What is Ethereum and How Does it Work?

Many quickly associate Ethereum as the Silver to Bitcoin, the digital Gold.

However, Ethereum is much more than the second-largest cryptocurrency by market cap.

Ethereum is a network positioned as the world’s programmable blockchain, which is home to the Ether token.

The distinction between the network and the token becomes crucial.

Besides providing the world with a technology that lets users send cryptocurrency to anyone for a small fee like Bitcoin, Ethereum has also become the foundation for decentralized applications created by developers.

Therefore, while it is true that Ethereum came after Bitcoin, it’s an offering that builds off Bitcoin’s initial innovation and has some major differences as a result.

What is Ethereum?

Ethereum is a community-built technology originating with the cryptocurrency Ether (ETH) and now powering thousands of applications that can be used today.

Powered by blockchain technology, Ethereum is perhaps best known for its native currency, Ether.

Ether, also known as ETH , like other cryptocurrencies, enables the movement of money directly with someone else and completely without intermediary companies.

However, the innovation isn’t the same as what Bitcoin positioned to the world when it was released in 2009.

Instead, Ethereum came out in the years following Bitcoin, created to improve on where Bitcoin fell short, namely, utility. 

Fun Fact

One of the main co-founders of Ethereum, Vitalik Buterin, dropped out of the University of Waterloo to work on Ethereum full-time.

Since its release in 2015, the Ethereum platform has since grown to include a network of decentralized apps (dApps) and self-executing contracts known as smart contracts.

Arguably, smart contracts are one of the most revolutionary aspects to come out of Ethereum, defining rules like a regular contract and automatically enforcing them through code.

The immutability of the blockchain secures these smart contracts, therefore, making them permanent by nature.

Smart contracts have since become central to the greater industry transformation known as decentralized finance (DeFi).

Ethereum 2.0

DeFi presented significant utility for the Ethereum network, which, although beneficial, has proven to be a double-edged sword.

Although many new applications could be brought to life, operating on a blockchain faster than Bitcoin, such widespread usage also attracted so much volume that transactions became expensive and slow.

The result was an unsolved answer to the blockchain trilemma, in which scalability is yet to be addressed.

Definition

The blockchain trilemma became a widely held belief first introduced by Vitalik Buterin. The concept states that decentralized networks should theoretically provide three benefits: decentralization, security and scalability. To this day, new blockchains have yet to crack the code in providing all three, although most have been successful with two.

Many believe that the network could become even more attractive for decentralized application (dApp) developers if a solution was found for scalability concerns.

Therefore, Ethereum 2.0 became the logical upgrade for the blockchain, aiming to enhance speed, efficiency, and scalability.

Core to this upgrade is a change in how ethereum transactions are validated and mined.

In this proposed upgrade, the current consensus algorithm known as proof-of-work (PoW) will shift to a more sustainable method known as proof-of-stake (PoS).

The second component of this upgrade is the introduction of sharding, a method that will distribute traffic on the blockchain into several smaller blockchains, thereby making the core blockchain faster.

That said, although the first phase of Ethereum 2.0 was already released in December 2020, there are still two phases to go, with a final release not expected until 2023.

Unfortunately, with many new networks rising to the challenge, many believe these upgrades may be too little too late.

How Does Ethereum Work?

Ethereum operates on blockchain technology, similar to the rest of the cryptocurrencies.

By definition, the blockchain is a chain of transactions organized into blocks and linked together.

However, the most unique part of this structure is that the data contained in each of these blocks are made available to every member of the blockchain network in a manner that one might describe as decentralized.

The technology effectively creates distributed consensus that allows users on the network (known as miners) to process the transactions, mint new Ether tokens or execute smart contracts as a part of an Ethereum dApp.

Pros of Ethereum

Ethereum has arguably taken the world by storm, allowing anyone to build and launch apps for payments, crowdfunding, insurance, or other uses.

However, this leads us to ask another pressing question, are there benefits to using the network? Or is its usage just hype?

Significant Developer Community

Ethereum is known as having one of the largest developer communities in the world.

In many cases, this community is said to be even larger than the Bitcoin community.

The benefit of this community is that many of these developers are dedicated to improving the network and building new applications, many of which push the bounds of traditional use cases.

Proven Security

Ethereum, like other networks, is not alone in having security scares.

However, the network has continued to grow without significant issues despite these scares.

In contrast, many new networks, including centralized ones, have struggled with security breaches.

Significant Interoperability

Ethereum also holds a unique advantage in connecting to hundreds of other protocols that are already in existence.

Through Ethereum bridges, users can easily send assets to other EVM (Ethereum Virtual Machine) compatible networks such as the Binance Smart Chain, opening up the door to even greater utility.

