a hardware wallet for storing Ethereum. Hardware wallets resemble small USB sticks and allow you to keep your Ethereum stored offline and away from live networks — and the hackers who depend on them to steal cryptocurrency.

Regardless of which route you choose for storing Ethereum, the only real sticking point is that the wallet must be ERC-20 compatible, but there are plenty of options to choose from.

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Ethereum Fundamentals