Extensive Functionality

Ethereum offers significantly more functionality than a digital currency, such as the ability to process many different financial transactions, execute smart contracts and become a method for data storage for third-party applications.

The network has since deployed a standard for fundraising that we now know as ERC 20.

Crypto exchange with ability to buy Ether

Cons of Ethereum

Unfortunately, the world has yet to be introduced to the perfect blockchain.

For this reason, we must also consider the flip side, the cons of the Ethereum network.

High Gas Fees

With so many people adopting Ethereum, it is no secret that the platform has become the basis for many smart contract use cases.

Unfortunately, this increase in usage has resulted in high gas fees (transaction costs) that make platform usage less advantageous, even detracting users in some cases.

Uncertain Future

Since the Ethereum blockchain is still undergoing many changes, building on the network has been viewed by some as unstable.

Many don’t know what the transition from PoW to PoS will hold and what the extenuating impact will be.

Slow Transaction Speeds

Although Ethereum has speeds that are double that of Bitcoin at 15 TPS, when considering the sheer number of applications running on the network, many quickly realized these speeds are not nearly enough.

As DeFi grows, the network will only become more congested, leading to even longer transaction wait times.

However, ETH 2.0 is expected to resolve this issue and enhance the network’s transaction speeds.

What Can Ethereum Be Used For?

One of Ethereum’s primary use cases is decentralized finance (DeFi).

This term, used in reference to financial services and products on the blockchain, opens the door to inclusive finance.

For example, with DeFi, users can send money anywhere in the world, access stable currencies, borrow funds, trade tokens and buy insurance, to name a few of the more common use cases.

More recently, the technology has noted other utility in nonfungible tokens (NFTs), a token designed to represent something that is one-of-a-kind, such as art or music, and the surrounding metaverse, a digital realm positioned as the next iteration of the Internet.

As previously mentioned, Ether, the native token of the Ethereum network, also enables users to conduct transactions online, such as in the purchase and sale of products and services, in a manner similar to Bitcoin.

Ether has also increased in value significantly, making it a powerful addition to any investment portfolio.

Did You Know?

NFTs gained significant popularity in 2021. According to Chainalysis, nearly $41 billion  worth of cryptocurrencies were spent on NFT marketplaces in that year alone.

Is Ethereum a Scam?

Ethereum has become a household name in recent years.

The main reasons why the asset has been considered a scam are either originating with someone who believes that all altcoins are scams or even all cryptocurrencies are scams.

Another reason stems from previous security threats.

Namely, in May 2016, an Ethereum smart contract existed that raised $150 million with a code that was not secure.

Consequently, someone wrote code that affected the smart contract, effectively losing $70 million in Ethereum.

Although the new Ethereum blockchain reversed the hack and refunded lost money, some still worried about what this meant for their own transactions.

While both viewpoints present valid concerns, one stems from a larger concern around a fundamental disruption of an industry and a change to human thinking, which rightfully warrants concern.

In contrast, the second around security hacks comes down to the technology still undergoing updates on its path to widespread usage. 

Looking at the big picture, Ethereum has presented a platform that enables an entirely new way of doing things, being the first to release what we now know as the smart contract.

Although the network was the first to do so, it is far from the only one doing so today.

Therefore, although the future of Ethereum, like any other platform, is uncertain, its impact is still being seen in millions of up-and-coming projects today. 

As a result, many industry analysts agree that Ethereum is not a scam and demonstrates several real use cases for the world we live in today.

Is Ethereum a Good Investment?

Ethereum continues to show potential, being at the core of several cryptoverse trends, including the metaverse, NFTs and DeFi. 

However, it is worth noting that before making a significant investment in Ether or supporting the network in another way, investors should consider the potential risks.

The market itself has been known for its high risk and volatility, which can result in significant earnings but may also lead to losses.

Frequently Asked Questions

  • How is Ethereum Different from Bitcoin?
  • How Do Ethereum Investors Make Money?
  • Can You Convert Ethereum to Cash?

Sarah Jansen is a passionate cryptocurrency investor, copywriter and marketing professional who has been working in the field since 2017. Sarah graduated from the University of Calgary in Canada with a degree in business, where she quickly found her passion in helping people.

She has worked for several major cryptocurrency exchanges, news outlets, and in the content marketing department of a local bank. Starting as a marketing assistant, Sarah quickly specialized in long-form content creation and technical writing. Here, she discovered her place in lowering the barriers to entry for personal investors looking to secure their financial future.

When she’s not staying on top of industry trends, you can find Sarah in the mountains hiking or across the world chasing another bucket list item.